Separated but not Divorced – Have This Couple Found a Way to Avoid CGT?

Life does not always go as planned and sometimes couples can find themselves separated but not wanting to go through the official – and often costly – divorce process. One such situation involving a couple’s separation has spurred an intriguing question to The Telegraph’s financial expert about UK capital gains and inheritance tax rules.

Understanding the Dilemma

Three years ago, Christopher and his wife separated, but neither expressed intentions of getting a divorce. They parted from their long-built family home, selling it and distributing some of the proceeds among their children. She bought herself a modest home, while he also purchased a separate property. They both coincidentally ended up in homes worth around £550,000. Their other assets and savings built over the years are also a significant part of their wealth.

As Christopher points out, the ageing couple’s life expectancy is somewhat unpredictable. However, as circumstances have it, the other will not have to worry about inheritance tax upon the death of one, thanks to their wills leaving all assets to each other. The surviving partner could sell the newly inherited property and share the benefits, optimistically hoping to survive another seven years to avoid serving their children a tax bill.

Dive into the Tax Complexities

Christopher’s main question, however, concerns the tax implications on their respective properties when the second death occurs. This query requires understanding some basic rules, and that’s where Mike Warburton, an experienced tax consultant, steps in to offer clarity.

The Role of Separation in CGT Exemption

When it comes to capital gains tax (CGT), separation is what matters, not divorce. Essentially, married couples, including civil partners, can transfer assets amongst each other without incurring CGT. However, said ability ceases three years after the tax year in which the separation occurred.

Married couples living together can claim tax relief for a single residence under the rule of “principal private residence relief”, but in the case of Christopher and his wife, both can claim the relief separately due to their permanent separation. This most likely allowed Christopher’s sale of his original house without any CGT due while providing his wife with the same exemption for her property.

The Implications of Divorce on Inheritance Tax

In contrast to CGT, the status concerning inheritance tax (IHT) depends on the couple’s marital status. Essentially, as long as a couple remains officially married, they can transfer assets between each other without having to worry about IHT.

This means in the event of either spouse’s death, the surviving spouse inherits all assets, including the deceased’s home. The inherited assets undergo a revaluation to match the current market value, which can later be sold to distribute the proceeds.

Christopher can also benefit from the “seven-year rule”, as should he survive another seven years after distributing his wife’s assets among his children, the inheritance will be tax-free.

Maximising the Inheritance Tax-free Bands

On Christopher’s passing, the executors of his will can access his £325,000 IHT free band. The estate should also qualify for an additional £175,000 “residence nil-rate band”, essentially a family home allowance, if his home and assets are worth over £175,000 but less than £2 million, and he’s leaving everything to his children. The team can also claim his wife’s unused allowances in a similar fashion.

Guarding Against Possible Misuse of Tax Rules

The insightful conversation has raised concerns about couples falsifying their separation to gain tax advantages. Some legal cases involving rental properties have thrown light on such fraud. However, in authentic situations like Christopher’s, it is wise for the separated couple to keep evidence supporting their claims.

For instance, to claim tax relief, both parties should be on the appropriate electoral role, registered with local medical practices, and have all services registered separately. It could prove beneficial to acquire documentation from reputable figures, such as local magistrates, solicitors, or vicars to attest to their status.

Ultimately, the journey’s end for this couple may still be a bit muddled. But handling delicate matters such as these with understanding, knowledge and advice from experts like Mike Warburton can lend some semblance of clarity to the complex world of tax implications in times of separation.