Contents
- Capital gains tax
- The interplay between roll over relief and the main residence exemption
- The interplay between roll over relief and the CGT discount
- The interplay between roll over relief and the small business CGT concessions
- The potential application of Division 7A in transferring assets
- GST, stamp duty and land tax implications
- Implications for Superannuation
- Tax Planning and Record Keeping
Capital gains tax
A taxpayer is subject to capital gains tax where a CGT event happens to a CGT asset they own.
When it comes to relationship breakdowns, one would expect a number of potential taxing point under the CGT regime as the assets held by the persons in the relationship (either individually or jointly) may need to be transferred or realised etc. as part of any asset division process.
Fortunately, subdivision 126-A of the ITAA 1997 steps in to provide temporary relief from CGT by enabling the relevant taxpayer to roll over (defer) CGT outcomes which arise from the asset division process.
The term spouse and former spouse is used in the ITAA to refer to a person in the relationship. However, that term is defined broadly to include another individual who, although not legally married to the individual, lives with the individual on a genuine domestic basis in a relationship as a couple.
Section 126-5 of the ITAA provides:
(1) There is a roll over if a CGT event (the trigger event) happens involving an individual (the transferor) and his or her spouse (the transferee), or a former spouse (also the transferee), because of:
(a) A court order under the Family Law Act 1975 or under a State law, Territory law or foreign law relating to breakdowns of relationships between spouses; or
(b) A maintenance agreement approved by a court under section 87 of the Family Law Act 1975 or a corresponding agreement approved by a court under a corresponding foreign law; or
(c) Something done under:
i. A financial agreement under Part VIIIA of the Family Law Act 1975 that is binding because of section 90G of that Act; or
ii. A corresponding written agreement that is binding because of a corresponding foreign law; or
(d) Something done under:
i. A Part VIIIAB financial agreement (within the meaning of the Family Law Act 1975) that is binding because of section 90UJ of that Act; or
ii. A corresponding written agreement that is binding because of a corresponding foreign law; or
(e) Something done under:
i. An award made in an arbitration referred to in section 13H of the Family Law Act 1975; or
ii. A corresponding award made in arbitration under a corresponding State law, Territory law or foreign law; or
(f) Something done under a written agreement:
i. That is binding because of a State law, Territory law or foreign law relating to breakdowns of relationships between spouses; an
ii. That, because of such a law, prevent a court making an order about matters to which the agreement applies, or that is inconsistent with the terms of the agreement in relation to those matters, unless the agreement is varied or set aside.
You can see from this section that there are a number of pathways for eligibility to the roll over relief e.g. where a CGT event happens because of a family court order, an approved maintenance agreement, certain binding financial agreements etc. The clear underlying requirement for these pathways is that the agreement or order is legally endorsed. That means that the CGT roll over exemption may not be available if an asset is transferred under an entirely private arrangement.
Section 126-5 also requires that the CGT event that occurs is either CGT event A1, B1, D1, D2, D3 or F1 occurs. Most commonly the settlement process will involve CGT A1 which concerns the disposal of a CGT asset (by selling it to a third party or transferring it in specie to the spouse). However, a settlement action which involves the the creation of rights over an assets (i.e. CGT event D1, D2 and D3) and the grant of a lease over the asset (CGT event F1) will also attract roll over relief.
Finally, there are number of additional conditions set out in section 126-25 which must be satisfied if section 126-5 (1)(d), (da) or (f) (listed above) apply. Essentially, at the time the CGT is triggered, the spouses or former spouses must be separated with no reasonable likelihood of cohabitation being resumed. Additionally, the CGT event must have happened for reasons directly connected with the breakdown of the relationship.
If the requirements of section 126-5 and 126-25 are satisfied, any capital gain or capital loss made by the transferor spouse is disregarded and the transferee will inherit the transferor’s cost base of transferred assets.
When is the roll over specifically not available?
There is no roll over if:
- The eligibility requirements of section 126-5, 126-25 and 126-15 (addressed below and to the extent applicable) are not satisfied.
