Taxing times on divorce and the family home

For most divorcing couples, how to deal with the family home will be an important issue.

It may be agreed or ordered by the court that the jointly owned family home will be sold.

More often, one of the parties will remain in the home (especially if there are young children) on one of the following bases.

• The house is transferred to one party with him/her assuming sole responsibility for the mortgage either with, or without, some sort of payment for the other’s share;
   
• The wife (usually, though it could be the husband) has the right to live in the house until, say, the youngest child is 18 whereupon the house is sold and the net  proceeds divided 50:50. This is what’s known as a “Mesher Order”; or
   
• The wife has a similar right to live in the house for a specified period with the husband entitled to a specific amount when the house is sold. This is what’s known as a “Martin Order”.

Divorce is not a “tax free zone”; Capital Gains Tax liability on a transfer of assets between the parties can be a major problem; but might the family home generally be regarded a “tax free asset”?

Capital Gains Tax

When you dispose of your main residence, or their share of it, the gain is usually CGT free under what is commonly called “Principal Private Residence Relief” (PPR).

If a married couple separate and the husband moves into rented accommodation, the family home will cease to be his main residence. Nevertheless, PPR will apply on any sale of the former family home (including the husband’s share), or on the husband’s transfer of that share to his wife (or ex-wife):

• In any event if the sale/transfer is within 18 months of his moving out, even if he’s bought a new place in the meantime;
   
• At any time if he hasn’t, meanwhile, bought a new property.

If, on the transfer to his wife, the husband retains the right to a fixed sum when the property is sold (a “Martin Order”), that future entitlement won’t be taxable when eventually received, but if the deal/order provided for an interest payment on top, that interest will be chargeable to income tax.

Where the transfer is on a “Mesher” basis, the ultimate sale of the property shouldn’t bring down a CGT charge on the husband. Mesher orders create a trust of the husband’s share of the property under which the wife can enjoy the property until, say, the youngest child reaches 18. PPR is available where a beneficiary (the wife) occupies a property under a trust arrangement; it does not matter if the husband has long ago bought a replacement main residence of his own.

Inheritance Tax

Inheritance tax (IHT) is rarely an issue on divorce.

Any transfers before decree absolute qualify for the “spouse exemption”.

Transfers post decree absolute normally aren’t treated as gifts requiring survivorship by 7 years before falling out of account for IHT. They’re generally exempt by reason of there being no “gratuitous intent” or on the basis the transfer is made for the maintenance of the other party or the children.

“Mesher” arrangements involve the creation of a trust. Transfers to a trust are normally chargeable to lifetime IHT but are normally exempt under the same principles of no gratuitous benefit of family maintenance. But there is a small trap in that the tenth anniversary charges to IHT (maximum 6%) that apply to trusts will apply, similarly, to a trust created under a Mesher Order.

Stamp Duty

A “sale” of an interest in the family home by one party to the other (usually by one party assuming sole responsibility for mortgage debt) on divorce pursuant to a court order or by agreement is free of stamp duty (whereas ,for an unmarried couple, such transfer is liable to stamp duty).

Might the principal stamp duty issue arise where, say, the husband has moved out of the family home, but his name is still on the title, and he wants to buy a new home? Will he be liable for the 3% stamp duty surcharge because he is buying an additional residential property? The answer (you’ll be relieved to hear) is generally “no” the surcharge won’t be payable if the parties are divorced, formally separated, or can establish that the separation while not “official” (as will normally be the case) is nevertheless “permanent”.