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. Prior to 6 April 2023, this rule only applied to couples living together at some point during the tax year, meaning any transfer of assets between couples after the end of the tax year of separation were taxed as connected party, market value disposals until Final Order. This could potentially create a tax liability for the transferring spouse even if no cash has exchanged hands. However, t from 6 April 2023, separating spouses and civil partners have up to three tax years after the year they separate in which to make “no gain no loss” transfers or for an indefinite period if the transfer is pursuant to an order of the Court or an agreement between the couple in consideration or completion of their end of the marriage or formal separation. This gives separating couples much more time to plan and ensure assets are transferred as efficiently as possible.

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 occupied as 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, until they separate. This means that if one party moves out of the former matrimonial home on the breakdown of their relationship, they will have a gap in their occupation history of that property. If that gap is more than nine months, it will expose the departing spouse to tax on any arising gain on the eventual sale of the property. From 6 April 2023, the departing spouse has been able to elect to treat that gap as if they hadn’t moved out. This is subject to the residing spouse continuing to occupy the property as their main home until sale, and the departing spouse not claiming any other property as their main home during that same gap period. This election enables the departing spouse to preserve their occupation history throughout ownership and therefore qualify for 100% PRR, mitigating any arising gain on sale to nil.

The residing spouse continues to qualify for 100% PRR on their share of the gain.

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. In the event of such a transfer, the no gain no loss transfers referred to earlier will also apply here. In addition, from 6 April 2023 measures were introduced to also cover situations where the departing spouse transfers their share of the property to the other party on the basis that they will receive a share of any profit made on a subsequent sale via a Deferred Sale Agreement or Order. The measure from 6 April 2023 exempts the transferor spouse’s share of profits 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 elect 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 grant of Final Order. A transfer made after the divorce has been finalised may be a Potentially Exempt Transfer (PET) unless it is a transfer pursuant to an official financial remedy order or a consent order. A PET 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, 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.