Below is an excerpt from the Life and Taxes: A Look at Life Through Tax book by Mark Chapman, available now on the CCH Bookshop.
One in three Australian marriages ends in divorce. Having said that, the average length of a marriage before it reaches divorce is actually increasing, from 10.7 years in 1993 to 12.1 years today1. That gives plenty of time for couples to accumulate a substantial pool of assets, including the family home, investment properties and superannuation, all of which will need to be divided between the spouses when they go their separate ways. This chapter considers the tax implications of the breakdown of a relationship — be it a marriage, de facto, registered or same-sex relationship.
Tax treatment of maintenance payments
Maintenance payments are generally exempt from income tax to the recipient, provided the payments are made to a person who is or has been a spouse (including de facto and same-sex spouses), are made to support a child of the payer, or to support a child of the recipient.
The exemption only applies to maintenance payments paid out of ordinary income. It will not cover the diversion of money which would otherwise be taxable income to the payer (such that income tax is avoided by the payer) or to cover the disposal of an income-producing asset (such that CGT is avoided by the payer).
No tax deduction can be claimed by the payer for maintenance payments.
As part of any financial settlement, there will usually be a split of assets between the separating spouses. This means that legal ownership of some assets will change, which would normally be a trigger for a CGT event. So how does CGT actually impact separating couples?
Roll-over relief for transfers between spouses
In most cases, where an asset subject to CGT is transferred between spouses as a result of a relationship breakdown, a CGT roll-over will apply which has the effect of disregarding any capital gain or loss arising on the transfer. The receiving spouse is effectively treated as if they had always owned the asset and will be liable to CGT on the full capital gain when they ultimately dispose of it. A similar exemption applies to stamp duty.
This type of roll-over is automatic. You cannot choose whether or not to apply it.
Note that the roll-over provisions only apply where the asset recipient is an individual. If the recipient is not an individual (eg the asset is transferred into a discretionary trust or a company), the roll-over provisions do not apply and CGT will be charged, with deemed proceeds for the disposal equal to the market value of the property at the date of transfer.
For tax purposes, it is important that any financial agreement put in place is formalised by a court order, maintenance agreement or binding financial agreement. Avoid “informal” private agreements. This is because in order for the roll-over provisions to apply, the asset must be transferred under a formal agreement or settlement. If the transfer is agreed as part of a private agreement, the roll-over provisions do not apply. Instead, the normal CGT rules will apply. In a separation situation, this means that the assets will be treated as sold at their market value by the disposing spouse (triggering a capital gain if the market value is greater than cost) and will be acquired at market value by the receiving spouse.
In most relationship breakdowns, either the family home is sold and the proceeds split, or the home is transferred to one of the separating spouses. In both cases, no CGT generally arises because of the operation of the main residence exemption.
If the home is sold, the only occasion where CGT might be an issue is where the home was used to generate assessable income, perhaps because a business was run from there or part of the home was rented out. In that case, a partial CGT exemption should still be available (see Chapter 12 for a detailed description of the main residence exemption rules).
If the home is transferred to one of the spouses, even if the main residence exemption is not fully available, any gain can be rolled over using the roll-over relief provisions (see above).
The CGT consequences for the receiving spouse will broadly depend on what happens to the property after the separation and can be summarised in three likely outcomes:
- The receiving spouse continues to live in the house. In this case, the main residence exemption continues to apply and the house can be ultimately sold free of CGT.
- The receiving spouse rents out the property but does not nominate another main residence. In this case, the six-year absence rule applies and the main residence exemption will continue to be available for that period (see ¶12-060).
- The receiving spouse rents out the property, buys another and nominates the other property as their main residence. In this case, the receiving spouse will be deemed to have acquired the property at the date it was first rented out for its market value at that time, which will then become its CGT cost base. No main residence exemption will be available and the gain arising from the date the property was first rented out to the date it was sold will be fully chargeable to CGT.
This chapter from Life and Taxes: A Look at Life Through Tax also covers:
- Transfer of assets held within a company
- Other assets
- Self managed super funds and relationship breakdown
1 Marriage and Divorces Australia, Australian Bureau of Statistics, 2015 at www.abs.gov.au/ausstats/abs@.nsf/mf/3310.0.