Capital Gains Tax in property settlements

At the end of a property settlement, there will be typically be exchanges and transfers of significant assets. Whether these assets will be subject to Capital Gains Tax (CGT) is a common concern.

What is Capital Gains Tax?

Capital Gains Tax (CGT) is a federal tax levied when there is a profit from the sale, transfer, or disposal of an asset. The taxable amount for a capital gain is determined by the difference between the selling price of the asset and its original purchase cost, which covers expenses such as stamp duty, legal, and agent fees.

Typically, capital gains tax is due in the year the capital gain is realised, constituting income for that specific year for the individual who earned the capital gain.

This article specifically explores the intersection of capital gains tax and property settlements.

What Assets attract Capital Gains Tax?

Assets that are subject to capital gains tax include investment properties, boats, and collectibles with a value exceeding $500.

Certain assets are exempt from capital gains tax. The primary residence or family home, as well as personal use items like cars, motorcycles, furniture, or electronics costing less than $10,000, and collectible items such as jewellery or art purchased for less than $500, fall into this category and do not incur CGT.

The Family Home

In essence, capital gains tax is typically applicable to the net profit derived from the sale, transfer, or disposal of property to another party.

Nevertheless, an exemption from capital gains tax is extended to the family home, provided it has been exclusively used by its owners throughout the entire joint ownership period, with the owners being the spouses themselves.

In the context of a family law property settlement, it’s customary for one spouse to retain the family home. In such cases, the other spouse often needs to transfer their stake in the home. This proves advantageous for the retaining party, as any future net profit from the home’s sale remains exempt from taxation.

However, if the home was initially owned by a company or trust and is later transferred to a spouse, the capital gains tax exemption cannot be claimed for the duration the home was held by the company or trust. Consequently, when the home is eventually sold, tax may be applicable to any net profit from the sale.

To qualify for exemption from capital gains tax, the home and its surrounding area must be less than 2 hectares in size.

Superannuation

Transfers of a spouse’s entitlement in a superannuation fund to another spouse are exempt from capital gains tax provided the transfer is in accordance with a court order or binding financial agreement.

SMSFs – transfers between self-managed superannuation funds are eligible for rollover relief.

Foreign Resident Capital Gains Withholding Tax

As of July 1, 2016, the Foreign Resident Capital Gains Withholding Tax now applies to vendors selling real property. Purchasers must withhold 12.5% of the purchase price and remit it to the Australian Taxation Department for properties with a market value of $750,000 or more, including those owned by a company with an indirect interest. 

Unfortunately, this regulation has inadvertently impacted property transfers between separated Australian resident parties governed by family court orders. 

To circumvent the 12.5% withholding, the party transferring property interest must obtain a clearance certificate and provide it to the other party before the transfer. Parties should anticipate the additional cost for obtaining this certificate and consider obtaining it promptly if a relationship property is worth $750,000 or more.

What do you need to consider during a property settlement?

When engaging in a property settlement with a former partner, it becomes essential to carefully assess the potential impact of CGT on any assets slated for transfer during the process.

In the landmark 1988 case of Rosati v Rosati, the Family Court established fundamental principles pertaining to the incorporation of CGT considerations in property settlements:

Firstly, the inclusion of CGT implications in asset valuation needs to be considered on the unique circumstances of the case. Factors can include the valuation methodology of a specific asset, the likelihood of its future disposition, and the intentions of the involved parties regarding the asset.

CGT implications should generally be taken into account when determining the value of an asset in the following scenarios:

• For assets acquired as investments with the intention of eventual profit.
• When the court mandates the sale of a specific asset.
• When a sale is highly probable in the immediate future.
• When a sale is deemed inevitable.

If there is a substantial risk of an imminent sale of an asset, and none of the circumstances above apply, the court may consider this risk in valuing the asset. However, even when factoring in the risk, the court should not incorporate the potential CGT payable upon sale.

The court reserves the right to take CGT implications into account for asset valuation if there are special circumstances in a given case, even if there is no indication of an impending sale. In such instances, the level of risk and the expected duration before any potential sale may influence the rate of CGT that the court views as appropriate for valuing the asset.