Dividing Assets During Divorce: How to Avoid Unexpected Tax Liabilities

Divorce is a significant life event that brings with it numerous changes, both emotionally and financially.

However, when going through a separation or divorce the main focus is unlikely to be on the tax implications of dividing assets.

So, in this article, Simon Hurren, Private Client Tax Partner looks at some of the typical assets involved during the separation process and how careful consideration can avoid stumbling into unwanted tax liabilities.

Selling the Family Home

It’s common for the family home to form the main assets in a divorce and it may well be agreed for this to be sold as part of the separation process.

This can trigger a Capital Gains Tax liability – although if you’ve occupied the property as your main residence throughout the period of ownership then it’s likely to qualify for Principal Private Residence Relief, which would potentially remove any CGT liability.

Whilst this is often the case, care needs to be taken if the property has not always been occupied as the main residence. For example, perhaps there was a break if you worked in another part of the country or overseas, or if you temporarily lived elsewhere for another reason.

While there are provisions which may mean relief applies to these periods where you did not occupy the property, it would be necessary to consider the position in detail. If relief is not available in full then it would be pro-rated based on the time spent occupying, or where you have been deemed to occupy the property, and any time where it was not occupied.

This can be particularly important where spouses own separate properties prior to marriage and use them both, as a married couple as you can only have one main residence.

Likewise, where two properties are occupied at the same time – perhaps if you split your time between a property near work and your family home –  if no election has been made as to which property is your main residence then it will be based on facts. So, taking into account a range of factors like where the doctor’s surgery you’re registered to is and your postal address. This could then result in a property which you do not consider to be your main residence actually qualifying for relief.

Retaining an Interest in the Property

It may be that rather than sell the property one spouse retains the house on the proviso that when it’s sold, their former spouse will be entitled to a proportion of the sale proceeds.

For the spouse that then continues to live in the property the position is relatively straight forward with the points highlighted above. But, for the spouse who has moved out, the property will no longer be their main residence.

Despite this – where certain conditions are met – relief can still apply, for example if they qualified for relief at the time when they transferred their interest.

However, whilst on the face of it this can look beneficial, there can be a sting in the tail.

As an individual can only have one main residence, if relief is claimed for the period since moving out, then relief cannot be claimed on a property that you move into, which subsequently becomes your main residence.

So, careful consideration should be given to your overall position before any claim for relief is made.

Investments

Transfers between spouses are made at “no gain no loss” for capital gains tax purposes, meaning the transfer can take place without triggering a CGT liability. And where there are investments perhaps in shares or investment properties, it’s natural for these assets to be transferred between spouses as part of the divorce proceedings.

But the no gain no loss rules following separation generally only apply for three tax years following the tax year of separation. So, any transfers made after this period could trigger CGT.

It may be possible to claim holdover relief if this time frame is exceeded but only if the asset meets the necessary conditions, such as business assets or agricultural land. Where the asset is transferred in exchange for something else, then holdover relief may not be applicable if there is deemed consideration.

Those transfers of assets which take place in accordance with a formal divorce or separation agreement will be at no gain no loss irrespective of the time frame.

Gifting and Inheritance Tax (IHT)

Any gifts between married couples who are both domiciled in the UK qualify for the spouse exemption and can therefore be made without any IHT implications.

This continues to be the case once divorced but only up to the point at which the divorce is finalised. Any gifts made after this point will be subject to the usual IHT rules and could still fall within your Estate for IHT purposes if you do not live for 7 years following the gift.

Therefore, following a divorce, it’s important to reassess an individual’s IHT liability as this will have inevitably changed along with the wishes for the assets retained. It’s also a good time to review Wills and update these for any changes you may wish to make to the beneficiaries of your Estate. As it’s common to overlook changing any election for the death benefits of any pensions you have, meaning a former spouse could inadvertently benefit in the future.

Single Joint Experts

For more complex cases there may be the need to involve a single joint expert – an independent expert, instructed by the parties involved, or the court to prepare a report on the issue or amount in dispute.

By not acting for either party, the SJE is able to give a fair, realistic and impartial review of business assets and accurate business or shareholding valuations to allow disputes to be resolved smoothly.

For more information on the tax liabilities of dividing assets during a divorce or separation contact Simon or one of the team by calling 0330 058 6559 or email hello@scruttonbland.co.uk