- The CGT asset is trading stock to the transferor.
- The CGT asset is a revenue asset to the transferor.
- When CGT event B1 occurs and the CGT asset does not pass to the transferee at or before the end of the agreement.
- When a CGT event occurs that is not CGT event A1, B1, D1, D2, D3 or F1. For example, CGT event E1 for the creation of a trust over the asset by declaration.
The CGT consequences for the transferee spouse when they eventually dispose of the asset under CGT event A1 or B1 occurs
Remember that the CGT roll over relief does not permanently disregard any portion of a capital gain.
This is because the entire capital gain generated between the time the asset was originally acquired by the transferor to the time the asset is eventually realised by the transferee (or where another CGT occurs) will be recognised and worn by the transferee. There is no cost base uplift for the transferee to eliminate the capital gain which accrues from the time the transferor spouse originally acquired the asset to the time the asset is transferred to the transferee spouse in accordance with an order or agreement. It is perhaps better to view the roll over relief in section 126-5 as a way of deferring and shifting the tax burden on the CGT asset to the transferee spouse.
The transferee who acquires the CGT asset will inherit the cost base of the transferor (at the time of transfer) as the first element of the cost base. Therefore, any cost base additions after the transferor acquired the asset may be included in the cost base of the asset in the hands of the transferee (for example, non deductible interest, non deductible land tax, professional fees added to the cost base of the asset).
By way of example, assume Poppy is required to transfer property to Samuel pursuant to a Family Court Order dealing with the distribution of assets following a relationship break down between the two. Poppy’s cost base of the property (a CGT asset held on capital account) was $1,000,000 at the time she acquired the property. Because of the accumulation of a number of non deductible expenses including renovations (capital works), the cost base of the land at the time of transfer was $1,500,000. When Poppy transfers the property Samuel who inherits the cost base of the property as it was at the time of transfer ($1,500,000) as the first element of the cost base of the asset. From that time onwards, further amounts could be added to the cost base of the asset, as allowable.
So if Samuel acquires the property and then undertakes further non deductible renovations of $200,000 and eventually sells the land for $2,000,000, he would make a capital gain under CGT event A1 based on $2,000,000 (as capital proceeds) less the cost base of the asset which is $1,700,000 (i.e. $1,500,000 as the first element cost base + $200,000 further cost base additions). Samuel’s capital gain would be $300,000. This realised capital gain may be discountable to Samuel if the combined period of ownership between Poppy and Samuel was at least 12 months and where the other requirements in Division 115 of the ITAA 1997 were also satisfied.
The CGT consequences for the transferee spouse following the creation of a right under CGT event D1, D2, D3 or F1
If a right (a CGT asset in and of itself) is created over an asset, the spouse who acquires that right will recognise as the first element of the cost base of that right the relevant amount/s listed below:
- CGT event D1: the incidental costs the transferor incurred that relate to the trigger event.
- CGT event D2: the expenditure the transferor incurred to grant the option.
- CGT event D3: the expenditure the transferor incurred to grant the right.
- CGT event F1: the expenditure the transferor incurred on the grant, renewal or extension of the lease.
Remember that expenditure can includes the market value of any property given.
For the transferor, any capital gain or capital loss which flows from the creation of the right will be disregarded.
Pre CGT assets
If the CGT asset transferred was acquired prior to 20 September 1985 (pre CGT), any capital gain to the transferee will generally be disregarded. Importantly, the pre CGT status is preserved to the transferee and to their benefit. The exemption may not be available in certain situations, such as where the majority underlying ownership changes from 20 September 1985 (apart from a change in ownership which is attributed to Subdivision 126-A roll over applying).
