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Exploring the tax treatment of the main home upon divorce

Sofia Thomas explains the tax treatment of the main home on divorce or separation, covering the reduction in period of deemed occupation, loss of lettings relief, changes to the transfer of ownership provisions and making an election, among other things.

DivorceThe inevitable transfer of assets in the breakdown of a family makes capital gains tax (CGT) the headline tax for divorcing couples. Advisers need to be aware of the changes from April 2020 and the impact these will have on divorcing couples. In this article I will provide an overview of the tax implications of transferring the main home – one of the most common large assets in divorce – and how upcoming changes to the tax law will affect this.

The main home

The government is making several changes to principal private residence (PPR) relief, which will be effective from April 2020. It says the aim of the changes is to ensure that the main beneficiaries of the relief are genuine owner-occupiers. The changes are expected to bring in an additional £50m in revenue in 2020/21, increasing to £150m by 2023/24. The three main changes to PPR relief coming into effect from April 2020 and which will be relevant to divorcing couples are:

  • the reduction in the period of deemed occupation from 18 months to nine months (prospective amendment to s223, Taxation of Chargeable Gains Act 1992 (TCGA 1992));
  • the loss of lettings relief (prospective repeal of s223(4), TCGA 1992 and replacement with prospective new s224A, TCGA 1992); and
  • changes to the transfer of ownership provisions (prospective amendment to s222(7)(a), TCGA 1992).

Reduction in period of deemed occupation

This amendment reduces the length of the final period of ownership that is always eligible for relief from 18 months to nine months (while retaining the existing 36 months available to people with a disability or those in a care home). It specifically affects couples who are divorcing, as it is common for one party to move out of the marital home before the final divorce. By the end of the divorce one party will usually own and occupy the home, requiring a transfer of 50% of the property to their spouse ahead of the final divorce.

If this takes place after the tax year of separation then the transfer takes place at deemed market value. The individual who is ‘gifting’ their share of the property therefore may be liable for CGT if they have been absent from the home for more than nine months (currently 18 months).

Of course, if certain conditions are met, it may be possible for the individual gifting their share to make a claim that the former marital home continues to be treated as their PPR (s225B, TCGA 1992). However, as one of the conditions is not giving notice for another home to be their PPR for any part of the period, the claim may not be advantageous.

It is also important to consider if any other PPR relief conditions might be applicable in their case (s223(3), TCGA 1992). For example, did the non-occupying spouse move for work abroad? If they moved abroad for work and were prevented from reoccupying the property due to working abroad, then a period of absence of any time frame will be covered.

Did they move for work within the UK? If they moved within the UK for work and were prevented from reoccupying the property due to working within the UK, then a period of absence of up to four years will qualify.

Flagging this up early in negotiations can be critical, as it enables both parties to consider this point and hopefully reflect it in the financial discussions regarding the home. While it may not be possible to negate the charge, the solicitors may include an indemnity of the CGT in the financial order, which will protect the client’s exposure. 

Loss of lettings relief

From 6 April 2020 lettings relief will only be available if the property owner was living in the property while it was rented out. It is clear that this relief withdrawal will affect owners who bought a property to live in and then bought a second larger property and rented the first property out. 

In the author’s experience, there are many couples to whom this applies. Again, it makes complete sense to quantify the exposure to CGT early on in the discussions so that the tax figure can be factored in. For example, a property worth £150,000 may have a potential CGT liability of £30,000 if sold or transferred in February 2020 but could have a CGT liability of £45,000 if sold in May 2020 due to the aforementioned changes in lettings relief.

Changes to the transfer of ownership provisions

From 6 April 2020, when a spouse or civil partner (CP) transfers an interest in a property to their spouse or CP, the receiving spouse or CP will inherit the transferring spouse’s ownership history, including previous use of the property, regardless of whether the property is the main residence at the time of the transfer. Currently, the spouse or CP only inherits the ownership history if the property is the main residence at the time of the transfer.

For couples who have not bought their marital home together, and where the property has not always been the main residence, this will add complexity in calculating the potential CGT charge as different rules apply to transfers depending on whether the transfer takes place before or on or after 6 April 2020.

Consider Jane and John. Jane bought her property in 2000 as a holiday home in Wales. She lived and worked in Birmingham. In 2005 John and Jane got married and both lived in Birmingham. In 2015, when the fixed term of the mortgage ended, Jane transferred 50% of the Welsh property to John. In 2016 they decide to move to the property in Wales. In 2020 Jane and John decide to sell the Welsh property.

As the transfer took place before 6 April 2020 and before the property became the couple’s main residence, PPR relief will be available on John’s share of the gain for the period from 2016 until the disposal in 2020. Jane’s ownership history prior to the transfer in 2015 is ignored for the purposes of calculating PPR relief on John’s share.

Making an election

The prospective insertion of new s222(5A), TCGA 1992 may prove helpful for people with second homes. It applies where an individual has failed to make a nomination specifying which of two or more residences is their PPR within the normal statutory time limit of two years. It allows a late nomination, provided that the individual has not made a nomination previously and the interest held in one of the homes has a negligible market value (eg, a weekly rented flat).

Timing issues

One of the biggest changes to CGT is not a technical change but rather an administrative one. The payment window for CGT is moving from 31 January following the end of the tax year to 30 days from the date of completion of the disposal. 

For some individuals who sell properties, the 30-day payment window (while it may be tight from an administration perspective) is likely to be manageable financially – assuming there is enough equity in the property to meet the CGT liability.

However, for couples who are divorcing, the connected persons rule (s286(2), TCGA 1992) means individuals are treated as connected persons for the period from the end of the tax year of separation until the divorce is finalised. As connected persons, any transfers between the parties take place at deemed market value (s18, TCGA 1992), resulting in individuals being assessed for CGT on a transfer that may result in no cash exchanging hands.

The 30-day payment window may create high-stress situations for individuals who do not have the cash immediately to hand, either because they need to remortgage a property or because they have been required to pay cash as part of a settlement. 

The date of disposal can be difficult to determine in cases where the disposal is made in accordance with a court order. The view of HMRC is set out in its Capital Gains Manual at CG22423. The normal timing of a disposal for CGT is the exchange of contracts, but for the purposes of the 30-day payment and reporting requirement, it is completion. However, it is assumed that the HMRC guidance for divorcing couples will also apply for this purpose.

About the author

Sofia Thomas CTA ATT is director of Sofia Thomas Ltd, which specialises in tax on divorce and inheritance tax matters