Loves Me Not: the tax consequences of a break-up and how to mitigate them

Breaking up is hard to do and amid the turmoil, tax concerns are unlikely to be at the forefront of anyone’s mind, however, this can be a costly mistake, as Julia Rosenbloom explains.

Tax and divorce – two words not often mentioned on Valentine’s Day. But Valentine’s Day does fall at a time of year when separation rates are known to rise, as couples have reflected over the holidays in December and January.

Amid the drama of separation and divorce, tax is usually the last thing on a couple’s mind. However, this can prove to be an expensive mistake. There can be some surprising tax consequences to the division of assets of that couples should be aware. It pays to keep a cool head and ask yourselves the following questions.

Is it possible to defer your official date of separation?

Couples considering separating between the end of the tax year and 5 April could face an extra tax bill.

Normally, transfers of assets between married couples do not incur capital gains tax. That means you can give your spouse company shares, a painting, or a house, without generating the tax charge that would normally be payable on asset transfers.

However, after you have officially separated, you are on the clock. Any transfers made after the tax year end, in the year of separation, are subject to capital gains tax. So, if a couple separates in February, they have only until 5 April to divide the assets and make all the appropriate transfers to avoid paying capital gains tax. How many warring couples can decide on the division of assets within a few short months?

By way of example, if a couple separate on 7 April 2020 and, 10 months later, one spouse transfers to the other a holiday cottage that has increased in value by £100,000 since the date of acquisition, there would not be any capital gains tax liability. By contrast, if they separated on 1 February 2020 and made the same transfer 10 months later, there would be roughly a £28,000 tax liability.

If you can, it pays to defer your official separation until after the new tax year has started on 6 April. That way you have another year to sort out your affairs and make the relevant transfers of assets. This may not always be possible, but it may work for more amicable separations. Where it is not possible, at least having an awareness of these issues means that they can be taken into account when dividing the assets. 

Do the assets to be divided have a CGT charge attached?

It is easy to look only at the capital value of the assets when trying to establish an equal distribution, but if some of the assets have a big future capital gains tax bill attached, that could leave one side substantially less well off.

For example, a family may have a main home and a holiday cottage, which are equal in value. However, the holiday cottage may have a large capital gain attached, which would knock, for example, £50,000 off the “net cash in hand” were it to be sold. This means the split is not as equal as it first appears and this should be considered as part of the divorce settlement.

Will you beat the clock in dealing with your main residence?

The rules are slightly different for the main home. This is usually exempt from capital gains tax thanks to Principle Private Residence Relief, which applies for the time you’ve used it as your main residence plus a further nine months. Prior to 5 April 2020, this was 18 months.

From April, if couples take a long time to agree a financial settlement after separation, they could inadvertently end up incurring a capital gains tax charge on the previous shared main residence.

In a separation, where one party has moved out of the house and they transfer their share of the house after nine months to the remaining spouse, they could incur a capital gains tax charge if they have declared another property as their main residence in the meantime. This is likely to be an increasing problem when couples take a long time to deal with their financial settlement after separation.

Have you made a new will?

Separation and divorce don’t revoke a will. That means that if you don’t change your will, your ex-partner could receive all your money. If you don’t have a will, they will receive all your personal property, the first £250,000 of your estate and half the remaining estate.

Once divorced, they receive nothing under the rules of intestacy - in this case it would be better to have no will than a will still benefiting your ex-spouse. That said, it is far better to make a will setting out your new intentions as quickly as possible following a separation.

Separation and divorce is a difficult time and not conducive to clear-thinking. However, it is worth taking tax advice as soon as you can face it. It can prevent some costly problems further down the line.

Julia Rosenbloom is a partner at Smith & Williamson.

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