@AmyC - can you please document your response with the supporting website and / or other documentation? It is a weak response to state it 'sounds like' purchase money; folks are making financial decisions on expert advice from TT employees
@tomk39 does not state the ownership of the home is changing, just that he is paying off a $250,000 liability to his former spouse. If the ownership is not changing there can be no sale. Presumably the assets were split per the 2017 divorce and now a liability is being paid off.
Let's say the house was purchased for $400,000 with a $350,000 mortgage. In the divorce Sam gets the house. His cost basis remains $400,000. Further in three years he owes Sarah $250,000; it doesn't matter where the money comes from or what it represents; the two negotiated the money in the divorce settlement
The three years goes by and the mortgage has amortized down to $275,000. Sam needs to fund $250,000 to pay off his liability to Sarah. He refinances his home so that the new balance is $600,000. Of the $325,000 proceeds, he gives $250,000 to Sarah to settle the liability from the divorce decree.
The 'acquisition debt' remains at $275,000 so the cashout is $325,000. Since the $325,000 was not used to improve the home (most was given to Sarah), it is cash out and NOT tax deductible.
lastly, if @tomk39 responses that in fact it was a sale, then his ex-spouse is going to be responsible for capital gains on the transaction. And since she presumably had not lived there for 2 of the last 5 years, the primary residence exclusion is not going to apply.
Messy! Talk to your accountant or divorce lawyer - I suspect this was all discussed (or should have been) in 2017.
p.s. and @tomk39 cost basis probably is the same as when it was originally purchased:
https://seiler.com/wp-content/uploads/2015/02/Basis-of-Residence-in-a-Divorce1.pdf
