Separation or divorce is never easy, but once the decision is made, limiting financial liabilities is key. Fortunately, Capital Gains Tax (CGT) rules from 6 April 2023 could make your tax position more favourable. Here's the current rules and what to look out for.

Capital Gains Tax (CGT)

If you’re married or in a civil partnership, any assets transferred or gifted between you and your spouse or civil partner are at a “no gain no loss” basis, meaning that no taxable gains arise on the transfer of assets. Currently, this rule only applies to couples living together at some point during the tax year. From the tax year following separation, you’re both considered connected persons for CGT purposes until you are legally divorced. This means that any transfers of assets between you are deemed to take place at market value, even if no cash has exchanged hands. The result is that the person making the transfer could be left with a CGT liability. However, the government has announced that for transfers made from 6 April 2023, separating spouses and civil partners will be given up to three tax years after the year they separate in which to make “no gain no loss” transfers. This gives separating couples much more time to plan.The proposals go further in relation to transfers made under a court order, as the plan is to make the extension for those transfers indefinite. There are suggestions this could apply to any other kinds of agreements too, and we await final proposals for clarification. We’ll update this article when confirmed.

The family home

Typically, the biggest source of contention between couples during the divorce process is the family home. After a separation, it’s not unusual for one spouse to move out to live elsewhere if staying in the family home becomes unfeasible.

Selling the property

Under general principles, the gain arising on the sale of a residential property, which has been your main residence throughout ownership, is exempt from CGT under Private Residence Relief (PRR). However, married couples and civil partners can only have one main residence between them. Currently, if the family home is to be sold and the proceeds divided between you both as part of the divorce settlement, the departing spouse will face part of their gain being taxable after nine months of them moving out, assuming they haven’t elected for another property to be treated as their main residence in this nine-month period.

However, the government’s proposed changes from 6 April 2023 allow for the departing spouse to apply the same proportion of PRR on the eventual sale of the property as if they hadn’t moved out.

The residing spouse continues to qualify for 100% PRR on their share of the gain under new and old rules.

Transferring the property to the occupying spouse

In many circumstances, it’s not practical to sell the family home. Instead, the departing spouse transfers their (sole or joint) ownership of the family home to the spouse still living in the property as part of the divorce settlement. We assume that in the event of such a transfer, the new time extension of no gain no loss transfers referred to earlier will also apply here from 6 April 2023.The new measures also cover situations where the departing spouse transfers their share of the property to the other party on the basis that the transferor will get a share of any profit made on a subsequent sale. The proposals from 6 April 2023 allow the transferor’s share of profit to be exempt from tax to the same extent that any gain on the original transfer was exempt (or would have been but for the no gain no loss treatment applying to it).A remaining (very important) point that often gets overlooked is that if the transfer of the family home takes place under a Court order, the departing spouse will be able to claim that the home should be treated as if it continued to be their main residence, from the date they moved out to the date of transfer (however long this takes).

Inheritance Tax (IHT)

Transfers between spouses are exempt from IHT, although this is restricted to a lifetime limit of £325,000 for those made from a UK domiciled spouse to a non-UK domiciled spouse. This remains true even during the period of separation up until the actual decree absolute. A transfer made after the divorce has been finalised may be a Potentially Exempt Transfer (PET). This is chargeable to IHT if the donor dies within seven years from the date of transfer, which would have the effect of reducing the lifetime limit available to be allocated against their estate and thereby increasing the IHT liability, leaving beneficiaries with less than was intended. Bad timing could potentially increase the IHT due on an estate by up to £130,000 (£325,000 x 40%). It's therefore imperative that you make any transfers at the “right” time.

While getting married often revokes pre-existing wills, getting a divorce does not. As such, it’s essential that you seek legal and tax advice when updating your will to ensure that your express wishes are carried out in the most tax efficient manner.

Income Tax

The transfer of assets under a divorce settlement is not subject to income tax. However, if you’ve received income producing assets from your former spouse, such as income bonds or shares, you’ll be taxable on the interest and dividend income received since the date of legal transfer.

Maintenance payments are generally outside the scope of UK tax. The result is that maintenance payments received do not count as taxable income and similarly, there is no tax relief for maintenance payments made to a former spouse.

What should you do?

Timing is key, even more so with the new proposals announced to apply from 6 April 2023, so it’s important you seek specialist tax advice early on in the separation process. Considered planning should help you avoid the nasty surprise of unexpected tax bills and will also allow you to keep on top of any changes to the announced proposals as it goes through the legislative process.