Capital Gains on Selling home after buyout in Divorce

[Eddie58]

Currently, as part of a divorce, we have our home listed for sale, but this is not the ideal market timing, and traffic is slow. As another option, I am considering buying her out. If I did, what would be my capital gains implication when I sell the home? Assume value now to be $700,000. Outstanding mortgage $100,000. I would pay her approximately $300,000. I would have to borrow $400,000 to do so. If the home sold for $750,000 in 18 months, with a cost basis of $425,000 (original purchase plus improvements), would I be liable for capital gains on the difference ($325,000 minus my $250,000 exclusion)?

[Opus 17]

Transfers and buyouts as part of a divorce do not adjust the cost basis, so no matter what you paid your ex or borrow to do it, your cost basis remains $425,000.  You would have a gain of $325,000 and owe tax on $75,000 after the exclusion.  (There may be other adjustments you can consider like the selling commission that will reduce your gain.)

However, if you both retain ownership, and your divorce agreement grants you the right to live there, then whenever you do sell, both you and your ex would qualify for the exclusion, even though your ex no longer lives there.  You would each report a gain of $162,500, which would be non-taxable because you each can claim the $250,000 exclusion.  Whether you want to be financially tied to your ex (in order to save about $12,000 of capital gains tax plus the interest on the loan) is something to discuss with your attorney.  

See publication 523,

https://www.irs.gov/pub/irs-pdf/p523.pdf