Most people will acknowledge that tax law is complicated, and the wealthier you are and the more assets you own, the more complicated it becomes. Even those of us with fairly modest assets can still be caught out if not paying attention and this is particularly the case if you are in the process of separating from your spouse or civil partner.
If spouses and civil partners are living together (which in tax means not formally separated or where actual separation is likely to be permanent) there is no capital gains tax payable when assets are transferred between them. However, when a couple decide to separate, timing is critical from a tax perspective.
Changes to principal private residence relief
For many married couples and civil partners, the largest asset they own is their home. Providing it has been their main residence since they have owned it, they do not have to pay capital gains tax (CGT) on any increase in its value when they sell it because, as their main home, it benefits from principal private residence relief (PPRR). As an aside, it is worth noting that the definition of ‘main residence’ (and thus the applicable tax rules) has been the subject of several court cases so is not always as straightforward as it might seem.
Nonetheless, PPRR is available to everyone selling their main residence and, until 5 April, people had an 18-month window, sometimes known as the final period exemption, (starting from the moment the house was no longer their main residence) in which to complete the sale before CGT might have applied. This was designed to help those people who, for instance, had moved house but were having difficulty selling their old one and were, perhaps, renting it out while looking for a buyer. Since 6 April, the rules have changed and the 18-month window has been reduced to nine months.
Final period exemption reduced to nine months
This change is particularly significant for divorcing couples as, once the departing spouse / civil partner has left the family home, if it is to be sold this would need to happen within nine months to avoid a possible CGT liability – which could be quite a stretch given the current market. There are alternatives such as remaining in the family home until the sale, or agreeing to share any CGT liability, but we do not underestimate how difficult those might be.
If the home is to be transferred to the spouse / civil partner in the tax year of separation, then there would still be no CGT payable. If certain conditions are met, even after this PPRR can still apply for the departing spouse until the transfer to the spouse who has continued to live in it. No other home owned by the departing spouse could though be treated as their main residence for that period.
Obviously it is difficult to plan for, but timing is key – separating on the 6 April rather than 6 March gives 12 months rather than one in which to make transfers free of CGT.
The rules are complicated and we recommend seeking specialist tax advice before making a decision about sale or transfer.
The government changed the final period exemption as it was believed that too many people were exploiting PPRR by allowing the tax relief to accrue on two properties. When the proposed change went out to consultation, the majority of responses indicated that nine months was too short a time, citing divorcing couples as potentially being among the hardest hit by the new rules.
Nonetheless, the government pressed on, believing that nine months provided ample time in which to sell a house. Time will tell, but this does illustrate the point that, when altering something as complicated as the tax rules, the law of unintended consequences is hard to avoid. Please do not hesitate to contact me or any member of the private client team to discuss how we can help you plan to mitigate taxes cost-effectively.