To my surprise I regularly find that people don’t know that the party keeping the family home in a property settlement can be liable for capital gains tax (CGT) when they sell it.
Often in a property settlement one party transfers their interest in a house to the other party. If that transfer is pursuant to a court order or a financial agreement then the transferring party does not incur CGT on the transfer. This is well known.
If it is an investment property then the party receiving the property will ultimately be liable for any CGT when they sell it. This is also well known.
But if we are talking about the family home then there may also be CGT consequences on sale. This is less well known.
Let’s consider the following scenario:
- At the time of separation the parties own one property, the family home.
- At separation the husband moves out of the home.
- 2 months later the husband buys a property to live in.
- 5 years after separation the parties reach a property settlement. Part of the agreement is that the husband transfers to the wife his interest in the family home.
- They have the agreement approved by the court (consent orders).
- The parties then implement the orders. The husband transfers to the wife his interest in the family home. This takes place 5 years after the husband has purchased his property.
The wife may be liable to pay CGT when she sells the family home.
Generally, the main residence exemption allows a person to disregard a capital gain in relation to their main residence. At any point in time a person can only apply the main residence exemption to one property (subject to one exception which is not relevant to our example).
In our example, the problem for the wife is that the husband may well elect his new property to be his main residence for the purpose of CGT. If he does so then, when she sells the family home, the wife will be liable for CGT relating to the 5 year period between the husband purchasing his new property and the husband transferring to the wife his interest in the family home.
So CGT on the family home can be an issue for the party receiving the family home when the party not receiving the family home has bought another property and elects to apply the main residence exemption to the new property. This will particularly be an issue when:
- There is a long time between separation and property settlement; and/or
- There has been substantial capital growth;
What can be done about this?
The first thing is to make sure that the person receiving the family home is aware of the possible issue.
The second thing is to factor the CGT into the settlement negotiations.
Thirdly, when a property was a person’s main residence, they can elect to treat the property as their main residence even though it has stopped being their main residence. This election can be made for an indefinite period if the property is not used for income producing purposes. If it is is used for income producing purposes then the property can be treated as the main residence for 6 years.
If you would like to learn how to avoid CGT issues in family law property settlement, please contact us on 02 4929 3995 or email@example.com.
by Alan Wright