Relationship breakdown rollover – CGT on property acquired as part of a divorce settlement
Divorce or Separation and Capital Gains Tax
When two people separate or get divorced, assets that are transferred between them typically fall under the “relationship breakdown rollover,” which means that capital gains taxes, which are typically applied when ownership of an asset changes, are postponed. When the recipient of the asset later disposes of it, CGT will be due.
Criteria for the Rollover for Relationship Failure
If a relationship breakup, divorce, or separation results in the transfer of an asset to you:
– The rollover is only applicable if the asset is transferred in accordance with a court order or another official agreement.
– When you sell a rollover asset, you must use your former spouse’s cost basis to determine your CGT as if you had owned it since your ex-spouse bought it.
– If the asset is a piece of real estate, you can qualify for the main residence exemption from CGT.
You must use the asset if the rollover is applicable to it.
When a relationship fails, CGT and how to handle the family home
Any financial arrangement involving your family home following a divorce or separation must be formalized by a court order, a maintenance agreement, or another legally binding financial arrangement, as we mentioned above. You should stay away from informal private agreements because the asset must be transferred through a formal agreement or settlement in order for capital gains tax (CGT) rollover provisions to be applicable. If not, the property will be deemed to have been sold by the disposing spouse at market value, resulting in a capital gain if market value exceeds cost, and will be purchased by the receiving spouse at market value. The main residence exemption typically prevents CGT from being due when the family home is transferred between divorcing spouses.
Notably, CGT will also be applicable in cases where the family home was used to make assessable revenue, such as when a business was operated out of it or a room was rented out. The liability is determined by the times and square footage set aside in the home for business operations.
The effects of CGT on the receiving spouse depend on what transpires following the divorce. Typically, there are three possibilities:
- If the receiving spouse continues to stay in the home, the principal residence exemption is still in effect, and the property may be sold without incurring CGT.
- A six-year primary residence exemption is applicable if the home is rented out without another main residence being designated.
- The value at the date the property is rented out will become the CGT cost base if the receiving spouse sells the primary residence and purchases another.
The rollover relief applies to vacation houses and investment properties, so when assets are divided, CGT is not levied.