Each new year offers a great opportunity to take stock on life and for many, that can mean re-evaluating the relationship you are in.
Put simply, the first months of each year are peak time for couples to split up. If you’ve made the choice to move on from your current relationship, the tax consequences of doing so might not be front of mind but sooner or later, the financial implications of splitting up will need to be considered.
To help you prepare, here’s H&R Block’s guide to the tax implications of relationship breakdown.
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), is 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 been the divorcing spouses. This means that legal ownership of some assets will change, which would normally be a trigger for a capital gains tax event. So how does CGT actually impact couples who are splitting up?
Rollover 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 rollover 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.
The relationship breakdown rollover is automatic. You cannot choose whether or not to apply it.
Note that the rollover 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 rollover 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.
Tip: 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 rollover 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 relationship breakdown 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.
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 rollover relief provisions (see above).
The CGT consequences for the receiving spouse will broadly depend on what happens to the property after the divorce and can be summarised in three likely outcomes:
The receiving spouse continues to live in the house. In that 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 purchase another main residence. In this case, the spouse can be absent from the property for up to six years and the main residence exemption will still be available.
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 original 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.
Motor cars are not normally subject to CGT, so can be transferred without tax consequences.
Pre-CGT assets (ie, assets acquired before 20 September 1985) are also exempt from CGT.
The Family Law Act 1975 and the Superannuation Industry (Supervision) Act 1993 (SISA) allow an interest in superannuation, or a super payment, to be divided or split by agreement or court order in the event of a relationship breakdown.
When couples divorce, funds held within the superannuation system generally need to remain within the superannuation system unless the individual has satisfied a condition of release, such as retiring after reaching the preservation age, turning 65 or starting a transition to retirement pension.
Superannuation lump sum payments: If a payment split is made to a receiving spouse who meets a condition of release and it results in a lump sum payment, the payment is assessed to the receiving spouse. It will be received tax free if they are over 60, and taxed at their marginal rates less 15% (the first $205,000 tax free) if they are under 60. The benefit payment will be divided into a taxable and tax-free component in the same proportions as the total benefit just prior to the payment split.
Superannuation income stream: Where an income stream or annuity is split, a new income stream starts for the receiving spouse and is assessed to them. It will be tax exempt if they are over 60 or taxed at marginal rates less 15% if they are under 60. The benefit payment will be divided into a taxable and tax-free component in the same proportions as the total benefit just prior to the payment split
Capital gains tax exemptions: Where capital gains or losses arise from the creation of rights when a superannuation agreement is entered into or terminated, these are disregarded for CGT purposes.