To illustrate, assume there are five individuals that acquire a 20% interest in a property in 1980. On 20 September 1985, all five owners continued to hold their interest. Assume in 2000, the transferor spouse was ordered to transfer their 20% interest in the property to the transferee spouse. Then assume that by 2024, two of the five interest holders as at 20 September 1985 had decided to sell their interest in the property. In this case, because the transferee spouse stands in the shoes of the transferor spouse, the transfer of the asset to them does not constitute a change of ownership. Therefore, as the majority underlying interests of the asset has not changed the asset remains a pre CGT asset which is exempt from CGT. There has only been a 40% change in ownership interests from 20 September 1985 i.e. 2 lots of 20%. Refer to Division 149 of the ITAA 1997 for further information.
Capital losses from collectables or personal use assets can be disregarded
If a collectable (such a jewellery or artwork) or personal use asset (assets used or kept mainly for personal enjoyment such a hobby boat) is passed to a transferee, the CGT rollover relief may also apply to disregard any capital gain or loss (if applicable).
What about trust and company assets transferred as part of a relationship breakdown?
The relationship breakdown roll over may also be available if a company or trustee of a trust disposes of a CGT asset to a transferee spouse as set out in section 126-15.
The types of trigger events which can attract roll over treatment are similar to those listed in section 126-5. For example:
- where there is a valid court order relating to breakdown of relationships,
- a maintenance agreement,
- a financial agreement under the Family Law Act.
- something done under a written agreement where that is binding because of a law relating to breakdown of relationships between spouses etc.
The additional conditions which apply to certain types of agreements (i.e. agreements under section 126-15 (1)(d), (da) or (f)) must also be satisfied, if applicable. These additional conditions include that:
- At the time of the trigger event, the spouses or former spouses are separated;
- At the time of the trigger event, there is no reasonable likelihood of cohabitation being resumed; and
- The trigger event happened because of reasons directly connected with the breakdown of the relationship between the spouses or former spouses.
Whether spouses have separated is determined according to how the Family Law Act answers that question.
If relief is available under section 126-15, any capital gain or capital loss made by the transferor entity is disregarded and the transferee will inherit the cost base of transferred assets as it was in the hands of the company or trustee (in the same way as under section 126-5).
Note that the asset must be transferred directly to the spouse in their individual name. The transfer of an asset to an entity controlled by the spouse will not be adequate for eligibility to roll over relief.
Section 126-15 also provides a mechanism which enables the cost base of the shareholders interest in the company to be altered where the asset is transferred by the company to a spouse who is a shareholder. Specifically, the cost base of shareholders may be reduced by the fall in market value of the shares caused by the transfer and increased by any dividend assessed to the shareholder.
However, if the property is transferred to an associate of a shareholder, the cost base of the shareholder’s shares may only be reduced by the fall in market value of the shares.
Refer to Taxation Ruling 2014/5 for further details.
Where the transferor is a controlled foreign corporation or a non resident trust
There are special rules contained in section 126–20 that apply if a CGT event happens to a roll over asset where the transferor was a controlled foreign corporation (CFC) or a non resident trust.
The interplay between roll over relief and the main residence exemption
The main residence exemption may be available to exempt a capital gain or loss where a dwelling is transferred from one spouse or former spouse to another who later sells the dwelling (or where another eligible CGT event happens).
For the transferee spouse to be eligible to utilise the main residence exemption for any component of a capital gain which accrues prior to the spousal transfer, section 118-178 sets out the following requirements:
- That an individual (the transferee spouse) acquires an ownership interest in a dwelling from their former spouse as a result of a CGT event, and:
- The transferor spouse acquired the interest after 20 September 1985; and
- The subdivision 126-A roll over relief applies; and
- A CGT event later happens in relation to that ownership interest (the later event).
If the transferee spouse is eligible, the main residence exemption applies to the later event (when the transferee spouse sells the property) in that way that it would if:
- The transferee spouse’s ownership interest had commenced when their former partner’s ownership interest commenced; and
- From that time until the time the former partner’s ownership interest ended: (i) the transferee used the dwelling in the same way that the former partner used it and (ii) the dwelling had been the main residence of the transferee for the same number of days as it was the former partner’s main residence.
