Divorce does not change tax basis on a home but its sale can bring big levy

Q: In a divorce, how is the income tax basis of the couple's home handled if one spouse keeps the house and the other spouse is cashed out of his equity?

What happens to the property tax assessment of the house if the selling spouse is cashed out at a far higher value than what the house is assessed?


Is the spouse who stays in the house subject to an increase in property taxes just for continuing to live there?

A: A divorce does not change the income tax basis or the property tax assessment of a couple's home in any way.


If one spouse keeps the house as part of the property settlement, the value assigned to the half of the house given up by the other spouse is irrelevant to the home's actual tax basis. So, if your house has a $100,000 tax basis and a $500,000 market value, the $250,000 value presumably assigned to each spouse matters only to the property settlement process. The spouse keeping the house keeps the original $100,000 tax basis as well.

So, if the spouse keeping the home were to sell it for $500,000, he or she would face an income tax bill on as much as $400,000 of the proceeds.

This is why attorneys and accountants who routinely handle property settlements urge divorcing couples to assign equally not only the marriage's assets but the cost bases of those assets.

As you can see, it does a spouse no good to receive an asset worth several hundred thousand dollars if virtually all of it is taxable upon sale.


Q: Our home currently does not have a mortgage on it. But we are thinking of mortgaging it and using the proceeds to purchase a second home. Will the interest on the mortgage be

deductible? We were told that it would not be.



A: Your interest payments will be deductible because the proceeds of the mortgage are being used to purchase a second home -- an allowable mortgage interest deduction. Anyway, homeowners are allowed to increase the mortgages on their primary residence by up to $100,000 and use the proceeds for anything they want and still deduct the interest.

Even though your plan gives you an interest deduction for your income taxes, are you sure this is the course you want to pursue?

Why not get a mortgage on your vacation home? Although a mortgage on a primary residence may carry a slightly lower interest rate, our experts believe that a second home loan is the cleaner and simpler way to handle your situation because it limits your exposure to potential problems should you ever fall behind in your payments.

By refinancing your current home, you expose yourself to the potential that all your assets could be tapped if you default on the loan. However, a "money purchase mortgage," the type you get when you buy a home, limits your exposure in the event of default to just the asset being purchased with that mortgage.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.