Principal of Justice Family Lawyers, Hayder specialises in complex parenting and property family law matters. He is based in Sydney and holds a Bachelor of Law and Bachelor of Communications from UTS.
Capital gains tax is one of these areas of taxation that crosses over with family law.
Property settlements in family law take into account a range of aspects of the parties’ financial situation. Many things to which they might otherwise not give much thought can create complexities.
Capital gains tax is rarely at the forefront of a separating couple’s mind when deciding on the division of property, whether in court, through mediation, or between themselves without third party involvement. However, it can have a significant impact on the final property settlement.
What Is Capital Gains Tax?
Capital gains tax is included in the legislation Income Tax Assessment 1997. It is payable on the disposal of most assets acquired on or after 20 September 1985.
It is a federal tax applied to the net profit gain from the sale, transfer or disposal of an asset.
It is calculated as the difference between the capital proceeds of the asset (its sale price) and the asset’s cost base. The cost base is the initial purchase price including other associated expenses such as stamp duty, real estate agents’ fees and legal fees.
Capital gains tax affects everyone, whether they are at the end of a relationship or not.
A capital gain after the disposal of an asset counts as income for the financial year in which the asset was disposed, and capital gains tax must be paid on this gain.
Significant assets such as investment properties, furniture, boats, collectables, art and shares incur capital gains tax. The disposal of these assets becomes a “CGT Event.”
Some assets are exempt from capital gains tax. Exemptions include the family home or main residence, cars, motorcycles and personal use assets (such as furniture, household items or electrical goods) that were acquired for a sum less than $10,000 and collectables (such as art, jewellery or coins) that were acquired for a sum less than $500. When such items are acquired for more than these values, they are affected by the tax.
Capital Gains Tax And Property Settlements
Capital gains tax is relevant in family law because, after a divorce or separation, property is usually transferred from one spouse to the other.
Many couples will have purchased or otherwise acquired assets either together or separately. A common example would be an investment property. After a property settlement, whether made in court, by consent or otherwise, the various assets will be divided between the spouses.
A property settlement is based on the principle of equity: each spouse receives a percentage of the divisible pool of assets according to their contributions, financial and non-financial, during the relationship.
In some cases, however, this tax can affect the fairness of the distribution.
Capital Gains Tax Rollover
Family law property settlements are unique in the way they affect capital gains tax.
When the ownership of an asset is transferred from one spouse to another due to the end of a marriage or de facto relationship, the asset can be eligible for capital gains tax rollover.
Capital gains tax rollover means that the party transferring the asset to their former partner disregards or defers the capital gain (or loss) that they would otherwise make. The recipient spouse will make the capital gain or loss when they dispose of the asset in the future. The capital gains tax, therefore, is rolled over to the recipient spouse.
The recipient spouse also receives the cost base of the asset. The cost base is the cost of the asset at its initial purchase, as well as other costs associated with acquiring, holding and disposing of the asset.
In family law property settlements, the rollover generally applies if ownership of an asset, or one party’s share in a jointly owned asset, is transferred from one spouse to the other, and additionally if this transfer of ownership is due to a court order, binding financial agreement or other formal agreement.
The parties cannot choose whether the rollover applies to their situation. If the transfer of ownership of their asset (or assets) fits the circumstances for a rollover, the rollover is mandatory.
Because capital gains tax can affect the equity of a property settlement, it is important to distinguish between the assets affected by and those exempt from capital gains tax in the divisible pool of assets.
When Does The Rollover Apply?
The rollover applies if the marriage or relationship ended on or after 20 September 1985, if ownership of the asset (or a share in a jointly owned asset) is being transferred from one spouse to the other, and if the ownership transfer is the result of a court order, formal agreement or award.
