Money Corner: Divorcing Couples and the Family Home – Five Tax Pitfalls

Don’t forget capital gains tax

In his article ‘Money Corner: All A Bit Unnecessary’ [2025] 2 FRJ 202, Simon Denton provided a timely reminder that capital gains tax (CGT) remains very much a relevant consideration when it comes to the treatment of the former matrimonial home (FMH).

This may seem contrary to the more commonly understood principle for the person on the street that the sale of a home is not a taxable event. Furthermore, specific to the divorce and separation scenario, the Finance Act (No 2) 2023 (FA 2023) introduced several provisions which expanded the application of this general principle that the FMH is not taxed. Notably, this included the introduction of the indefinite application of the no gain, no loss principle on the transfer of an asset between the parties pursuant to a court order and additional provisions closing gaps in eligibility for full relief from CGT under the ‘Private Residence Relief’ (PRR) regime.

However, whilst the FA 2023 mostly eliminated exposure to tax on the FMH at the time of the divorce itself, it has possibly created a false sense of security and a general oversight of the fact that the CGT liability is not extinguished but remains latent and passes from one party to the other.

The practical point therefore is that it remains advisable to obtain expert advice, as without understanding the net of tax liabilities fully, the receiving party may be given a false impression of being awarded more than they actually are.

The aim of this article is therefore to highlight the main pitfalls that pertain to the transfer/sale of the family home. These, by definition, only come to light after proceedings have ended and only once the order has been implemented and lawyers are no longer involved. However, we can offer value to our clients by highlighting such issues before they discover them for themselves.

Before commencing our list, it is useful to recap some of the key characteristics of PRR, which are as follows.

Private Residence Relief recap

• PRR reduces the taxable gain arising on the sale of a person’s only or main home by an amount reflecting the proportion of ownership of the home that was occupied by them as their only or main home, i.e.: (Occupation (months) / Ownership (months)) x Gain
• A person can only have one main home at a time and married couples can only have one main home between them. This continues only up until the date of separation, thereafter they can apply PRR separately.
• Certain periods of ‘deemed occupation’ are permitted. This includes amongst others:
• the last 9 months of ownership (automatic);
• 3 years’ absence from the home for any reason, provided the home is returned to;
• unlimited absence from the home where the absence is due to employment duties being carried out wholly overseas; and
• the period between moving out of the FMH on separation and selling the FMH as part of divorce proceedings.
• Where a person or couple have more than one property they reside in, HMRC will determine which is the ‘main home’ based on factual uses of the properties unless the parties make a formal election to nominate one of those properties as a main home, generally within a 2-year window of any change in occupation.
• PRR automatically applies to a house and gardens where the size of the plot is less than 0.5 hectares (5,000 square metres). A larger plot may be permitted if considered to be necessary for the reasonable enjoyment of the property bearing in mind its size and character.

Common PRR pitfalls for the family home on divorce

Pitfall 1 – failing to elect ‘deemed occupation’ on sale

• As stated above, where the sale of the FMH is ordered by the court and one party has moved out of their home following separation, the leaving party has the option to treat the period of absence between moving out and sale as ‘deemed occupation’ in order to maximise their PRR to any arising gain.
• However, it is not always tax efficient to do this (since it prevents relief being claimed on any other property during this period) so the position must be elected (a ‘section 225B election’).
• The election must be made to HMRC either in writing within 2 years of the sale or via the self-assessment tax return for the tax year of disposal.
• If the election is overlooked, the leaving spouse will be liable to CGT on exposed gains, which should be reported and paid to HMRC within 60 days of completion.

Example 1

Husband and wife acquired their FMH in November 2010 for £200,000. In November 2022, the couple separated and husband moved into rented accommodation (so the FMH was no longer his ‘main home’, irrespective of the fact that he did not own the new home). Wife remained in the FMH as her main home, with their children. The FMH was sold in November 2025 on order of the court as part of their divorce proceedings for £475,000.

Wife has occupied the FMH throughout her ownership period so 100% PRR is available to offset her gain of £137,500, so she has no tax liability on disposal and no need to register the disposal within 60 days with HMRC. However, as husband occupied the FMH as his main home for only 153 months (including the automatic last 9 months’ deemed occupation) out of the total 180 months of ownership, his PRR only covers 85% of his gain.

