Tax and Capital Gains Tax in Divorce and Property Settlements

Why Tax Matters in a Settlement

The family-law property regime under Part VIII (marriage) and Part VIIIAB (de facto) of the Family Law Act 1975 (Cth) requires the parties and the Court to identify the property pool, assess contributions and future needs and make orders that are just and equitable in the circumstances. Tax intersects with that regime at every step: it affects the value of individual assets, the fair allocation between the parties, the choice between sale and transfer, and the transactions that will be needed to implement the settlement.

Two assets with the same market value can have materially different after-tax values because of embedded capital gains, depreciation history, main-residence history, franking-credit balances, Division 7A loan accounts, trust interests or foreign-tax exposure. A settlement that ignores those differences can produce a result no party intended.

CGT Rollover Under Subdivision 126-A

Subdivision 126-A of the Income Tax Assessment Act 1997 (Cth) provides an automatic rollover for certain transfers of CGT assets between spouses or former spouses on relationship breakdown. Where the rollover applies:

• the transferor disregards any capital gain or loss on the transfer;
• the transferee acquires the asset with the transferor's cost base and, in relevant cases, the transferor's acquisition date and other CGT attributes; and
• tax is generally deferred until the transferee's later disposal of the asset.

The rollover is not automatic in the colloquial sense. It requires that the transferor and transferee are within the class described in section 126-5 (marriage) or section 126-15 (de facto), that the transfer is because of the breakdown of the relationship, and that the transfer occurs under one of the qualifying instruments listed in the Subdivision — a Court order under the Family Law Act, a maintenance agreement approved by the Court, an award of an arbitrator, or a Binding Financial Agreement under Part VIIIA or Part VIIIAB that satisfies the statutory conditions. A separation alone, an informal agreement or an ad-hoc transfer does not engage the rollover.

The rollover defers rather than removes the tax. The transferee bears the future capital gains tax on the eventual disposal, calculated using the transferor's cost base and, generally, the transferor's acquisition date. In economic terms the latent tax travels with the asset and should be reflected in negotiations.

The Family Home and Main-Residence Exemption

The main-residence exemption in Subdivision 118-B of the Income Tax Assessment Act 1997 (Cth) may reduce or eliminate the capital gain on a dwelling that has been used as the taxpayer's main residence. The exemption is not automatic — it depends on ownership and occupation history, the absence rules in section 118-145, any income-producing use, area and use limits, ownership through a trust or company, and, on relationship breakdown, the interaction between the parties' separate main-residence histories under section 118-178.

Where the home has been rented at any time, used partly for business, held for less than the full ownership period as a main residence, or transferred through a trust or company structure, the exemption may be partial or unavailable and specific advice is required. An external sale by court-ordered auction is a disposal on its own merits and is taxed accordingly; the subsequent division of proceeds between the parties is generally not a separate CGT event.

Investment Property, Shares and Managed Investments

A transfer of an investment property, listed shares, managed-investment units or fixed-trust units between former spouses under a qualifying instrument may attract the Subdivision 126-A rollover. The retaining party then holds the asset with the transferor's cost base, acquisition date, depreciation and capital-works history under Division 40 and Division 43, and any prior main-residence interaction. On future disposal:

• the reduced cost base after capital-works claims can produce a materially larger taxable gain than the simple purchase-price-versus-sale-price calculation suggests;
• the CGT discount under Division 115 depends on the transferor's original acquisition date being carried across;
• capital losses generally remain with the party that incurred them and cannot simply be transferred to a former spouse; and
• trust and company losses are subject to the continuity-of-ownership, same-business and family-trust election rules in their own right.

Businesses, Companies, Trusts and Division 7A

Where a private company, a discretionary or unit trust, a partnership or a sole-trader business forms part of the pool, the transaction implemented matters as much as the words of the family-law order. A transfer of shares is not the same as a transfer of underlying assets; a buy-back is not the same as a dividend; a change of trustee is not, without more, a transfer of the underlying beneficial interests; a resettlement risk can arise on trust variations under Commissioner of Taxation guidance and Commissioner of Taxation v Clark (2011) 190 FCR 206.

Division 7A of the Income Tax Assessment Act 1936 (Cth) targets payments, loans and forgiven debts by private companies to shareholders or their associates. Family-law transfers of company assets to an individual, extinguishment of shareholder or director loan accounts, and restructures touching related-party balances can each trigger deemed dividends. The small-business CGT concessions in Division 152 have their own basic conditions — the active-asset test and the maximum net asset value test or small-business turnover test — and cannot be assumed to be available on a relationship- breakdown transfer.

