A summary of Capital Gains Tax on property disposals in a divorce.
The taxation implications on the division of assets between parties who are contemplating divorce is rarely their most important consideration but as we will see, there are a number of complexities to taxation which can make a significant difference to how parties may decide to divide their assets and indeed when such decisions are best made.
The general rule
The general rule for tax purposes is that transfers of assets between spouses does not create either a taxable gain or loss and the transferee spouse ‘inherits’ the original cost history of the donor. This rule continues to apply for the tax year of separation but thereafter things become more complicated.
The first issue is determining the tax year of separation as the legislation merely states that separation for these purposes occurs, if not under a court order, when separation is likely to be permanent. This therefore is largely a matter for the parties to agree but can be complicated where for example the couple continue to occupy the same property whilst the divorce is proceeding.
After the tax year of separation any transfer of assets will give rise to a chargeable gain or loss as the general rule ceases to apply but the couple remain connected for tax purposes until decree absolute so that any transfers are undertaken at market value for tax purposes.
Particular concerns with property assets
The family home is normally considered to be exempt for tax purposes unless it has not been solely used as a home or if the grounds are extensive. This rule however applies providing the parties are occupying the property as their home throughout the period of ownership.
If one party vacates the home through separation that party may be liable to capital gains tax on a pro-rata element of the gain for the period they were absent. Currently the last 18 months of ownership by either party is allowed as deemed occupation for these purposes but this period reduces to 9 months from April 2020.
On divorce a specific concession applies to allow the departing party to claim full relief for the whole period of ownership if the property is transferred into the name of the spouse who remains in the property. There are specific conditions which apply to this concession and the departing spouse cannot claim another property as their main residence for the same period.
There are other instances where the family home may not have been occupied for the entire period in which it has been owned and in those instances a pro-rata gain will arise unless another period of deemed occupation can be claimed. If an owner is required to live away from the family home due to work requirements either elsewhere in the UK or overseas it may be possible to claim some or all of that period as deemed occupation. An absence for up to 3 years for any reason can also be claimed as deemed occupation. These rules generally require the property to have been occupied both before and after the period of absence and therefore detailed analysis of periods of occupancy are important.
It is not unusual for parties to retain a previous residence for letting when they move and they may therefore have more than one property which qualifies for main residence relief for different periods. Where a property has been occupied as a main residence and is subsequently let it has been possible for each owner to claim lettings relief which, subject to the precise facts, could exempt up to £40,000 of the gain for each owner. This rule changes from April 2020 and will only apply where the owner was in shared occupation with the tenant.
A couple may own more than one property which they use for their own purposes and it is possible that they have elected which property should be treated as their main residence for relief purposes. In the absence of an election the main residence will be determined on the facts of actual occupation.
It is important to note that a married couple can have only one main residence for relief purposes between them.
Historically where an individual was non-UK tax resident at the time of disposal of UK property no gain would arise for UK tax purposes. These rules changed from April 2015 for residential property and from April 2019 for non-residential property or investments in property companies or funds investing in the UK. These rules enable a non-resident owner to elect to rebase the property for tax purposes to the April 2015 or April 2019 values as appropriate if this is beneficial to the calculation of the liability. This can give rise to three different calculations of the gain for tax purposes and the taxpayer can elect whichever gives rise to the lowest gain. Where one party to the marriage has remained UK tax resident and the other party is non-resident this can give rise to very different gains for each of them for tax purposes.
A disposal of property by a non-resident, including a transfer on divorce, must be reported to HMRC within 30 days of disposal.
UK Capital Gains Tax will also be due on any sale or transfer of interest in a property held overseas but local taxes will also need to be considered.
The calculation of a chargeable gain may be different in the local jurisdiction than in the UK in relation to items such as enhancement expenditure and the rate of local tax may be affected by how long the property interest has been held. In some countries the disposal will be liable to social security contributions similar to National Insurance costs and whilst the tax payable may be offset against the UK liability social security contributions are rarely deductible and hence give rise to an additional total liability.
It is also worth noting that some countries levy a gift tax even on transfers between spouses and so this should be reviewed before deciding to make any transfer of interest.
Special considerations on divorce
There can often be situations in a divorce where it is not possible to be able to make a simple division of assets between the parties at the time of the divorce. This may be due to young children where it is necessary for the family home to be maintained until the youngest perhaps reaches majority.
There are different ways in which this may be structured but a common approach would be to utilise what is known as a ‘Mesher Order‘.
HMRC considers property which is subject to a Mesher order as settled property for Capital Gains Tax purposes with the property being held on trust. Usually, such arrangements will not create any capital gains tax consequences as the person occupying the property will benefit from main residence relief. As the Mesher Order creates a trust and the property is occupied by a beneficiary of the trust, namely the spouse, no capital gains tax will arise when the property is sold at the end of the specified period. A gain may however arise if there is a significant delay in selling the property.
In the case of a Mesher order it is also relevant to consider Inheritance Tax issues as an Inheritance Tax charge could arise on the trust if the property is likely to be held on trust for more than 10 years.