The tax consequences of separation

By James Ward, Head of Private Client, and Jane Keir, Partner in Family & Divorce at Kingsley Napley LLP.

The last 12 months have put an awful lot of pressure on the family unit and sadly this has led to a spike in separation and divorce amongst married couples. With the end of the tax year fast approaching (last day Monday 5th April – Easter Monday) it is timely to consider the tax consequences of separations.

Most separations lead to a transfer of assets between the married couple whether that be the family home, buy-to-let properties, business assets or investments. For wealthy couples there can be significant exchanges of capital sums which may have increased in value over the course of the marriage.

In normal circumstances, there is no capital gains tax liability when assets are transferred between a married couple or a couple in a civil partnership. The base cost from which the gain is calculated is not increased but importantly there is no capital gains tax charge – a no gain / no loss position.

So it might seem logical that there should be no capital gains tax between divorcing couples if they transfer the assets between each other before the actual divorce is formalised. Unfortunately that is a common misconception.

While most couples understand that they have to pay some capital gains tax on the transfer of assets after the partnership has been legally dissolved, they do not realise that they may have to also pay on separation before the formal divorce. In fact the rules are quite strict on this.

In simple terms, if you have lived together at any point in the tax year in which you transferred the asset, then the married couple do not have to pay capital gains tax. However, if a couple have separated in the previous tax year then capital gains tax will be owing on the transfer of assets.

In certain circumstances this has an important tactical, timing impact on separation and divorce agreements and the transfer of assets. It also suggests that separating is best done on the 6th April (earlier in the tax year), not for example the 31st March (right at the end).

There can also be an issue for the main home around gifting or selling. Once legally separated the exemption of principal private residence relief will be assessed individually. So a spouse who moves out of the family home will potentially lose a portion of their principal private residence relief without realising it. This has been made worse by a change in the period you can still claim this relief after leaving your main home that was introduced in April 2020. From this date the party in the separation who has moved out will only have a reduced 9 month window to sell or transfer their share in the main home before capital gains tax becomes an issue.

While capital gains tax can be complicated in separation, inheritance tax is somewhat easier. Assets passed between married couples remain inheritance tax free even after separation. This only comes to an end on formal divorce.

Of course, any consideration as to tax planning and saving needs to be done in the cold light of day which may not be an option for a spouse or civil partner in the throes of a separation, especially if it has all happened rather suddenly.  However, where the financial estates of the parties are varied in terms of ownership of the family home, other real estate, shares in private companies etc., advice needs to come early from a trusted expert in order to minimise or avoid tax liabilities for the ultimate benefit of the entire family.  Assets can be transferred entirely without prejudice to any subsequent divorce settlement, but it is important to seek advice upon the realisation that it is the year of separation, and not the year of the divorce itself, when the transfers have to be effected.