Capital gains tax following a separation

Last month the Government released draft legislation in relation to changing how capital gains tax (CGT) will apply after a married couple have separated. The intention is for the new legislation to apply to any transfers or sales which take place on or after 6 April 2023. 

All references to married couples can also be taken to mean those in a civil partnership.

Current rules on capital gains tax

If a person transfers an asset (eg a house) to their spouse who they are still in an ongoing relationship with, there is no CGT on the transfer. Instead, the recipient spouse is broadly treated as acquiring the asset for the same original cost that their spouse acquired it for. This is generally known as the “no gain no loss (NGNL) rule”.

The NGNL rule continues to apply until the end of the tax year in which a married couple separate. But as from the first day of the following tax year, any transfers which take place between them are deemed to take place at market value – which potentially can lead to CGT being payable. This includes any transfers which are required under the terms of a divorce agreement.

If the separation results in one of the spouses moving out of the family home, this can have consequences in terms of how much principal private residence (PPR) relief they might qualify for when they come to either sell the house or transfer it to their spouse. PPR is a relief from some or all of the capital gains tax which would otherwise be payable on any gain realised on the family home. Usually it covers the period where the spouse actually lived in the property, plus their final nine months of ownership (if they had already moved out). There are some exceptions to this. This therefore can mean that if the period between them moving out, and selling or transferring the property, is more than nine months then a CGT charge might arise.

One exception is where the spouse who has moved out will be transferring their share to the spouse who has remained. In such a scenario, it potentially can be that PPR relief can cover the entire period post moving out (rather than just nine months). But if the spouse making the transfer chooses to claim this extra PPR relief, they are prevented from claiming any future PPR relief (for that same period) on any other property which they own and might now live in.

New rules on capital gains tax

As from 6 April 2023, it is proposed that the NGNL rule will continue to apply until the end of the third tax year after separation (or until the date of divorce, whichever occurs first). For example, if a couple separate during 2023-24, any transfers made between them up until 5 April 2027, whilst still married, will continue to fall under the NGNL rule. Whereas previously it would have only applied to transfers made up until 5 April 2024.

Furthermore, any transfers made between them under the terms of a divorce agreement will also be covered by the NGNL rule – regardless of when that divorce agreement is signed.

By extending the availability of the NGNL rule, it is less likely that CGT will become payable on transfers between spouses (whether before divorce, or upon divorce). This in turn reduces the relevance of PPR relief, because for PPR relief to be applicable there first needs to be a gain arising on the family home. However, PPR relief will still be relevant for some, because in some cases the family home will be sold on the open market rather than transferred. A gain is still likely to arise where the family home is sold.

Therefore, a further proposed new rule is that if a spouse moves out of the family home and sells the property more than nine months later, they potentially can qualify for PPR relief for that extended period. Again though it is choice – and choosing it will prevent them from claiming future PPR relief on any other property which they own and may have moved into.

The extension of the NGNL rule will no doubt be welcomed by many who might otherwise be faced with needing to sell land, or other assets, in order to raise the necessary cash to pay the CGT. However, whilst that is a positive outcome, it does need to be appreciated that the entire historic gain which has accrued on the spouse transferring the asset will be passed onto the spouse who is receiving the asset. If the recipient spouse was to ever dispose of the asset in the future, they would be realising both the gain which accrued during their own ownership plus that which accrued to the former spouse. On the hand, if the recipient spouse was to retain the asset until they die, then under current legislation the entire unrealised gain would die with them.

Important timings on capital gains tax

It should be appreciated that separation can potentially occur before 6 April 2023. It is the timing of the transfer between spouses (including whether they are still married at that time), which determines what rules will apply to that particular transfer. Hence the date of 6 April 2023 is very important in relation to the timing of the transfer, and indeed the timing of the divorce – but less important in relation to the timing of the separation.

For example, if a married couple separated in 2021-22, any transfers made between them in 2022-23 (before divorce) would fall under the current rules (meaning NGNL does not apply). But any transfers made between them in 2023-24 (before divorce) would fall under the proposed new rules (meaning NGNL does apply).

How Moore Barlow can help

If you think that these rules, or the proposed rule changes may affect you or a wider family member, please do contact Alex Wavell, our in house private wealth chartered tax adviser. If you would like to discuss a personal, or wider family separation or divorce issue, please contact Debra Emery one of our family law partners.