Many divorcing couples are unaware of the significant tax implications around divorce and particularly in relation to tax obligations arising after the transfer of real property from one party to another.
When going through a divorce it's essential that you're not only are getting the best legal advice but also sound financial and tax advice before finalising any family law property settlement.
You can also ask your accountant to talk to your family lawyers while they are preparing your court paperwork.
One of the biggest questions about the tax implications around divorce is whether a family law property settlement (of any size) will result in negative tax consequences.
The answer principally lies in how a property settlement or transfer affects a person's capital gains (or losses) over time. This article discusses the main tax implications around divorce which divorcing couples need to be aware of.
What are the main tax implications around divorce and property division?
The biggest tax implications around divorce emerge from flow-on effects from Capital Gains Tax or CGT. Other tax areas of relevance include stamp duty, "deemed dividends", superannuation and even your legal costs. One area which is not affected is child support.
Child support payments are not counted as taxable income nor can you claim your child support payments made as an income tax deduction.
The Australian Taxation Office does not assess tax on child support payments received. Spousal maintenance (or alimony) is also not included in taxable income or permitted to be claimed as a tax deduction by the person paying it.
Child support payments may however affect Family Tax Benefits (from the ATO) received by the person receiving child support. Family Tax Benefits (FTB) are a two-part payment delivered to eligible families in Australia to help with the cost of raising children.
Family Tax Benefits have two elements: Part A - is a payment made for each child determined by the family's financial circumstances. Part B is an additional payment given to help families who need extra financial support. If a parent's child support payments increase or decrease then this will affect the amount of Family Tax Benefits that the government will give them.
The key role played by Capital Gains Tax (CGT)
Capital Gains Tax works by calculating a net capital gain (or loss) on the sale, transfer or disposal of a piece of property to another party. It usually includes real estate (apart from the family home), shareholdings, lease or other types of assets. There are several items which 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).
Capital gains taxes will be triggered by the occurrence of a capital gain event - which can be either a gain or a loss. The Income Tax Assessment Act 1936 (ITAA) identifies 50 potential events which can raise tax implications around divorce and family law property settlements.
However, 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.
How marriage or relationship breakdown rollover relief works
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 which 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 then later on 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 which are transferred from a couple's former company or trust. For complex asset transfers like this your accountant and lawyer needs 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.
It's important for divorcing couples to be working 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.
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 percent 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.
The next area which divorcing couples need to pay close attention to - is accurate recordkeeping. This applies particularly for other tax implications around divorce - issues arising around stamp duty, income tax consequences "deemed dividends", GST and even your legal costs.
Importance of accurate recordkeeping
Divorcing couples should be keeping accurate records around the ownership of their key assets - including all the relevant costs of acquiring, holding and selling property. You should have copies of items such as:
- the contract of purchase or sale of land and real property (including motor vehicles).
- stamp duty paid on initial purchases.
- cost of major renovations.
You should be holding these records for between five to seven years - and you can ask your accountant and family law specialist on the best ways to safely store this information.
Other tax implications around divorce
Other tax implications around divorce can arise related to stamp duty, deemed dividends, GST and even your legal costs. The effects of these are not as considerable as those from capital gains tax effects though.
Stamp duty
During a family law property settlement, stamp duty is not payable on the transfer of real property from one spouse to another - as long as the transfer is shown to be pursuant to a court order or Financial Agreement (defined in the Family Law Act 1975).
Deemed Dividends
The Income Tax Assessment Act (ITAA) will consider that a person has been "deemed" to have received a taxable dividend during the following events:
- transfer of an asset
- transfer of cash
- debt forgiveness (from a private company)
In this way, the person who receives the financial benefit is the person who is expected to be taxed at the full marginal tax rate.
For example, if your former spouse owns a company and pays you as part of an existing contract, the Australian Taxation Office (under the ITAA) will deem the amount you receive as a dividend which will be added to your existing taxable income. This will make you liable to pay more income tax. Company trusts when split during divorce can have similar dividend consequences.
Divorcing couples who are dealing with multiple company assets need to have skilled accountants on hand to guide them through the correct procedures to keep their taxation burden as low as is legally possible.
Goods and services tax (GST)
Goods and services tax (GST) is one of the easiest tax implications around divorce to deal with. The laws are simple and straightforward. The person receiving the house or car won't be required to pay GST on the transfer in a family law property settlement.
Real estate and property transfers (family home, cars and furniture) made as part of family law property settlements will generally not attract GST because they are considered private assets and not "enterprise assets". Enterprise assets must be registered for GST, private assets are exempt from this requirement.
However if divorcing couple's company is formally disposing of assets from one party to another, that company will have to pay GST on the transfer - particularly if the company is claiming the item (house, shares or car) as a credit or an enterprise asset.
There could also be some instances where company held investment properties could be considered enterprise assets. Your accountant and your legal team should be able to guide you in these instances.
Legal Costs
Your legal costs are included in capital gains calculations as incidental costs which are incurred when transferring a capital gains asset (house, car, etc - as part of your divorce settlement). Legal costs will be treated differently from your other assets though. They will likely be deductible under the Income Tax Assessment Act - and you should be asking both your accountant and lawyer about this while drafting your court paperwork.
Understanding your tax obligations
The tax implications around divorce and asset division are extremely complex and nuanced and it's important to consult with both your accountant as well as your family law specialist while you are working towards the splitting of your marital assets. Even in quite straightforward cases, clients can experience unexpected tax consequences if they are not careful.
The skilled legal team at Justice Family Lawyers can advise you in more detail about many of the tax implications around divorce - including how capital gains tax and relationship rollover relief works. We've been helping couples negotiate complex family law matters including taxation and estate planning since 2017 and have successfully resolved over 2,000 cases to date.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
