Taking your relationship to the next level? Think of the tax consequences

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If you’re thinking of moving together or getting serious with your relationship, Eddie Chung advises to consider these tax issues first.

Most people enter into serious relationships without any financial and tax planning. This is understandable as practical matters such as financial and tax planning are not exactly romantic considerations when one is head over heels in love.

However, failing to consider such issues could cost you down the track – especially if you have already accumulated a reasonable amount of wealth prior to entering into the relationship. This article looks at some of the financial and tax issues you should perhaps consider when Cupid is knocking on your door.

Existing assets

If you own material assets when you enter into a relationship, you need to understand that such assets could become ‘divisible property’ if the relationship breaks down in the future.

To protect these assets, you should consider speaking to a family lawyer, who may advise you on the steps that could potentially be taken to reduce the likelihood of you losing some of these assets if the relationship turns bad. For instance, you may be advised to enter into a Binding Financial Agreement or pre-nuptial agreement, which could involve some delicate discussions between you and your partner.  

As with all asset protection strategies, there is no guarantee that the strategy you adopted would work. The Family Court, in particular, has very wide powers, which include overlooking legal structures and setting aside previous agreements made by the parties.

 For instance, if you transfer an asset into a discretionary trust before your partner becomes your spouse or de facto spouse, the Family Court may still include the asset in the divisible property pool if your relationship breaks down.

Having said that, asset protection is really about putting up ‘hurdles’.

One of those hurdles that may be reasonably effective is for you to surrender your interest in the asset. For example, you may gift your investment property to your parents or siblings or transfer the property to a discretionary trust over which you have no control.

However, there may be taxation and stamp duty implications on the asset transfer. While you may not receive any consideration for the gifting of the property, the capital gains tax provisions include a market value substitution rule that treats as if you have received market value consideration for the property, which may give rise to capital gains tax in your hands.

Accordingly, it is critical that you fully understand the impact of your strategy before it is implemented. The same may apply to stamp duty.

Also, you need to ensure that your strategy does not ‘throw the baby out with the bath water”. While disowning your interest in an asset may protect it from future spousal claims, you are effectively giving away your control over the asset, which means that your beneficiary may do whatever they want with the asset without consulting you. Not having an interest in the asset also means that you will not be able to easily use it as security for a loan in future.

For instance, if you give away your existing home before entering into a relationship and the two of you want to buy a new home, you cannot easily access the equity in your existing home to obtain finance for the new home, unless the beneficiary who is gifted your existing home agrees to offer the property as security.

Real property

If you are generous enough to transfer half of the interest in your principal place of residence to your other half, there may be an exemption from stamp duty in relation to the transfer. As the stamp duty law differs from different States and Territories, you should confirm with your adviser that such an exemption applies in your case.

Further, as the property is your main residence for capital gains tax purposes, the disposal of your half interest in the main residence will not give rise to any capital gains tax.

On the other hand, if both of you enter into the relationship with your own properties, you will then have to choose how the main residence exemption will apply going forward:
 
  1. You may pick one of the properties as the main residence for the both of you during the period you are together; or
     
  2. You may nominate a different property each as your main residence but the main residence exemption will only apply to half of the period while you are together.
To determine which of these options will provide you with a better tax outcome, you may need to crunch some numbers, which may also involve doing some crystal ball gazing for the likely future value of each of the properties.

Interestingly, if neither of you own any property when you enter into the relationship but you buy two properties for personal use as co-owners, you may still pick one of the properties as your main residence, which will remain your tax-free home while any capital gain derived on the other property will attract capital gains tax if it is sold in future. Alternatively, the two of you may elect to treat a different property each as your main residence under the following rule:
 
  1. If you do not own more than half of one of the properties that you choose as your main residence, that property will be treated as your tax-free main residence during the entire period you are together; otherwise, it will be treated as your main residence for only half of that period; and
     
  2. The same rules apply to your spouse’s interest in the properties.
By way of an example, you and your spouse own a suburban house on equal basis; the two of you also own a holiday house, which is owned 30% by you and 70% by your spouse. If both properties are sold and you nominate the suburban house to be your main residence while your spouse nominates the holiday house as their main residence, the suburban house will be treated as your tax-free main residence throughout the period you were together because you own half or less of the property. However, the holiday house will only be treated as your spouse’s main residence for half of the period during which you were together because they own more than half of the property.

