In the event of a divorce, determining the value of the asset pool is a major consideration. But have you considered the capital gains tax implications of a divorce settlement?

More often than not, assets received as part of the property settlement will be capital assets, such as real property and shares. Generally when capital assets are transferred between two parties, the transfers will likely attract capital gains tax (CGT) for the party disposing of the asset.

The potential future tax liability attached to the assets that are received can be sizeable also.

Divorce and CGT: Key Considerations

CGT Relationship Breakdown Rollover Relief

The good news is that for many of the assets received under the property settlement, CGT relationship breakdown rollover relief will be granted.

The marriage CGT relationship breakdown rollover is dependent on various conditions being met.

The primary condition is that the asset is transferred under a court order or binding financial agreement (BFA).

If assets are transferred between the spouses without meeting this condition, the rollover relief is not granted and CGT will apply to the transfer of the assets.

Where the conditions have been met, the marriage breakdown rollover rules automatically apply and the CGT gain or loss arising from the transfer is disregarded. The cost base and tax status of the transferred asset is also preserved under the rules.

Main Residence Exemption

It is worth noting that, in most circumstances, a gain realised on the family home is exempt from taxation under the main residence exemption.

However, any rollovers or exemptions applied should be taken into account when splitting the assets in a property settlement.

So how can CGT affect the split of the asset pool?

Example: Where CGT Affects A Divorce Settlement

To illustrate the importance of considering CGT during settlement negotiations, let’s use the example of a Mr and Mrs Smith.

Together, they own their family home and a rental property, each costing $700,000 and each valued at $1,200,000.

As a result of their divorce settlement, it is agreed that Mr Smith will retain the rental property and Mrs Smith will retain the family home. The transfer of the assets into each of their names is eligible for CGT relief, so no capital gains tax is paid at the time of settlement.

Not An Equal Divorce Settlement Because of CGT

On the face of it, it seems that each spouse will walk away with assets worth $1,200,000.

However, should Mr and Mrs Smith then sell their respective properties, Mrs Smith will pay no capital gains tax as she retained the family home and it retains a tax-free status.

Unfortunately for Mr Smith, the investment property he holds will likely attract capital gains tax, which could be as much as $117,500 on a capital gain of $500,000.

So while Mrs Smith does walk away with the expected $1,200,000, Mr Smith only benefits by $1,082,500.

Where CGT Relief Does Not Apply To The Divorce Settlement

It is critical to note that CGT relief does not extend to assets transferred to anyone other than the former spouse, e.g. to a company or a trust.

In the case of a transfer to anyone other than the former spouse, capital gains tax will be payable by the spouse or entity transferring the asset.

So if Mr Smith had directed that the rental property should be transferred to a family trust, the tax consequence of the above settlement would be significantly different again.

Does CGT Affect Shares In A Divorce Settlement?

In the above example, we consider real property, divorce and capital gains tax.

However, the same rules would equally apply for instance to shares in the family business. The important takeaway is that capital assets will have unique CGT histories and tax implications, even if on paper they are valued equally.

Achieve A Divorce Settlement With No Surprises

Capital gains tax is a complex area of tax legislation and its nuances are often overlooked by advisors, resulting in unintended settlement outcomes.

Our business valuation team has many years’ experience navigating capital gains tax, and we can work with legal advisors to identify issues and achieve a settlement with no nasty surprises. If you need assistance in this area, please contact us below or call (02) 4969 6600.