The essence of section 118-178 is that the transferee stands in the shoes of transferor between the time the ownership interest commenced until the time that ownership interest ended (where the spousal transfer occurred). Any entitlement to the main residence exemption for the transferor prior to the spousal transfer is imputed to the transferee. That means that the behaviours of the transferor prior to their disposal of the dwelling will need to be taken in account when determining if the main residence exemption is available to disregard capital gains referrable to that period.
To illustrate, take Tim who owned property and was in a long term de facto relationship with Tammy. The relationship broke down and Family Court Orders were made directing Tim to transfer the property to Tammy. The property was initially acquired by Tim in 2005 for $100,000. From 2005 to 2020 (15 years), the property was used as Tim’s (and later as Tammy’s) main residence (we will assume the cost base of the asset remained unchanged during that period). Tammy was transferred the property and lived in it for 2 years. She then moved out and rented the property for 2 years before selling it in 2024 for $2,000,000.
From first glance, we can see that Tammy is entitled a partial main residence exemption. She stands in the shoes of Tim in both determining her capital gain (per section 126-5) and the period of entitlement to the main residence exemption. Therefore, she inherits Tim’s cost base in the asset ($100,000) and she is deemed to have commenced her ownership interest when Tim’s ownership interest commenced (i.e. 2005). She is also treated as having used the dwelling in the same way as the former partner (i.e. as a main residence from 2005 – 2020). Following the transfer of the dwelling, she uses the property for 2 years as her main residence and then for 2 years as an investment.
Tammy’s capital gain on disposal of the property is $1,900,000. That is, capital proceeds of $2,000,000 less the inherited cost base of $100,000.
From first glance, the main residence exemption can be used to disregard the capital gain which is attributable to the period the property was used her main residence. Therefore, Tammy’s capital gain is reduced to $200,130. That is, 731 days (i.e. 2 years in which the property was not used her main residence from 2022 – 2024) / 6,940 days (i.e. the total ownership period of 19 years from 2005 – 2024) x $1,900,000 (i.e. the capital gain).
On closer inspection, we can see that Tammy may also be entitled to utilise the six year absence rule which enables her to classify the dwelling as her main residence for up to six years while the property is rented. Assuming she meets the eligibility criteria and does not recognise another dwelling as her main residence during the absence period, Tammy is able to treat the dwelling as her main residence from 2022 – 2024 despite not having used it as her main residence during that period. The entire capital gain of $1,900,000 can be disregarded.
As you can see from this example, the transferee spouse’s eligibility for a partial or full exemption really depends on how both persons used the dwelling (that is, the way the transferor spouse used the dwelling prior to the transfer of the dwelling and then the way the transferee spouse used the dwelling after the transfer).
Remember that access to the main residence exemption is also dependent on Australian tax residency status. A non resident of Australia for taxation purposes is not entitled to the exemption.
The main residence exemption is not available to a transferee spouse who acquires an ownership interest in a dwelling from a company or trustee, even where the roll over under Subdivision 126-A was available.
The interplay between roll over relief and the CGT discount
The CGT discount remains available to the transferee spouse to discount any future capital gain on the transferred asset, provided of course that the taxpayer satisfies the basic eligibility criteria in Division 115.
Importantly, for the purposes of the 12 month rule, the transferee spouse is deemed to have acquired the asset on the same day the asset was acquired by the transferor. Therefore, the transferee spouse will not miss out on the CGT discount if they sell the transferred asset within 12 months provided the combined period of ownership of the asset (between the spouses) was at least 12 months.
The interplay between roll over relief and the small business CGT concessions
The small business CGT concessions remain available to the transferee spouse to reduce any future capital gain on the transferred asset, provided of course that the taxpayer satisfies the eligibility criteria in Division 152.
For the purposes of the active asset test, where a transferee acquires an active asset the transferee can make a choice to stand in the shoes of the transferor. That is, the transferee can elect to be treated as having acquired the asset at the same time as the transferor and be deemed to have used the asset (either in active manner, or not) in the same way as the transferor.
