How to Avoid Paying Taxes on Divorce Settlement

No one likes the thought of having to pay taxes, especially during an already emotionally taxing period like a divorce. It can be difficult enough to come to an agreement with your former spouse about how to split up your assets without introducing taxation factors into the equation.

Capital gains tax is imposed on any capital gains made when disposing of an asset, such as an investment property, shares or a business. This includes when disposing of assets when getting divorced – i.e. when going through the financial division of assets and debts.

When an asset is sold, it is subject to capital gains tax in Australia and there are different requirements for assets held for different periods However, the reality is that not properly addressing capital gains tax (CGT) issues during a divorce can cause costly problems down the track for potentially only ONE of you.

This doesn’t sound very fair right? Make sure that does not happen to you.

At Justice Family Lawyers, we specialise in helping clients with their divorce proceedings and ensuring that entitlements are protected. We understand the law and strive to be proactive in helping you create an effective asset division strategy so that you never take on more of a liability than you need to.

In this article, we will look into the different ways you can minimise any capital gains tax costs during your divorce.

CGT Exemptions

Several items are exempt from CGT and these include:

• Assets acquired before 20 September 1985;
• Cars and motor vehicles;
• Collectables worth less than $500;
• Some personal assets less than $10,000;
• Assets used to produce income (eg, personal computers);
• Sale of a small business or business asset; and
• The main residence of the parties (the family home).

Case Study – Property transfers and CGT

The following (fictional) case study provided by the Australian Taxation Office shows how CGT could operate in the context of a family law property settlement.

In this scenario, a typical Australian couple, “Sergio” and “Nina” – bought a home on 1 February 1985 for $175,000 and later bought a larger home (for $325,000) on 1 January 1996 (after capital gains tax was in place).

Their second home became their main marital residence. The couple converted the first home they bought into a rental investment property. For both properties, the couple, Sergio and Nina each owned 50% of the properties.

On 1 April 2017, the couple’s marriage broke down and the divorce settlement was as follows:

• Nina transfers her interest in the rental property (originally purchased for $175,000 – 1 February 1985) to Sergio.
• Sergio transfers his interest in the family home (originally purchased for $325,000 on 1 January 1996) to Nina.

Following the divorce, the wife, Nina, continues living in the family home and Sergio moves into the rental property. The capital gains tax implications around this property settlement are:

• For the rental property acquired by Sergio – as the property was purchased before the introduction of CGT (on 20 September 1985), Sergio is deemed to have acquired Nina’s interest in the property before that date. This means that there are NO capital gain or loss obligations for either party – UNLESS – there were major capital improvements made to the property after 19 September 1985 (date of CGT introduction into Australia).

So, in this example, there were no capital gains tax implications in this settlement regarding the initially purchased property as the purchase occurred well before the introduction of CGT in Australia. However, if there had been the couple could have successfully applied for marriage breakdown rollover relief to be applied.

Marriage or Relationship Breakdown Rollover Relief

The Australian Taxation Office offers divorcing couples some tax relief in the form of a marriage or relationship breakdown rollover which means that capital gains (or losses) are disregarded in this particular instance.

The marriage or relationship breakdown rollover relief only applies when a property transfer (from one spouse to another) is the result of a formal court order, binding financial agreement or court award.

This rollover relief means that any capital gains (or losses) incurred in this property transfer will be disregarded. The rollover relief only applies in this specific instance. If a party later decides to sell the property (at a gain) a year later – they will be liable to pay capital gains tax on those profits.

Relationship rollover relief can’t be applied to properties that were acquired by either spouse before the date that Capital Gains Tax (CGT) was formally introduced in Australia – that is, any transferred property acquired before 20 September 1985. However, if a couple purchased property before that date and later made significant capital improvements on the property, then the capital gains effects will be triggered.

This rollover relief provision can also be applied to assets that are transferred from a couple’s former company or trust. For complex asset transfers like this your accountant and lawyer need to pay close attention to Division 7A of the Income Tax Assessment Act 1936 (ITAA) – and any potential adverse tax consequences arising from things like deemed dividends – considered briefly below.

Divorcing couples need to work closely with both their legal team and their accountants during family law property settlements. The Family court system can also consider some CGT liabilities or losses – if these are flagged during court filings – to ensure that both parties are given a just and equitable property division.

One approach is to refrain from selling assets subject to CGT before finalizing the divorce. Instead, these assets can be transferred to one spouse, triggering a CGT rollover event.

When an asset is transferred from sole or joint ownership to the sole name of one spouse, a CGT rollover event occurs. This defers CGT payment until a future date, but it’s important to note that the CGT liability remains for the recipient when the asset is eventually sold.

Also read: Can My Ex-Girlfriend Take Half My House?

Immediate Sale

Alternatively, you may opt to sell CGT assets promptly, allowing the CGT liability to be addressed and distributed among both parties as part of the overall asset division.

Also read: Selling Property Before Finalising Divorce in Australia

Final Thoughts

Dividing assets during a divorce can be confusing and complicated, and it’s important to work with a qualified legal and financial advisor to ensure you are not taking on tax liabilities that could negatively affect your financial future.

If you want more advice on How to Avoid Capital Gains Tax in Divorce, speak to the team at Justice Family Lawyers. We can provide advice and guidance during this process to make sure that any capital gains tax implications are properly addressed.

We believe that every individual should remain financially secure during and after a divorce, and our goal is to provide legal representation that provides the best possible outcome for our clients.