Beware: Tax traps on separation and divorce
All references to marriage in this note include civil partnerships. The rules for each are very similar.
If you are married and thinking about separation, or ending the relationship, early advice may save you a significant amount of tax.
Capital Gains Tax (CGT)
Married couples who have been ‘living together’ at some time in a tax year (starting 6th April and ending the next 5th April) can transfer assets between them in that tax year at a value that incurs neither a gain nor a loss for capital gains tax purposes.
The optimum time to separate on a permanent basis, therefore, is 6th April, or soon after, as it gives you a whole tax year in which to negotiate a financial settlement and transfer assets without incurring a CGT liability. Transfers of assets that take place after the end of the tax year will be treated as taking place at market value. CGT may then be due.
A couple are ‘living together’ for CGT purposes unless:
- they are separated under a court order;
- they are separated by a formal deed of separation; or
- they are separated in such circumstances that the separation is likely to be permanent.
The family home
Principal private residence relief generally applies to exempt any capital gain arising on the sale or transfer of the family home, but to benefit from this exemption, the property must be occupied by the individuals as their main residence. A person can only have one main residence at a time. The family home will cease to be the departing spouse’s main residence when he or she leaves it.
With careful planning, potential CGT liabilities can be minimised or eliminated, so taking advice at an early stage is key.
Stamp Duty Land Tax (SDLT)
There is normally no exemption from SDLT for married couples who transfer property to each other while they are married and ‘living together’ (same definition as for CGT). So long as the couple are the only people involved in the transaction, SDLT will be at normal residential rates. The “higher rates”, generally known as the 3% surcharge, will not apply.
However, spouses who are ‘living together’ cannot buy two houses (one each) without paying surcharge on at least one of them, since each spouse is treated (for SDLT purposes) as owning whatever dwellings the other owns.
An agreed separation
If a couple agree to separate permanently but do not seek a court order, then they will be treated for SDLT purposes as an unmarried couple. Each can buy a house without affecting the other. On the other hand, there are no special rules for transactions between them.
A Court Order
If a couple are considering a judicial form of separation – a divorce, an annulment, a judicial separation, or a separation order – and they agree one or more property transactions in relation to that event, no SDLT will be payable so long as the couple are the only parties to the transactions and the transactions are either
- ordered by the court or
- agreed between the couple before or after the court process, but in contemplation of or in connection with it. As the agreement relates to property it must be a formal written agreement signed by both of them and they would normally each have to use separate conveyancers.
Buying somewhere else to live
Say Amy & Ben divorced in March 2020. The court has ordered Ben to transfer his half of their former home to Amy. That transfer happens in June 2020. Ben now owns no accommodation anywhere in the world. He will pay normal rates of SDLT on his purchase of somewhere to live, whenever that happens.
But let us say Ben also owns a buy-to-let flat. No problem if he is “replacing his main home” by transferring his half of his former home to Amy – except that timing is critical. He must buy his new home no more than 3 years after the earlier of the following dates
(a) the date of his transfer to Amy in June 2020 and
(b) the date he moved out of the family home. If that was in June 2016, then he is already too late. He cannot use the exemption and will be surcharged.
What if Ben keeps his 50% share of the former family home? Perhaps Amy needs to look after children and cannot afford to take on the mortgage. It would not be fair for Ben to go on paying and having no right to his share of the property when it is sold. If Amy and Ben agree to remain joint owners, then when Ben buys somewhere else to live he must pay surcharge – since he still owns half his former home.
Since November 2017, however, if that arrangement is contained in a special form of court order – a “property adjustment order” – then for SDLT purposes, Ben will be treated as not owning his share in the former house, so will not pay surcharge on his purchase. Ben must not buy anywhere to live until that order has been made. If he decides to buy a house and pay surcharge, there is no way he can get that surcharge back later.
These are just a few examples of the complex SDLT issues that can arise on separation or dissolution. The extra tax payable if one gets the timing of events wrong can be very large.
We do not give tax advice in isolation, but if you were to use our services in connection with family issues, then CGT and SDLT advice would be offered. Similarly, SDLT advice forms part of our conveyancing services.