There will be circumstances where the choice is not beneficial e.g. if it means the asset has not been active for at least 7.5 years or half of the ownership period in which case the transferee spouse would not be eligible to utilise the small business CGT concessions.
Note that there are certain circumstances where the choice is compulsory.
If the choice is not exercised, the transferee spouse will be treated as having acquired the active asset at the time of transfer.
The active asset choice may also impact on eligibility to the 15 year exemption. If the transferee makes the election, the 15 year period will commence when the transferor acquired the asset. That means the 15 year continuous ownership period will remain unbroken for the transferee. In this way, the transferee spouse may benefit from earlier access to the highly desirable concession.
The potential application of Division 7A in transferring assets
The transfer of an asset from a company to a spouse or former spouse may constitute a payment for Division 7A purposes (if that transferee is a shareholder of the company or an associate of a shareholder of the company). Such payment is deemed to be a dividend unless the payment is put onto complying loan terms in which case the payment will be treated as a loan. If the payment is considered a dividend, it will generally be assessable to the shareholder.
Generally, a deemed dividend under Division 7A is not able to be franked. However, section 109RC of the ITAA 1936 provides relief by enabling a dividend to be franked if it is taken to be paid because of a family law obligation. The dividend must be franked at the private company’s benchmark franking percentage for the franking period in which the dividend is paid. If there is no benchmark franking percentage for the period, then the dividend is franked at a franking percentage of 100%.
The issue with the treatment of a payment as a dividend is particularly problematic where the company does not have adequate franking credits or a high enough benchmark franking percentage to offset against the transferee’s tax liability referrable to the assessable dividend.
GST, stamp duty and land tax implications
Keep in mind that a number of alternative taxes may be imposed in respect of the transfer of property as part of a relationship breakdown.
This includes GST, stamp duty (or transfer duty) and land tax.
There may be exemptions from these taxes. However, this article does not delve into the operation and availability of such exemptions.
Implications for Superannuation
If a relationship breakdown occurs (i.e. where the spouses or former spouses are separated and there is no reasonable likelihood of cohabitation resuming), superannuation interests may be subject to splitting.
This is usually also subject to any restrictions imposed by the rules of the relevant superannuation fund.
This means that a splitable payment can be made from one spouse’s superannuation fund to the other spouse’s fund by way of roll over. It may also be possible for the non member spouse to open a new super account for themself within the same fund as the member spouse. If a non member spouse has met a condition of release, the splitable payment may be made directly to them as a super benefit.
If a super income stream had commenced prior to the relationship breakdown, the income stream itself could be split. Generally, the income stream would need to be commuted to a lump sum and the non member spouse would be paid their relevant entitlement that way. Any income stream or lump sum payment to the non member spouse forms an entirely separate superannuation benefit for them.
As set out in section 126-140 of the ITAA, if an interest in a small superannuation fund (i.e. an SMSF) is subject to a payment split and the trustee of the fund transfers a CGT asset to the trustee of another complying fund for the benefit of the non member spouse, then (provided the other requirements in section 126-140 are met), any capital gain or capital loss flowing from the transfer may be disregarded and rolled over. There may also be transfer duty exemption on the transfer which occurs.
Essentially, section 126-140 provides a similar roll over type exemption to section 126-5 and 126-15 for the transfer of a CGT assets from one fund to another.
Tax Planning and Record Keeping
To the extent possible, it is worth keeping in mind that the tax treatment of dividing assets in a relationship breakdown context varies according to the asset and the way it is divided.
Assets such as cash held by an individual, a main residence, superannuation, pre CGT assets may be more tax effective to dispose of, whereas assets such as revenue assets, cash in a company, or assets with significant increases in value from acquisition may be less tax effective to dispose for reasons outlined in this article.
It is very important to keep in mind that many of the tax concessions afforded in a relationship breakdown context rely on sufficient recording keeping. Appropriate records are necessary to substantiate the circumstances which grant the taxpayer eligibility to the various concessions. Without these, you can assume many of the concessions addressed in this article will not be available.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.