The relevant orders, agreements and awards include the following:
- Court orders made under the Family Law Act 1975, including orders made by consent and orders made under a similar law in a foreign country
- Court orders made under state, territory or foreign legislation relating to the breakdown of a relationship
- Binding financial agreements made under section 90G of the Family Law Act 1975
- Binding financial agreements made under section 90UJ after 1 March 2009 (agreements concerning de facto relationships)
- Binding financial agreements made under state or territory laws
- Binding written agreements made under a corresponding foreign law
- Arbitral awards as referred to in section 13H of the Family Law Act 1975
- Similar awards made under corresponding state, territory or foreign laws
From 1 July 2009, rollover also applies to separating same-sex couples.
State and territory legislation governing binding agreements includes:
- Property (Relationships) Act 1984 (NSW)
- Domestic Relationships Act 1994 (ACT)
- Property Law Act 1974 (QLD)
- Relationships Act 2008 (VIC)
- Domestic Partner Property Act 1996 (SA)
- De Facto Relationships Act 1991 (NT)
- Relationships Act 2003 (TAS)
- Family Court Act 1997 (WA)
In terms of binding financial agreements and similar, the capital gains tax rollover applies if the spouses are separated with no reasonable likelihood of them resuming a relationship and the transfer of ownership of the asset occurred as a direct result of the breakdown of the marriage or de facto relationship.
When Does The Rollover Not Apply?
The rollover does not apply to informal or privately made agreements.
If a transfer of ownership of an asset occurs due to a binding financial agreement but for reasons that are not directly related to the end of the relationship, then the capital gains tax rollover does not apply. For example, if the spouses had an agreement concerning the transfer of ownership of an asset made prior to their separation, the spouse making the transfer would be liable to pay the tax.
How Does Capital Gains Tax Affect Property Settlements?
Because some assets are exempt from the tax while others are not, a property settlement that appears at first fair and equitable may not remain so in the future.
For example, for a couple that owns two properties – one as their main residence and one as an investment property – each party may retain one property upon their divorce or separation.
The main residence is exempt from capital gains tax in any case, and provided that the recipient party continues to use it as their principal home, they will not be liable for capital gains tax when disposing of the asset in the future.
The investment property, on the other hand, is affected by the tax. The party receiving ownership of the investment property (or receiving their former spouse’s share of the investment property) will be liable to pay capital gains tax on the profit made upon their disposal of the asset in the future.
The case Rosati & Rosati 1998 is often cited as a precedent in financial family law matters relating to capital gains tax.
This case established four general principles regarding capital gains tax:
- Whether the incidence of capital gains tax should be taken into account in valuing a particular asset varies according to the circumstances of the case, including the method of valuation applied to the particular asset, the likelihood or otherwise of that asset being realised in the foreseeable future, the circumstances of its acquisition and the evidence of the parties as to their intentions in relation to that asset
- If the Court orders the sale of an asset, or is satisfied that a sale of it is inevitable, or would probably occur in the near future, or if the asset is one which was acquired solely as an investment and with a view to its ultimate sale for profit, then, generally, allowance should be made for any capital gains tax payable upon such a sale in determining the value of that asset for the purpose of the proceedings.
- If none of the circumstances referred to in (2) applies to a particular asset, but the Court is satisfied that there is a significant risk that the asset will have to be sold in the short to mid term, then the Court, whilst not making allowance for the capital gains tax payable on such a sale in determining the value of the asset, may take that risk into account as a relevant s.75(2) factor, the weight to be attributed to that factor varying according to the degree of the risk and the length of the period within which the sale may occur.
- There may be special circumstances in a particular case which, despite the absence of any certainty or even likelihood of a sale of an asset in the foreseeable future, make it appropriate to take the incidence of capital gains tax into account in valuing that asset. In such a case, it may be appropriate to take the capital gains tax into account at its full rate, or at some discounted rate, having regard to the degree of risk of a sale occurring and/or the length of time which is likely to elapse before that occurs.
In Rosati & Rosati 1998, the court clarified that a potential capital gains tax liability should not be automatically taken into account in the property settlement. This will depend on the individual circumstances of each case.
Capital gains tax in property settlements is a complex issue. It is important to seek personal advice tailored to your situation.