Protecting Your Wealth: Understanding Tax Considerations in Property Settlement
If you’re facing a property settlement as part of a divorce or separation, the financial complexity extends far beyond dividing assets. For individuals with significant assets, such as investment properties, share portfolios, business interests, trust structures, and superannuation, understanding the tax implications is essential to protecting your financial position.
This article explores some of the key tax considerations that arise during property settlement. While we can guide you through the tax implications of different settlement scenarios, Accounting Heart are accountants, not lawyers. You'll need legal advice for the settlement process itself.
Understanding Property Settlement
When a marriage or de facto relationship breaks down, the Federal Circuit and Family Court of Australia has the power to make financial and property orders under Part VIII of the Family Law Act 1975.
Property settlement addresses how assets and debts are divided between the separating parties. The tax implications of how these assets are divided can significantly impact the after-tax value of your settlement. This is where strategic tax advice becomes invaluable.
Capital Gains Tax (CGT)
Capital gains tax (CGT) is one of the most significant tax considerations in property settlement. When assets are sold or transferred, CGT may apply to any capital gain, which is the difference between what you paid for the asset and what it's worth now.
How CGT generally works
Under normal circumstances, when you dispose of an asset, you calculate your capital gain by taking the sale proceeds and subtracting the asset's cost base (what you originally paid for it, plus certain costs). For assets held for 12 months or more, you may be entitled to the 50% CGT discount. The taxable capital gain is then added to your other income and taxed at your marginal tax rate.
For affluent individuals with substantial investment portfolios or property holdings, the potential CGT liability arising from a property settlement could be significant without proper planning.
CGT Rollover Relief for relationship breakdown
Fortunately, Australian tax law provides specific relief for asset transfers during relationship breakdown.
When Rollover Relief applies
The CGT relationship breakdown rollover applies only if assets are transferred under a court order or another formal agreement. Specifically, it applies to transfers made in relation to:
Court orders
Binding financial agreements under the Family Law Act
Arbitral awards
Certain state or territory relationship agreements
This is critical: the rollover does not apply if you and your spouse divide assets under a private or informal agreement. The agreement must have legal force.
How the Rollover works
When rollover relief applies, the person transferring the asset doesn't pay CGT at the time of transfer. Instead, the receiving spouse will pay CGT later when they sell or dispose of it. This defers the tax liability rather than eliminating it.
Importantly, when you dispose of a rollover asset, you calculate your CGT as though you had owned it since your former spouse acquired it. The receiving spouse "inherits" the transferring spouse's cost base.
Example
If your former spouse purchased an investment property for $500,000 fifteen years ago, and it's now worth $1.5 million, you inherit that $500,000 cost base. When you eventually sell the property, you'll be liable for CGT on the full $1 million gain (subject to any applicable discounts or exemptions).
Strategic implications
This creates important strategic considerations such as:
Timing of asset realisation
Which party realises the gain
Offsetting capital gains with capital losses
Considering which assets to hold versus sell
Structuring the settlement to minimise overall tax
These are complex considerations that benefit from professional tax modelling specific to your circumstances.
Main Residence Exemption
If a property was used as the main residence, additional exemptions may apply. The main residence exemption can fully or partially exempt a property from CGT. When a property transfers between spouses under rollover relief, the receiving spouse must consider how both they and the transferring spouse used the property during their respective ownership periods to determine if a main residence exemption applies.
This becomes particularly complex when a former family home has been used to generate income at some point, or when one spouse continues to live in it while the other has established a new main residence.
SMSF Asset Transfers and CGT
For individuals with self-managed super funds, property settlement often involves SMSF assets.
A CGT asset of a small super fund (one with no more than 6 members) can be transferred to another complying super fund under the relationship breakdown rollover, with the consequences being the same as for other transfers between spouses.
This is particularly important when SMSF assets include property or shares with significant unrealised capital gains. The rollover relief allows these assets to be transferred between spouses' super funds without triggering immediate CGT.
