Will your divorce cost you in Capital Gains Tax?

Divorce is a fact of life – sometimes things just stop working and it's the only route to peace of mind for both parties.  Except there's the divorce process to tackle.

The recent change in divorce law means that there is only one reason for divorce – a 'no fault' divorce.  That means no need to prove adultery, unreasonable behaviour, etc.  But those changes haven't affected property owned jointly by the divorcing partners.

A bit of background

When property and other assets are owned jointly by a married couple (or civil partnership) these can be transferred between the partners without any tax implications.  So, for instance, if the wife earns a much higher salary than the husband, it makes good tax sense for assets to be in his name as any tax on income he earns is likely to be in a lower tax bracket. 

There is no Capital Gains Tax (CGT) applied to assets transferred between legally connected partners.  It's treated as a no gain, no loss asset transfer.

Until now, if a couple's main residence is in joint names and they separate, as soon as one of the partners moves out, the clock starts ticking.  They only have 9 months to sort out their transfer of their principal private residence before an element of CGT applies. Also, for transfers of all other assets they only have until the end of the current tax year to get their affairs in order and to transfer these at no gain no loss.  If their separation occurs late in the tax year, that can add considerable pressure to an already fraught situation.

Most divorces take much longer than nine months to sort out all the issues and get through the court process, so that means whoever moves out is going to take a hit in CGT if they can't sort out the finances before that nine-month deadline.

What's changed?

HMRC have changed the tax treatment of divorcing couples and this will come into effect in April 2023. 

Instead of the pressure of getting assets transferred within the tax year in which they separate, the couple will now be treated as connected parties for a period after the break-up.  In essence this will be three tax years from the date on which they separated.  But that time period is unlimited if they include transfers of assets as part of a divorce process - as long as the divorce has started going through the legal process within that initial three year period.

Also, rather than being restricted to 9 months, Private Residence Relief (PRR) can be claimed in full by the partner who has moved out of the family home, but only if the remaining partner stays in residence and buys them out.  It applies regardless of whether or not they have bought another residence and puts both partners in an equal and fair financial situation.

If the jointly owned main residence is sold to a third party in order to give both partners their 'half' in cash, CGT will still be partly payable on the amount the partner who has moved out receives, but not on the resident partner.

While it's not ideal in the latter situation, it is a positive and practical step.  It seems that HMRC have applied common sense for a change!