What Happens To My Investment Property In A Divorce?
Written by: Krys Canny-Smith l Accounting Team
Sometimes we receive questions from couples who are divorcing about the capital gains tax consequences of the divorce. More often, though, we don’t get questions about it, and that’s more of a worry for us because it means that couples may be dividing their assets and not considering whether the assets they receive in the divorce have future tax liabilities attached to them.
The most common asset we see that will have future tax liabilities is investment properties, and that is exactly what we are going to base this article on! However, we could equally apply the same concept to any investment such as shares, managed funds, cryptocurrency, and land.
Most people who purchase investment properties understand the broad principles of capital gains tax. They know that they can claim the expense against the income of the property, and when they sell it, will need to consider and calculate capital gains tax.
In this article, we will work through some very simple examples and ignore potential capital gains tax exemptions, such as the 6-year rule, and disregarding the potential ways to minimise capital gains tax such as contributions to superannuation. These are very rough figures used for this case study only, and in calculating the exact capital gains tax payable we would include adjustments on settlement, stamp duty, legal fees and depreciation, among other things that can also lead to capital gains tax when selling your rental property.
Let’s Give You Some Background
Chris and Alex have been in a relationship and living together as partners since 2008 and are both Australian residents.
They own their principal place of residence jointly, which has an estimated current value of $700,000. As Chris and Alex have lived in this for the entirety of the time that they have owned it, and it has been their principal place of residence, there will be no capital gains tax consequences on the eventual sale of this property.
In 2010 Chris and Alex purchased an investment property in a nearby town. The investment property has been rented out from the time of purchase through to the time they separated in 2023. The investment property was purchased for $400,000 and also has an estimated current value of $700,000.
Investment Property Is Sold + Becomes Part Of The Property Pool
Neither Chris nor Alex wants to live in the investment property. They both like the town they live in and have decided to sell that property so that it becomes part of the property pool, to be divided up per their agreed settlement.
As it is being sold by them, we calculate the capital gain as $300,000 ($700,000 sale price, less $400,000 purchase price). We discount this gain by 50% as they have owned the property for more than 12 months, and include the share of the gain in each of Chris and Alex’s income tax returns. They will then pay tax based on their individual circumstances and marginal tax rate and depending on their agreed settlement terms.
In this instance, both partners can move forward knowing that the capital gains tax has been dealt with and be clear on the money left in the property pool to be divided by them.
Alex Moves Into The Investment Property
Alex has decided to move into the investment property as they prefer the town it is located in. Alex and Chris have agreed that as both properties have an estimated current value of $700,000, Alex can take the investment property in the settlement and Chris will keep the principal place of residence.
While on the surface this seems like a fair arrangement, what Alex does not realise is that there is a future capital gains tax consequence attached to the investment property.
To illustrate, let’s assume that Alex moves into the investment property and lives there for five years. At the time it was sold for $900,000. Moving into the property in 2023 and living in it until 2028 will only exclude capital gains tax for that five-year period, it does not wipe out the tax applicable on the period in which the property value grew from $400,000 to $700,000. So, while Alex will sell the property for $900,000, they will have a gross capital gain of $300,000 ($700,00 value at separation less $400,000 purchase price). Worse still, Alex will not be able to split it with Chris! This leaves Alex paying the full capital gains tax.
This example stays true regardless of whether Alex keeps the property for one year or 20 years! There will still be capital gains tax attached to it when it is eventually sold, and that will be calculated based on the property value when it becomes Alex’s principal place of residence, less the cost of the property (and any associated costs, which have been disregarded in this example).
Let’s Look At The Financial Information… What Is The Answer?
If Alex and Chris had received advice when they were settling their property pool, they could have calculated the capital gains tax payable based on current income and included that future debt in their split calculations.
Although we don’t know exactly what Alex will be earning when the property is eventually sold, we can make assumptions and estimate future income and likely tax consequences. We can also calculate the total capital gain accurately so Alex is confident about what their future liability will be. This could then be included in the property pool calculations to ensure a fair result.
Canny Accounting + Your Investment Property
Capital gains tax can sometimes be the three words that can send shivers down your spine – but – they don’t have to!
Want to know more about Capital Gains Tax? Check out this previous article we put together: A Guide To Capital Gains Tax – FAQs
Canny Accounting has a wide range of expertise when it comes to giving advice on investment properties and this can be at the beginning of the process or if you find yourself needing advice in a separation and/or divorce situation.
Get in touch with our team today, no matter what stage of your investment property journey you are at, we are able to assist.