However, it's crucial to understand that while the rollover defers CGT on the transfer, the underlying assets may still trigger CGT when the SMSF eventually disposes of them. The receiving spouse's SMSF inherits the cost base of the assets, just as with non-super assets.
The Net Tax Value Question
For SMSF splits, it's essential to consider the "net of tax value" of the underlying assets. Simply splitting the nominal value of shares or property on a 50/50 basis doesn't account for the tax liabilities embedded in those assets.
Example
If an SMSF holds shares worth $2 million with a cost base of $500,000, there's a $1.5 million unrealised capital gain. Depending on the fund's circumstances, there could be significant future CGT liability when those shares are sold. A prudent party will request not just an independent valuation of SMSF assets, but also a tax analysis to determine the after-tax value.
This is where accounting expertise becomes essential for modelling different scenarios and understanding the true value being transferred.
Superannuation splitting: Tax treatment
Superannuation is treated as property under the Family Law Act 1975, and superannuation splitting laws allow it to be divided between the couple when they separate.
No tax on super splits
Super splits themselves are not taxable events. The tax consequences of splitting super on a relationship breakdown are that super lump-sum and income-stream payments are taxed to each party separately.
When super is split in relation to court orders or binding financial agreements, there's no tax payable at the time of the split. Tax becomes relevant only when the superannuation is accessed (if accessed before age 60).
Tax components transfer proportionally
Superannuation balances consist of two parts: a taxable component and a tax-free component. The proportions vary depending on how the super was accumulated (employer contributions vs. personal contributions).
When super is split, both spouses receive the same proportion of taxable and tax-free components. You can't cherry-pick the tax-free portion for one person and leave the taxable portion with the other.
Total super balance implications
Your total super balance is affected by the amount you received (or lost) from the split. This matters because your total super balance determines your eligibility for certain super contributions.
For the receiving spouse, an increase in total super balance may limit future concessional or non-concessional contribution opportunities. For the transferring spouse, a reduction in total super balance may restore contribution capacity that had previously been exceeded.
This creates strategic planning opportunities around future wealth accumulation that should be considered as part of the overall settlement.
Why professional tax advice matters during divorce or separation
The tax implications of property settlement decisions can amount to hundreds of thousands of dollars for individuals with complex financial portfolios. Understanding these implications helps you:
Negotiate more effectively
When you understand the after-tax value of different settlement options, you can negotiate from a position of knowledge rather than making decisions based on pre-tax values that may be misleading.
Preserve wealth
Strategic structuring of settlements can legitimately minimise the overall tax burden, preserving more wealth for both parties.
Avoid costly mistakes
Some settlement structures that seem straightforward can trigger unexpected tax consequences. Professional advice identifies these risks before they become problems.
Model different scenarios
Sophisticated tax modelling can demonstrate the long-term implications of different settlement options, helping you make informed decisions.
Coordinate with legal advice
Your accountant and lawyer should work together to structure settlements that are both legally sound and tax-effective.
The Accounting Heart approach
If you’re navigating a property settlement, we work compassionately and sensitively with you to:
Model the tax implications of different settlement scenarios
Analyse the after-tax value of assets being divided
Provide sophisticated tax analysis of SMSF assets
Coordinate with your legal advisors to structure tax-effective settlements
Identify opportunities to legitimately minimise tax within the settlement framework
Plan for your financial future post-settlement
We provide discreet, professional advice focused on protecting your financial position.
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Sources
https://www.fcfcoa.gov.au/fl/divorce/divorce-overview
https://www.fcfcoa.gov.au/fl/fp/overview
Disclaimer: This is general information only and is not advice of any sort. No warranty or representation is provided by Accounting Heart Pty Ltd as to the accuracy, currency or completeness of the information contained in this blog. Readers of this blog should not act or refrain from acting in reliance upon any information contained herein and must always obtain appropriate taxation and/or other advice as may be appropriate having regard to their particular circumstances. The information in this article relates to tax law and should not be considered legal advice regarding property settlement. You should obtain legal advice from a qualified family lawyer for all aspects of property settlement proceedings.