Lately we’ve all become familiar with the Met Office issuing “traffic light” warnings about potentially disruptive weather. Couples contemplating divorce or separation could face similarly rough going when it comes to their tax affairs, especially Capital Gains Tax (CGT) when property or a business is involved.
The alert level right now would be considered “amber” - think before you separate as you might not be able to complete a settlement in time for this tax year. The alert level in March would be “red”, with only one month to go before the start of the new tax year.
So how are the tax rules different in marriage and separation and what can couples do to get the green light?
Rules during marriage and after separation
There are different tax rules that apply depending on whether a couple are married, separated or divorced. Tax advantages that apply to a married couple are withdrawn at different stages of the divorce process. For tax purposes a couple are treated as ceasing to be a married couple from the point of separation, rather than the start of the divorce proceedings. Under legislation, separation is defined as the point at which a couple are separated under a court order or in circumstances in which the separation is likely to be permanent.
Capital Gains Tax on asset transfers
- CGT during marriage: Married individuals can transfer chargeable assets between themselves without any CGT arising. The transfer takes place on a no gain/no loss basis. The recipient is deemed to have purchased the asset for the same price that their spouse paid for it, so no capital gain arises.
- CGT after separation: When a married couple separate permanently, they are considered to be connected parties for CGT purposes until the date of the decree absolute. This is relevant as transfers of assets between connected parties are deemed to take place at market value, regardless of the actual proceeds that are paid (if any). A chargeable disposal will arise, and CGT will be due (subject to any annual exemptions, reliefs and losses available). It should be noted also that any transfers made under a court order, but at a later date than the date of the order, are deemed to have taken place on the date of the order.
Exception and example
The only exception to this rule is that any transfers that arise in the tax year of permanent separation of the married couple are treated as no gain/no loss.
Example: Mr and Mrs Shoosmiths separate on 5 May, they have until 5 April the following year to transfer assets without a CGT charge arising. If they separated on 1 April, they would only have five days to take advantage of the no gain/no loss CGT treatment.
Principal Private Residence Relief
Principal private residence relief (PPR) provides an exemption from CGT on an individual’s main residence (including grounds of up to half a hectare). An individual can only have one PPR at a time. No relief is available for any proportion of the property that is used exclusively for business purposes, including a letting business. For example, if a garage has been converted into a therapy room or beauty salon no PPR relief will be given on the proportion of the gain relating to the garage.
The split is usually calculated on the basis of area, but any just and reasonable method of apportionment can be used. HMRC accept that the position is different if the tenant is a lodger sharing communal spaces with the owner. Lettings relief may be claimed if owners have occupied the property at the same time as their tenants, provided they were not carrying on a trade or business.
- PPR during marriage: For married couples, or individuals living together as married couples, only one property can be their main residence and therefore qualify for the relief. If an individual or couple own more than one property that can be occupied as a residence, they may elect which of their properties will be considered their main residence and qualify for the relief. Such an election must be made within 2 years of acquiring the additional property.
A home is only eligible for PPR relief for a tax year in which the individual disposing of the property is either resident in the same territory as the property or is non-resident, but the individual (or his or her spouse or civil partner) spent at least 90 nights in that property (or all their properties in that territory).
- PPR after separation: When a married couple permanently separate, the no gain/no loss rules still apply in the tax year of permanent separation. After the tax year of permanent separation, spouses are each entitled to relief on their own PPR. If either has more than one residence, they are separately entitled to nominate which property should be considered their main residence for the purposes of PPR relief.
Exceptions and examples
A special extension to PPR may apply where the spouse who moves out of the matrimonial home transfers their interest in that home to the other spouse under a court order or other agreement made in contemplation of a permanent separation. In this situation, provided the transferee has continued to occupy the property as their residence throughout the period since the transferor left the property, PPR relief will be extended from the date the transferor moved out of the property up until the date of the transfer.
There is no maximum time that can be covered by this relief; however, the transferor will not be able to claim PPR on any other property during the extended relief period. Note however that this additional relief will not apply if the property is being sold to a third party.
If the transferring spouse has left the matrimonial home for a period that exceeds nine months, the property will not have been his or her PPR for the full period, so any resulting gain may not fully qualify for PPR relief.
Example: Mr and Mrs Shoosmiths separate on 1 May 2021 and Mrs Shoosmiths moves out of the family home. Mrs Shoosmiths transfers the family home to Mr Shoosmiths in March 2022. As the transfer takes place in the tax year of permanent separation the no gain/no loss rules apply.
If, however the transfer is delayed until March 2023 and Mr Shoosmiths has continued to occupy the property as his residence and the transfer is taking place under a court order, the special extension to PPR will apply, covering the whole period. Neither party will have a chargeable gain.
The situation is different if, instead of a transfer, there is a sale of the family home in March 2023. Mr Shoosmiths has occupied the property as his main residence and therefore any gain will be covered by the PPR relief. For Mrs Shoosmiths the family home ceased to be her PPR on 1 May 2021. The final nine months from 1 May 2021 to February 2022 will be treated as being her PPR regardless of occupation. The period February 2022 to March 2023 will fall outside of the PPR relief and will be chargeable to CGT. Mrs Shoosmiths will therefore have 60 days from the date the sale completes to make a return and payment to HMRC.