This article is intended to be a broad guide to the taxation issues that may arise in family law property settlements. This area is complex, and we recommend that you seek advice from your accountant and lawyer as to your particular circumstances.
This article examines the tax consequences for the different types of assets that are often held by de facto or married couples. We highlight some beneficial restructuring opportunities that are unique to family law property settlements and, if used with care, can allow parties to maximise their property settlement outcome.
There are two main revenue taxes, namely Stamp Duty and Capital Gains Tax:
Section 90 of the Family Law Act exempts from “any duty or charge” under any State or Territory law transfers and other instruments executed “for the purposes of, or in accordance with” a property or spousal maintenance Order or Financial Agreement.
In some cases, if the terms of the Order or Financial Agreement clearly provide for it, property can also be transferred from a spouse to a company (trustee of a trust), or vice versa.
In New South Wales, pursuant to section 68 of the Duties Act 1997, transfers may be matrimonial property (i.e. not just the former matrimonial home, but also investment properties), transferred to either of the parties or a child of one of them, in accordance with an Order of a Financial Agreement.
Capital Gains Tax (CGT)
In lengthy marriages, it is not uncommon for the property pool to comprise investments acquired many years prior with significant unrealised capital gains. Fear can surround the selling down of these assets to create cash sufficient to give effect to a property settlement, given the tax liability which will be triggered on the disposal and which will immediately erode the asset pool.
However, if Court Orders are made, either by consent or at the end of a defended hearing, or if the parties enter into a Financial Agreement in accordance with the Family Law Act, the triggering of such CGT liability is automatically deferred as roll-over relief under the matrimonial exemptions of the Income Tax Assessment Act 1997.
This means that the title to the asset passes from one party to the other on the basis that the unrealised gain is deferred until the spouse receiving the asset disposes of it at some future point. The receiving spouse is deemed to have acquired the asset when the transferor did, the extent of any gain being calculated based on the transferor’s cost base at the time of the transfer to the receiving spouse, plus incidental costs.
This relief can potentially be used to address ‘sleeping giant’ tax issues by moving an asset from one spouse to the other (so as to access concessional rates of tax or capital losses available to one spouse but not the other) before a disposal occurs, so that the optimum tax outcome can be achieved in respect of any capital gains.
Important points to remember:
- CGT assets acquired post 19 September 1985 may be subject to CGT upon the occurrence of a CGT event.
- There is a CGT main residence exemption (you can ignore a capital gain or capital loss you make from a CGT event that happens to a dwelling that is your main residence).
However, this exemption may not apply in full if:
- it was your main residence during only part of your ownership period; or
- it was used for the purpose of producing assessable income.
If a CGT asset is to be sold in accordance with Court Orders or a Financial Agreement and that sale may or will incur CGT, it is important to ensure that CGT is factored into the calculations of the asset pool. Written advice should be obtained from an accountant at the early stages of negotiations taking into consideration variations on possible sale prices and expenditure required to prepare the property for sale.
The most common form of real estate is the matrimonial home which is often held in the joint names of the separating couple. Generally, a settlement which involves the transfer of the matrimonial home from one person to the other will not be affected by Capital Gains Tax. This is because the Capital Gains Tax legislation contains a main residence exemption.
The matrimonial property owned by one spouse or both spouses jointly, can be transferred to the other spouse by way of property settlement, with a stamp duty exemption.
Parties often have investment properties which are held in the name of one or both of the parties, or in the name of a corporate entity as Trustee for a Family Discretionary Trust.
If the property was acquired after 20 September 1985, a transfer of the property will generally trigger a Capital Gains Tax liability. This means that the difference between the cost of the property and the sale price (or half the difference if the property has been held for more than 12 months), will be added to the income of the person selling and taxed at the marginal income tax rate.
An investment property owned by one spouse can be transferred to another spouse by way of property settlement, with a stamp duty exemption.
Where a Trustee of a Family Trust holds real estate this can, in some instances, be transferred to a spouse beneficiary through a Court Order or Financial Agreement. This may attract a ‘rollover relief’ which will postpone the payment of Capital Gains Tax.
It is common in a marriage or de facto relationship for income to be split between both spouses. This is most commonly achieved by way of a family discretionary trust, of which both spouses are beneficiaries. It is important to ensure that any unpaid entitlements are taken into consideration in the property settlement.
Companies – loans, debts and payments
Often spouses operate a business through a company and, commonly those spouses are also the directors and shareholders of that company. In a family law property settlement, it is usual for one spouse to leave the company and for the other spouse to retain it. This is achieved by one spouse transferring their shares in the company to the other spouse. Usually there are no tax consequences arising from the transfers of shares in small family companies of this kind.
One tax issue that may arise with family companies is when property that is owned by the company is to be transferred to a spouse as part of their property settlement. This will trigger a taxation consequence such that the value of the property to be received will be regarded as an unfranked dividend and will form part of the receiving spouse’s taxable income on which they will pay income tax. If the asset is of significant value this could result in a sizable tax liability for the receiving spouse.
Another issue that may arise is where either spouse is a shareholder and that spouse owes a debt to the company or has loan from the family company. This debt or loan will likely have arisen during the relationship and the funds will have been used for the benefit of the whole family. This debt cannot be forgiven or written off. These liabilities will need to be repaid to the company and this obligation to repay the company should be part of the family law property settlement.
The tax implications that may arise through a property settlement can be complex. For those who take advice from their lawyer and accountant in the early stages of their property settlement, there is potential for some restructuring benefits.