Capital Gains Tax for Divorcing Couples: Improvements in the Law

Posted: 31/07/2023

Many readers will already know that, on the transfer of an asset from one individual to another, the transferring party may have to pay capital gains tax (CGT) if the market value of the asset being transferred is higher than the value at which they acquired the asset - i.e. there is a gain in value. This is the case even where the transfer of the asset is a gift.

The transfer of assets between married couples does not, however, attract CGT. This is a position that may change if the couple separates but remains married, which is of relevance whilst a couple is going through divorce proceedings.

In March 2023, the government introduced legislation (the Finance (no 2 Bill) 2023) to improve the CGT position for divorcing couples. This legislation, which was effective from 6 April this year and received Royal Assent on 11 July, means that couples now have a longer period in which to agree their financial settlement and transfer assets between each other, without facing unwanted CGT consequences. In addition, amendments were made to improve the CGT position where couples agree, or the court orders, that the sale of the family home should be deferred to a later date.

Background

In March 2021, we reported on the unjust CGT position some couples could find themselves in following separation (It’s all in the timing: the family home and capital gains tax on divorce). Prior to 6 April 2023 a divorcing couple had to transfer assets within the tax year of separation to avoid paying CGT on the transfer of assets. This meant that if they separated on 1 April 2022, they had four days to transfer assets between each other or else face a potential CGT bill, whereas a couple separating on 6 April would have 364 days to transfer assets.

In May 2021, we further reported that the Office of Tax Simplification (OTS) had proposed reforms to this legislation in their report on CGT (What next for capital gains tax? Part 2: The Office of Tax Simplification recommends targeted reforms). The government agreed with their proposals and on 6 April 2023 amendments to legislation were introduced.

How long do couples now have to transfer assets between each other?

Divorcing couples now have three tax years after the tax year in which they separate to transfer assets between each other without facing a CGT bill, as opposed to having to transfer assets within the tax year of separation.

Couples should, however, be aware that if their divorce is finalised before the end of the three year period, their ability to make transfers on a no gain no loss basis ends. For this reason, it is essential that couples with assets that would attract CGT on transfer seek appropriate legal advice before finalising their divorce.

Where transfers are made in accordance with a formal divorce agreement or court order, a CGT charge is not triggered provided any disposal is made in accordance with that agreement.

Caroline East, senior associate in the our family department comments: “The previous law had potentially devastating financial implications for families in terms of there being ‘enough to go round’ post-divorce. Sometimes this could be in cases where the amount of equity in second properties (if left intact) could have made all the difference in terms of both parties’ successful rehousing post-divorce. Instead, divorcing couples could inadvertently trigger an immediate, debilitating CGT liability through the timing of their separation, thereby automatically depleting the amount of capital available for rehousing. The government helping separating spouses manage their finances in a tax efficient manner following relationship breakdown is a long-awaited and most welcome development.

The family home

In divorce proceedings, negotiations often centre around the family home, which can be the most valuable and emotive asset. Transfers of a family home often attract a special CGT relief known as principal private residence relief (PPR relief). This relief enables individuals to transfer or sell their main home without paying CGT on any gain made. PPR relief is only available where the property in question is an individual’s main residence and is occupied by them, except in certain limited conditions.

The amendments described above (the extension to the period in which couples can transfer assets between each other without CGT consequences) may mean there is no CGT to pay when the family home is transferred between a divorcing couple. However, the position is different when the property is sold to a third party and one party is no longer living in the family home.

The recent amendments to legislation address those circumstances where a couple ceases living together and the spouse, who leaves the family home, is entitled under an agreement or court order to receive a share of any gain made when the property is sold at a later date. The later date could, for example, be when the couple’s youngest child reaches 18, which may be many years after the transfer takes place.

The amendments will benefit the non-occupying spouse if a gain is made on the disposal of the family home because they can still claim PPR relief, despite no longer meeting the PPR relief requirement of occupying the property.

If the non-occupying spouse ceases to retain an interest in the family home, but retains a right to a share of the proceeds when the property is sold, PPR relief could be claimed in relation to the sum received if:

1. immediately before the non-occupying spouse leaves the family home, the property is their only or main residence;
2. the non-occupying spouse disposes of their interest in the family home to the spouse that remains;
3. the disposal of that interest to the spouse who remains is in accordance with a formal divorce agreement or court order.

If the non-occupying spouse does retain an interest in the family home and subsequently disposes of that interest to a third party, different conditions apply: 

1. immediately before the non-occupying spouse leaves the family home, it must be their only or main residence;
2. the sale proceeds received by the non-occupying individual on the disposal of the family home must be received pursuant to a formal divorce agreement or court order;
3. in the time between the non-occupying individual ceasing to live in the family home and the disposal of their interest in the family home to a third party:
   • the house must continue to be the main residence of the former spouse; and
   • the non-occupying individual must not have nominated another property as their main residence for the purpose of claiming PPR relief. This last condition means individuals will need to think carefully about the impact on a disposal of any other property to which PPR relief could attach.

The above changes will be welcomed by private wealth advisors, including this firm, who have previously requested changes to these rules. Divorcing couples will also no doubt be pleased that there is one fewer matter to be concerned about, and that their joint assets will not be further depleted by CGT charges, during what can be a difficult time for all parties involved.

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