Divorce and Tax

Although the financial impact of divorce is something that the parties are likely to expect, often the tax implications are not something that is initially considered. However, any change in circumstances can affect your tax liabilities and so it is very important to get advice at an early stage about the impact that your divorce will have in relation to tax. Where there is an international element involved, the tax implications can be even more complicate. 

The key taxes to consider are: 

• Capital gains tax (CGT) 

• Inheritance tax 

• Income tax. 

Capital Gains Tax (CGT) 

Depending on when assets are transferred between the parties during the divorce process, it is possible that capital gains tax could be applicable.  

Asset transfers 

Individuals married to each other can transfer assets between themselves without incurring any CGT. As such, transfers between married partners are deemed to have taken place at nil gain/nil loss, meaning the receiving spouse is deemed to have purchased the asset from the transferring spouse for the same price they originally paid for it. This is only possible where the spouses are living together for some of the tax year. A married couple will be treated as living together unless they are separated either by an order of the court, a deed of separation or whether the separation is considered likely to be permanent.  

Once a married couple permanently separate, CGT will apply from the end of the tax year that they separate (as opposed from the point that they divorce). If they separate early in the tax year then they will have the remaining time to make transfers before CGT applies. Conversely, separating at the end of the tax year could have significant implications since there may not be time to do a transfer before CGT starts to apply. Following separation, the parties will be regarded as connected persons until the decree absolute is issued. Transfers of assets between connected parties are deemed to have taken place at market value, regardless of the actual proceeds paid. Following on from this, if an asset which has risen in value, is transferred between the connected parties, CGT will be due (subject to any annual exemptions, reliefs and losses available). 

Private residence relief in relation to the family home 

Often the family home is the asset of highest value. When a couple is separating, it may not always be possible to sell the home straight away and this can give rise to a CGT issue. Generally, CGT does not apply to the sale of someone’s main residence known as private residence relief (PRR). For spouses, only one property between themselves qualifies as a ‘main residence’ eligible for PRR.  Once a married couple permanently separate and if one party moves to a new residence then this could change what is the main residence. There is a nine-month grace period (reduced from 18 months on 6 April 2020) after the spouse moves out before CGT will become applicable. This can be extended in the form of special relief where one spouse receives the house as part of the divorce settlement, presuming the spouse that left has not elected for another property to be their main residence.  

Inheritance Tax 

Transfers between spouses are exempt from inheritance tax (IHT), which means that, in the event of one spouse’s death, the surviving party can inherit the whole estate tax-free. Also in these instances, spouses can transfer their unused tax-free allowance to their surviving partner. However, this only applies while the parties are married and ends once the decree absolute is issues (though not while the couple are separated or after the decree nisi).  

Once decree absolute is granted, transfers may still be exempt is specific exemptions apply, for example, if the transfer is done as part of a court order since the intention here was not to pass on a benefit. These potentially exempt transfers will fall within the scope of inheritance tax if the donor dies within seven years of making a gift. 

Income Tax 

Marriage allowance may be available to married couples, which allows you to transfer £1260 of your personal tax allowance to your spouse.  However, married couple’s allowance will end where a couple divorce. It will be available in the tax year of permanent separation.