Capital Gains Tax And Family Law

capital gains tax and family law property settlement

When going through a property settlement, you should understand how capital gains tax and family law property settlements intersect with one another.

Do you want to be left with a fat tax bill payable to the ATO after your property settlement?

Probably not.

Capital gains tax is rarely at the forefront of a separating couple’s mind when deciding on family law property settlements.

However, you need to understand the relationship between capital gains tax and family law property settlements, otherwise, you may be in for a nasty surprise down the line.  

Key Points:

  1. There is no capital gains tax transfer between spouses as there is a CGT rollover event.
  2. You may end up with an asset that will require you to pay a large amount of capital gains tax when you sell it.
  3. Your investment property will be subject to capital gains tax, even after your divorce settlement is finalised.

 

What is Capital Gains Tax?

Capital gains tax is included in the legislation Income Tax Assessment 1997. It is payable on the disposal of most assets acquired on or after 20 September 1985.

It is a federal tax applied to the net profit gain from the sale, transfer, or disposal of an asset.

It is calculated as the difference between the capital proceeds of the asset (its sale price) and the asset’s cost base. The cost base is the initial purchase price including other associated expenses such as stamp duty, real estate agents’ fees and legal fees.

Capital gains tax affects everyone, whether they are at the end of a relationship or not.

A capital gain after the disposal of an asset counts as income for the financial year in which the asset was disposed, and capital gains tax must be paid on this gain.

Significant assets such as investment properties, furniture, boats, collectables, art and shares incur capital gains tax. The disposal of these assets becomes a “CGT Event.”

Some assets are exempt from capital gains tax. Exemptions include the family home or main residence, cars, motorcycles and personal use assets (such as furniture, household items or electrical goods) that were acquired for a sum less than $10,000 and collectables (such as art, jewellery or coins) that were acquired for a sum less than $500. When such items are acquired for more than these values, they are affected by the tax.

 

Capital gains tax and family law property settlements

Understanding capital gains tax in the context of family law is important as it is common that as part of a property settlement, property is usually transferred from one spouse to the other.

Family law property settlements are unique in the way they affect capital gains tax.

When the ownership of an asset is transferred from one spouse to another due to the end of a marriage or de facto relationship, the asset can be eligible for capital gains tax rollover.

Capital gains tax rollover means that the party transferring the asset to their former partner disregards or defers the capital gain (or loss) that they would otherwise make.

This means that if after your divorce, you are left with shares, an investment property, or a business that you intend to sell at some point, you NEED to consider the CGT implications and debt that you may have to pay to the ATO.

The recipient spouse will make the capital gain or loss when they dispose of the asset in the future.

The capital gains tax, therefore, is rolled over to the recipient spouse.

The recipient spouse also receives the cost base of the asset.

The cost base is the cost of the asset at its initial purchase, as well as other costs associated with acquiring, holding and disposing of the asset.

In family law property settlements, the rollover generally applies if ownership of an asset, or one party’s share in a jointly owned asset, is transferred from one spouse to the other, and additionally if this transfer of ownership is due to a court order, binding financial agreement or other formal agreement.

The parties cannot choose whether the rollover applies to their situation. If the transfer of ownership of their asset (or assets) fits the circumstances for a rollover, the rollover is mandatory.

Because capital gains tax can affect the equity of a property settlement, it is important to distinguish between the assets affected by and those exempt from capital gains tax in the divisible pool of assets.

 

family law property settlements and CGT

 

How does capital gains tax affect family law property settlements?

Because some assets are exempt from the tax while others are not, a property settlement that appears at first fair and equitable may not remain so in the future.

A real life example of capital gains tax and separated couples:

A couple owns two properties – one as their main residence and one as an investment property – each party may retain one property upon their divorce or separation.

The main residence is exempt from capital gains tax in any case, and provided that the recipient party continues to use it as their principal home, they will not be liable for capital gains tax when disposing of the asset in the future.

The investment property, on the other hand, is affected by the tax. The party receiving ownership of the investment property (or receiving their former spouse’s share of the investment property) will be liable to pay capital gains tax on the profit made upon their disposal of the asset in the future.

 

When does the capital gains tax rollover apply in family law?

The capital gains tax and family law property settlements rollover applies if the marriage or relationship ended on or after 20 September 1985, if ownership of the asset (or a share in a jointly owned asset) is being transferred from one spouse to the other, and if the ownership transfer is the result of a court order, formal agreement or award.

The relevant orders, agreements, and awards include the following:

When does the capital gains tax rollover not apply in family law?

Capital gains tax and family law property settlement rollovers do not apply to informal or privately made agreements.

 

cgt rollover family law

 

Example of a case with capital gains tax and family law property settlements

The case Rosati & Rosati 1998 is often cited as a precedent in financial family law matters relating to capital gains tax and family law property settlements.

This case established four general principles regarding capital gains tax:

  1. Whether the incidence of capital gains tax should be taken into account in valuing a particular asset varies according to the circumstances of the case, including the method of valuation applied to the particular asset, the likelihood or otherwise of that asset being realised in the foreseeable future, the circumstances of its acquisition and the evidence of the parties as to their intentions in relation to that asset
  2. If the Court orders the sale of an asset, or is satisfied that a sale of it is inevitable, or would probably occur in the near future, or if the asset is one which was acquired solely as an investment and with a view to its ultimate sale for profit, then, generally, allowance should be made for any capital gains tax payable upon such a sale in determining the value of that asset for the purpose of the proceedings.
  3. If none of the circumstances referred to in (2) applies to a particular asset, but the Court is satisfied that there is a significant risk that the asset will have to be sold in the short to mid term, then the Court, whilst not making allowance for the capital gains tax payable on such a sale in determining the value of the asset, may take that risk into account as a relevant s.75(2) factor, the weight to be attributed to that factor varying according to the degree of the risk and the length of the period within which the sale may occur.
  4. There may be special circumstances in a particular case which, despite the absence of any certainty or even likelihood of a sale of an asset in the foreseeable future, make it appropriate to take the incidence of capital gains tax into account in valuing that asset. In such a case, it may be appropriate to take the capital gains tax into account at its full rate, or at some discounted rate, having regard to the degree of risk of a sale occurring and/or the length of time which is likely to elapse before that occurs.

In Rosati & Rosati 1998, the court clarified that a potential capital gains tax liability should not be automatically taken into account in the property settlement. This will depend on the individual circumstances of each capital gains tax and family law property settlement case.

Capital gains tax and family law property settlements is a complex issue.

It is important to seek personal advice tailored to your situation.

We are Family Law Solicitors based in Sydney and Melbourne.

 

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