The taxing issues in a divorce – the family home
Going through a divorce is difficult and emotional for most, even if the decision would produce a better outcome for both parties in the long run.
More often than not, it is unrealistic to expect that the parties could think clearly and rationally during this time, especially when valuable assets such as property are involved. However, getting it wrong when dealing with these assets in the course of the divorce may inadvertently invite a sting in the tail, costing you more than just the emotional heartache and stress.
The main trigger for potential tax issues associated with any divorce is the matrimonial property division process under which the assets of the former couple are split up between them so they can separate their wealth and affairs from each other going forward. This process often requires assets or interests in assets to be transferred from one person to the other, which would normally trigger a disposal for capital gains tax (CGT) purposes. To that end, it should be noted that assets owned by a separate entity (eg, company, trust, etc) that is controlled by the couple but not in the couple’s own hands are also fair game – they are most likely included in the matrimonial divisible asset pool, which will need to be addressed.
While there is some potential relief provided by the tax law in these circumstances, it would not be helpful if you:
- are unable to negotiate a position that would allow you to utilise the tax relief;
- fail to take advantage of the relief altogether; or
- fail to execute the property division properly to satisfy the conditions for the relief.
This series of articles aim to provide some tips that may help you avoid these common mistakes, bearing in mind that tailored advice is critical as everyone’s circumstance is different.
If proper structuring advice was obtained and heeded when the family home was originally acquired, the property is often held by the individual who is exposed to lower risks (eg, a non-working spouse or de facto spouse). Alternatively, the home may be jointly owned by the couple, either on a 50/50 or disproportionate ownership basis.
If the home or an interest in the home (assuming that it was purchased after 20 September 1985) is transferred to one of the individuals as a result of the divorce, the ‘main residence exemption’ would generally apply to disregard any capital gain derived or capital loss incurred as a result of the transfer.
In some circumstances, the main residence exemption may not fully apply to the transfer. For instance, if the property was originally acquired by the couple as an investment property, which was subsequently turned into their home, then an apportioned capital gain may apply. In these circumstances, it may be necessary to apply the ‘marriage breakdown roll-over’ to disregard the capital gain (refer to the section under ‘Other CGT assets’ below for further details on how to access this roll-over).
Assuming that the transferee is an individual and the transferee subsequently sells the property, whether the subsequent sale would attract capital gains tax (CGT) in the transferee’s hands would depend on how the property has been put to use after the marriage breakdown.
If the transferee has continued to live in the property until it is sold and does not own another home elsewhere, the main residence exemption will continue to apply and the property will not be exposed to any CGT on the subsequent sale.
If the transferee has started renting out the property after the divorce but does not own another home elsewhere, the temporary absence rule may apply – the property may continue to enjoy tax-free treatment for up to 6 years before the property becomes exposed to CGT.
On the other hand, if the transferee has started renting out the property after the divorce and owns another tax-free home elsewhere, the property will cease to be a tax-free main residence at this point. Assuming that the property was never rented out before the divorce, a special rule will apply that the transferee will be deemed to have acquired the property at its market value when it first became available for rent; this market value will become the cost base of the property for the purpose of calculating the future capital gain on the property when it is eventually sold.
It is important to note that special rules apply if a couple owns two dwellings at the same time. Before they were permanently separated, they may either choose one of the properties as their sole tax-free main residence or nominate both properties as their main residence but claim a partial main residence exemption on both properties. However, once the couple has started living permanently apart in each of the properties, they may start applying the main residence exemption on the property in which they reside as they are essentially treated as unrelated individuals once they are separated.
While the rules above seem relatively straightforward, if the divorcing couple own multiple properties or they have used their home for other purposes before the divorce, the tax treatment can become considerably more complex.
Important disclaimer: No person should rely on the contents of this article without first obtaining advice from a qualified professional person. This article is provided on the terms and understanding that the author and BDO (QLD) Pty Ltd are not responsible for the results of any actions taken on the basis of information in this article, nor for any error in or omission from this article. The article is provided for general information only and the author and BDO (QLD) Pty Ltd are not engaged to render professional advice or services through this article. The author and BDO (QLD) Pty Ltd expressly disclaim all and any liability and responsibility to any person in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this article.