Husband does not have a tax adviser as he has never prepared a tax return since all his taxes are covered by PAYE. He believes it is common knowledge that the sale of his home is not liable to tax, so assumes that he has no liabilities on selling the FMH, particularly since it is his only owned property as he is renting where he currently lives.

Without a timely section 225B election, with only 85% of his gain covered by PRR, husband is exposed to tax on a gain of £20,625 (being £4,950 of tax, assuming a rate of 24%). Furthermore, if this tax is not paid and notified to HMRC within 60 days of completion, husband could also be liable to penalties and interest for late notification and late payment of taxes.

Pitfall 2 – large properties

• Where the plot exceeds 5,000 square metres, it is important not to assume the whole property is eligible to PRR.
• The presence and use of additional buildings including garages, barns, guest cottages, stables, etc must be considered, along with proximity to the main house. In addition, it is important to obtain an understanding of the use of land around the house and whether it is used as cultured gardens, paddocks or grazing land for animals, etc. This is all very much a question of fact and so understanding these details is key.
• If HMRC determines that part of the plot is not relevant to the reasonable enjoyment of the house itself, then the value attributed to that element will be excluded from PRR exposing the owners to CGT on the eventual sale.
• Typical areas HMRC considers not to be part of the residence for PRR purposes include:
• land used for equestrian purposes;
• outhouses used by the family office team to work in; and
• land bought to ensure good views by preventing third-party development, but used to graze hobby farm sheep.

Example 2

The parties own a large country property. It comprises the main building, which is 500 square metres. Also included is a guest house, which is 65 square metres. Further, the total grounds, i.e. the plot of land on which the property is situated, measures 8,000 square metres.

The property was purchased for £2,000,000 in 2010 by the parties. They separated in 2020 but both remain living together. Wife issued her Form A and the parties settled at an FDR in 2025. The FMH is now valued at £4,750,000, and husband will transfer his interest to wife.

Leaving the notional costs of transfer and any improvement costs aside, there is a capital gain of £2,750,000. Husband transfers his 50% to wife at no gain, no loss (with his base cost of £1,000,000), but the pitfall to think about is that as wife has used the FMH as her primary residence throughout the ownership, she can claim the full PRR and therefore has no latent gains.

However, had further questioning been undertaken, it would have been discovered that the guest house is situated on a corner of the plot furthest away from the house. It has its own access from the main road and had not consistently been owned with the main house over its history. When acquired, the house had been occupied by a gardener, but after his death, the property was left empty apart from the odd guest when the couple had a large gathering (most guests preferring to stay within the main property given the distance of the cottage from the house). Based on case-law examples, it is likely HMRC would reject the guest house as being part of the main house from the time the gardener died, so PRR could not be applied in full.

In addition, part of the land was a paddock used by wife to practice show jumping. As case-law determines, whilst it was nice to have such land in proximity to the house, it was not relevant to the enjoyment of the house as a residence, so HMRC would prevent the application of PRR to this part of the gain.

If 25% of the value of the property was attributed to the equestrian land and the guest house, £687,500 of the gain on disposal will be subject to tax (being £165,000 at 24%).

Pitfall 3 – business use

• When is a home a home? The answer is not always clear-cut. PRR applies to a ‘dwelling-house’, which although not statutorily defined, need it be said, applies as per case-law to the parties’ residence only. It does not apply where part of a home has been used exclusively for a business purpose.
• For example, this might arise where a utility room is converted into a dog-grooming parlour, from which the owner’s dog-grooming business is carried out (and clients access from a side gate that leads directly to an external utility room door). If the room is no longer used for anything but the owner’s clients, this part of the house has been exclusively used for business purposes.
• Where the property is sold, the value attributed to the grooming parlour, as part of the total proceeds, will restrict the amount of PRR available to offset any gains arising on sale, even where the parties have occupied the main house as their only home throughout ownership.

Example 3

The parties jointly own a modest 3-bedroom end of terrace property. The parties purchased it in 2020 for £345,000. In 2021, they built a garden room. From this room wife carries out her beauty business and clients access it from a side gate that leads directly through the garden to the room. The cost of the studio and fittings was £10,000. In 2022 the parties separate and wife and the children remain in the FMH. The home is the main asset and is now valued at £500,000. Cash is tight – the parties live on their overdrafts and on credit cards – but husband has a good pension. The parties agree at the FDR that the FMH will be transferred to wife. Wife will pay husband a very small lump sum by borrowing money from her family and husband will keep his pension.