Other affairs

As your relationship becomes more serious, you will need to review your existing taxation and financial arrangements to see if the incorporation of your spouse into these arrangements would bring about a better outcome.

1. Discretionary trust

If you have a discretionary trust that generates income and your partner is a lower income earner than you, you may want your trust to distribute income to them to utilise their lower marginal tax rate. However, you cannot assume that your partner will automatically be an eligible beneficiary of your trust. The trust deed of the trust will need to be reviewed.

 If your partner does not automatically become a beneficiary of the trust, you should consider if the deed allows them to be added as a beneficiary of the trust. If the deed does not allow for that to happen, there may be other indirect ways of achieving the same outcome. For example, the existing trust may distribute income to a new trust beneficiary of which your partner is a potential beneficiary, which may in turn distribute the income to your partner.

Naturally, professional advice is recommended due to the highly technical nature of these issues. For instance, incorrectly appointing your partner as a beneficiary of your trust may inadvertently give rise to a ‘trust resettlement’, which will give rise to severely adverse taxation consequences.

2. Will

As ‘common sense’ as it may seem, many people forget to update their will when their circumstances change. That is fine as long as you do not die and you have the ability to control this certainty of life. Otherwise, failing to update your will could give rise to considerable headache to those you leave behind. Not having a will may also mean that an external party, such as the Public Trustee, may become involved in splitting your assets, which may give rise to unintended outcomes that do not accord with your wishes.
Another area people often overlook is their superannuation benefits. Some people assume that their wills will automatically dictate where their superannuation benefits will go if they die. On the contrary, your superannuation benefits are not dealt with by your will and if you want to leave your superannuation benefits to a specific beneficiary or specific beneficiaries, you will need to make a death nomination while you are alive.

 Nowadays, you may make a non-binding death nomination, lapsing binding death nomination, or non-lapsing binding death nomination. Each of these nominations serves a particular purpose, so professional advice may be warranted to ensure that you pick the option that best suits your circumstance.

3. Insurance policies

Further, you should also consider reviewing your insurance policies. You may need to add new policies to take into account your new relationship status, modify some of your existing policies, or cancel policies that are no longer necessary.

For instance, you may want to take out a new life insurance policy now that you need to provide for someone else should your life unexpectedly end, combine insurance policies that were previously in your own separate names to take advantage multi-policy discounts and potentially better terms and conditions (i.e. private health insurance), or cancel your contents insurance policy over one of the your properties that used to be your separate homes but will now be rented out to tenants.  

Conclusion

Relationships and finances may seem to be quite separate aspects of your life but they are actually inextricably related. Inviting someone special into your life means that you are also inviting them into your financial world. It should not be mistaken that just because you are not married to someone means that you do not have to worry about these issues.

Under the law, your partner is treated as your de facto spouse if you have been living together on a genuine domestic basis, regardless of whether your partner is the opposite or same gender as you. Once you are each other’s de facto spouse, you may have a claim against each under in the Family Court. Therefore, it is important that you protect yourself and each other as much as possible when your relationship is set to become serious.   

Eddie Chung  (eddie.chung@bdo.com.au) is Partner, Tax & Advisory, Private Client, BDO (QLD) Pty.
Important disclaimer: No person should rely on the contents of this article without first obtaining advice from a qualified professional person.   The author and BDO (QLD) Pty Ltd expressly disclaim all and any liability and responsibility to any person in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this article. 
 

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