Instruments should be drafted so that the transaction actually implemented — whether a share transfer, an asset transfer, a distribution, a repayment on complying Division 7A terms or a restructure — matches the terms of the Order or Binding Financial Agreement. Divergence between the instrument and the implementation is the single most common source of unexpected tax on settlement.

Superannuation and SMSFs

Superannuation is dealt with under Part VIIIB (marriage) and Part VIIIAB Division 4 (de facto) of the Family Law Act, and is generally split by a payment split or interest split under a superannuation splitting order or agreement. Splitting an accumulation interest does not, by itself, trigger CGT. Where a self-managed superannuation fund holds assets, a splitting order may require an in-specie transfer or a rollover to another fund; specific CGT relief may be available under the provisions preserved in the transitional CGT relief provisions of the ITAA 1997, but the availability depends on the fund's circumstances, the form of the transfer and the applicable regulations.

SMSF in-specie transactions must also satisfy the in-house asset rules, the related-party acquisition prohibition in section 66 of the Superannuation Industry (Supervision) Act 1993 (Cth) and the fund's investment strategy. Preservation, transfer-balance-cap and contribution rules continue to apply.

Transfer Duty on Relationship-Breakdown Transfers

Transfer duty (stamp duty) is imposed under state and territory law. Each jurisdiction provides a relationship-breakdown concession or exemption for qualifying transfers of dutiable property between spouses or former spouses effected under a court order or a qualifying binding agreement — for example, section 44 of the Duties Act 2000 (Vic) in Victoria. The relationships covered, the property types covered (real property, motor vehicles, business assets, units or shares in landholders), the form of the instrument required and the application procedure differ between jurisdictions and between transaction types within a jurisdiction. Eligibility should not be assumed and the application is normally lodged with the state or territory revenue authority.

Landholder duty and corporate reconstruction relief regimes may also be engaged where interests in landholding entities are transferred as part of the settlement.

Latent Tax Liabilities in the Just-and-Equitable Assessment

The Family Court has long recognised that latent CGT and other tax liabilities attached to an asset may be relevant to the assessment under sections 79 (marriage) and 90SM (de facto). Since Rosati v Rosati (1998) 23 Fam LR 288 and Campbell v Campbell (1998) 22 Fam LR 720 the authorities have declined to adopt a rigid rule. The weight given to a latent tax liability depends on:

• whether the disposal is contemplated, likely, uncertain or speculative;
• the quality of the evidence supporting the estimate;
• the asset's history, including cost-base records and depreciation claims;
• who controls the disposal decision under the proposed orders; and
• whether the tax will be crystallised as part of implementing the orders.

Latent liabilities are not mechanically deducted at nominal face value; they are not automatically ignored merely because the CGT event has not yet occurred. An evidence-based estimate — supported where appropriate by an accountant's report — is the usual approach. The Court may recognise the liability by direct valuation adjustment, a reserve, an indemnity or a section 75(2) or 90SF(3) factor.

Drafting Instruments and Implementation

To engage the Subdivision 126-A rollover and any available state transfer-duty concession, the instrument and the implementation must line up:

• the instrument (Consent Order, court order, arbitral award or qualifying Binding Financial Agreement) must identify the asset transferred, the parties, and the connection with the breakdown of the relationship;
• the transaction implemented must match the instrument — the same asset, the same parties, the same character;
• cost-base records, depreciation schedules, main-residence history, prior rollover documents, corporate-action records, trust deeds, distribution minutes and beneficiary loan ledgers should be handed across with the asset; and
• indemnities between the spouses do not bind the Australian Taxation Office or a state revenue office — they allocate risk contractually between the parties only.

Neither a Consent Order nor a Binding Financial Agreement binds a revenue authority as to the availability of any concession. The tax outcome depends on the legislation, the facts and what is actually done to implement the settlement.

When to Obtain Advice

Tax should be considered at the outset of any family-law negotiation where the pool includes a family home that has ever been rented, an investment property, listed or unlisted shares, managed investments, an interest in a business, a private company, a trust or SMSF, a beneficiary or shareholder loan account, an inheritance, cryptocurrency, a foreign asset or a contemplated sale or restructure. Time limits under the Family Law Act — 12 months from the divorce order under section 44(3), or 2 years from the end of a de facto relationship under section 44(5) — apply independently of any tax analysis and cannot be extended by tax considerations.

Coordinated family-law, commercial and accounting advice obtained before values, retention and implementation are agreed is materially more effective than advice sought after documents are signed.

Frequently Asked Questions