When negotiating a property settlement with your former spouse, it is important to consider any potential Capital Gains Tax (“CGT”) implications.
What is CGT?
CGT refers to the tax payable on the profit, (the capital gain), of selling an asset such as property. Some assets, such as the marital home, are exempt from CGT. CGT is not a separate tax but a part of your income tax, as the capital gain is reported as income on your tax return. GCT refers to that portion of your income tax that is attributable to the increase in income due to your capital gain.
CGT Rollover
After a relationship breaks down, assets transferred between former spouses usually qualify for a CGT rollover. The rollover will apply only if the asset is transferred under a court order or formal agreement. The transfer of the asset from one spouse (“the transferor”) to another (or from a company to a spouse) would normally attract CGT, however, the CGT is rolled over to the spouse receiving the asset (“the transferee”). When the transferee disposes of a rollover asset, the CGT is calculated as though they had owned it from the date the transferor acquired it and at the cost base it was acquired for.
Latent GCT
Latent CGT liabilities can also be taken into account when valuing assets in the property pool. Latent GCT refers to the amount of tax you expect to pay on the sale of an asset in the future.
The recent decision of Shnell & Frey [2021] FedCFamC1A 55 involved a 35 year marriage and a property pool of over $8 million. The wife appealed the decision of the trial judge on several grounds, one being her refusal to include the latent CGT liability in relation to the wife’s investment property on the balance sheet.
The Full Court relied upon Rosati v Rosati [1998] FamCA 38; (1998) FLC 92-804 which summarises the general principals to be followed regarding the treatment of potential CGT:
- Whether the incidence of capital gains tax should be taken into account in valuing a particular asset varies according to the circumstances of the case, including the method of valuation applied to the particular asset, the likelihood or otherwise of that asset being realised in the foreseeable future, the circumstances of its acquisition and the evidence of the parties as to their intentions in relation to that asset.
- If the Court orders the sale of an asset, or is satisfied that a sale of it is inevitable, or would probably occur in the near future, or if the asset is one which was acquired solely as an investment and with a view to its ultimate sale for profit, then, generally, allowance should be made for any capital gains tax payable upon such a sale in determining the value of that asset for the purpose of the proceedings.
- If none of the circumstances referred to in (2) applies to a particular asset, but the Court is satisfied that there is a significant risk that the asset will have to be sold in the short to mid term, then the Court, whilst not making allowance for the capital gains tax payable on such a sale in determining the value of the asset, may take that risk into account as a relevant s.75(2) factor, the weight to be attributed to that factor varying according to the degree of the risk and the length of the period within which the sale may occur.
- There may be special circumstances in a particular case which, despite the absence of any certainty or even likelihood of a sale of an asset in the foreseeable future, make it appropriate to take the incidence of capital gains tax into account in valuing that asset. In such a case, it may be appropriate to take the capital gains tax into account at its full rate, or at some discounted rate, having regard to the degree of risk of a sale occurring and/or the length of time which is likely to elapse before that occurs.
The Full Court held that the circumstances referred to in guideline (2) of Rosati applied. The wife gave credible evidence that she intended to sell her investment property in the next two years in order to purchase another property in which to live. Although unable to provide the exact amount of the latent CGT liability, the wife provided evidence of the CGT payable if the property was sold at the date of the trial, being almost $300,000. The trial judge erred in failing to find that the sale of the property “would probably occur in the near future”. The property had always been rented and there was no evidence indicating that the wife intended to occupy the property before the sale. The Full Court held that it was appropriate for the latent CGT to be included as a liability of the wife in the balance sheet.
In contrast, in the matter of Blake & Blake [2007] FamCA 10, the husband gave evidence that he intended to rely on the rental income of the property as his principal source of income and he did not intend to sell the property until some stage in “the future in the longer term”. The trial judge allowed the latent CGT as a liability on the balance sheet, as the property had been originally acquired as an investment and would ultimately be disposed of for a considerable profit. However, the Full Court found that the husband’s clear desire was to retain the property for the long term, and it would not be just and equitable for the wife to share the burden of potential CGT.
It is important to note that the Court cannot deal with the treatment of latent GST without evidence of both the intention of a party in relation to the future dealings of an asset and a calculation of potential CGT liability from a person properly qualified to give it.
If you have a property settlement issue, please contact us on (02) 9688 6023 to book a free first consultation with our experienced family lawyers.
This is not legal advice.