Here the gain is £145,000 (in this scenario we have included the improvement costs). The pitfall is to assume that the parties can claim the full PRR.

Assuming that 10% of the value of the property on disposal relates to the studio, but all of the studio build costs can be offset against the gain, there remains exposure to a gain of £5,500 (depending on whether the annual exemption is already utilised). The arising tax on this sum (assuming a rate of 24%) is £1,320. Where cash is tight, this can still be an unwelcome surprise.

Pitfall 4 – tenants

• Similar to the above, the residence needs to be the parties’ exclusive residence for full PRR to apply. Any part of the property that is not used exclusively by them is excluded from PRR.
• However, if the parties lived in the home at the same time as tenants (such as renting out the basement whilst the parties lived in the main house), then Letting Relief is available for that part of the gain relating to the tenanted part of the house (up to a gain of £40,000).
• However, if the parties rented out the property whilst they were not living there, Letting Relief is not available and that part of the gain relating to the letting period would be excluded from PRR (if not covered by ‘deemed occupation’ rules).

Example 4

In the above scenario, instead of building a beauty studio in the garden the parties built a self-contained garden room. It was previously used for 6 months by wife’s father but since he passed away the parties have let it out via Airbnb. The parties strike the same deal at the FDR. Again, the pitfall is similar, which is to assume that any CGT liability will be nil and/or a distant problem.

In this scenario, even though the garden room is separate from the main house, it will be considered as part of the main house for PRR purposes, part of which has been let out (from the point it started to be let via Airbnb). Prior to letting, the father’s residence as a lodger, living there as a member of the family would not have affected the relief. As the parties continued to live in the main house whilst the annex was let, and the arising gain is less than £40,000, Letting Relief will apply so that the gain will be fully mitigated.

Alternatively, if all circumstances remained the same except the period that the garden room was let out via Airbnb was only after all parties had moved out prior to moving into new homes, any period in excess of the final 9 months of ‘deemed occupation’ would be exposed to a gain. As the family were not living in the property at the same time as the tenants, Letting Relief will not apply.

Pitfall 5 – occupation history

• As explained, occupation is key to the availability of PRR, yet occupation history is often not requested in a divorce scenario. Although there are many opportunities to claim ‘deemed occupation’ they may not always fully cover the parties’ situation, exposing them to CGT on disposal of the FHM.
• Examples of gaps in occupation that expose the parties to CGT include:
• periods of living overseas due to work, where the duties of the expat employee still include some duties (even if incidental) that are performed in the United Kingdom. In this instance, the maximum deemed occupation that can be permitted is 4 years;
• where there is a delay in moving into a property due to renovation work that exceeds 2 years; and
• where the parties move out of the property for any reason, but do not return within 3 years.

Example 5

A family from the United Kingdom were sent abroad with husband’s work for 8 years. They lived in Singapore for 2 years where husband worked exclusively, then he was moved with the same company to Malaysia for 5 years with a role that meant he came back to report to the UK board twice a year. At the end of the contract, the family decided to take their time coming home. Instead, they travelled and did not return for another year, so will have been out of the family home for 8 years (which they rented out in their absence). A summary of the treatment of each stage for PRR purposes is below:

This means that on disposal of the FMH, one year’s worth of ownership will be excluded from the ‘deemed occupation’ rules and therefore exposed to CGT on sale. Letting relief is not available in this period as the family did not occupy the property at the same time as the tenants.

How to avoid the pitfalls

The above are just some examples of how CGT can cause unforeseen issues for divorcing parties in relation to the FMH. There are other examples and other taxes. The solution is to seek expert tax advice at the earliest opportunity from a qualified tax adviser. Care should always be taken in selecting the correct expert, and on matters such as the family home, those experts specialising in the personal tax aspects of private client advice, holding the Chartered Tax Adviser qualification, are recommended.

Disclaimer

The one message of this article is always to seek expert advice. Although every effort has been made to ensure the accuracy of the information in this article, it is not intended to be read or used as expert advice. No liability is accepted for any losses incurred as a result of relying upon information contained in this article.