Buying Out Your Spouse's Equity in Divorce: Property Tax and Capital Gains Implications in California
The buyout seems simple. Pay your spouse their share, refinance, move on. But you may be taking on a hidden tax liability worth hundreds of thousands of dollars.
- No property tax reassessment on divorce buyouts. You keep your Prop 13 base under the interspousal exclusion.
- No immediate tax on the buyout payment. IRC Section 1041 makes it a tax-free property division.
- You inherit the full capital gains liability. Your cost basis stays at the original purchase price, not current value.
- The "true value" of keeping the house is significantly less than fair market value once you account for embedded taxes.
The Buyout Seems Simple. It's Not.
You're getting divorced, and one of you wants to keep the house. Simple solution: one spouse pays the other their share of the equity, refinances the mortgage into their name alone, and life goes on.
That's how most people think about divorce buyouts. And they're missing critical tax implications that can cost tens of thousands of dollars down the road.
When I sit down with a spouse who wants to keep the house, the first question I ask isn't about the property. It's "Have you run the numbers on what you're actually taking on?" Most haven't. They're thinking about staying in the home, keeping the kids in their school, maintaining stability. Those are valid reasons. But they deserve to know the full financial picture before they commit.
Here's what's really happening in a buyout:
- You're taking on your spouse's share of the future capital gains tax liability
- You're committing to refinance on a single income (which may not be possible)
- You're making assumptions about future home values and your eventual sale timeline
This guide covers the full picture: what actually happens tax-wise when you buy out your spouse, what you're really taking on, and how to make an informed decision.
How the Buyout Works: Basic Mechanics
Calculating the Equity Split
The buyout amount is based on your equity: the difference between the home's current value and any outstanding mortgage balance.
- Current home value: $1,400,000
- Mortgage balance: $400,000
- Equity: $1,000,000
- Each spouse's share (50/50 community property): $500,000
In this example, the keeping spouse would pay the departing spouse $500,000 to buy out their share of equity.
Payment Options
The buyout payment can come from several sources:
Cash: The keeping spouse pays cash, often from refinancing proceeds.
Asset offset: Instead of cash, the keeping spouse gives up their share of other assets (retirement accounts, investments) of equivalent value.
Structured payments: The settlement agreement specifies payments over time, though this is less common and more complex.
Refinancing Requirements
In most cases, the keeping spouse must refinance the existing mortgage to:
- Remove the departing spouse from the mortgage obligation
- Access equity to fund the buyout payment
- Establish the new mortgage in their name alone
This is often the biggest practical obstacle to buyouts. The keeping spouse must qualify for a new mortgage based on their single income alone.
Good News: No Immediate Tax on the Buyout
Under IRC Section 1041, property transfers between spouses (or former spouses if "incident to divorce") are not taxable events.
What This Means
The $500,000 buyout payment in our example is NOT:
- Taxable income to the departing spouse
- A taxable sale triggering capital gains
- Subject to gift tax
The payment is treated as a property division, not a sale. The departing spouse receives their equity share tax-free at the time of transfer.
The Basis Trap: Your Future Tax Problem
Here's what most people miss, and it's significant: the keeping spouse takes over the original cost basis of the ENTIRE property, not just their half.
When property transfers between spouses incident to divorce, the receiving spouse takes the transferor's basis. There's no step-up in basis for divorce transfers. You inherit the full embedded capital gains liability.
What This Means in Practice
- Original purchase price (2010): $500,000
- Current value: $1,400,000
- Capital gain embedded in property: $900,000
After the buyout, the keeping spouse's cost basis remains $500,000, not the $1,400,000 current value, and not $950,000 (original basis plus buyout payment).
The Future Tax Liability
When the keeping spouse eventually sells:
- Sale price: Let's say $1,600,000 (some future appreciation)
- Cost basis: $500,000 (original purchase price)
- Capital gain: $1,100,000
- Exclusion available (single): $250,000
- Taxable gain: $850,000
- Tax at 33.3% (federal + CA): approximately $283,000
The departing spouse walked away with $500,000 cash, tax-free. The keeping spouse walks away with a $283,000 tax bill when they sell.
This is complicated. You don't have to figure it out alone.
I help people understand what they're really taking on, so they can make the right decision for their family.
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Property Tax: The Good News
Unlike the capital gains trap, property tax treatment for divorce buyouts is favorable.
Interspousal Exclusion from Reassessment
California Revenue & Taxation Code Section 63 excludes transfers between spouses from property tax reassessment. This applies to:
- Community property divisions
- Buyouts per divorce decree
- Transfers between spouses during marriage or divorce
The keeping spouse maintains the existing Prop 13 base year value. Your property tax stays the same.
How to Claim the Exclusion
You'll need to file a claim with the county assessor:
- Obtain the appropriate exclusion form from your county assessor's office
- Include a copy of the divorce decree or settlement agreement showing the property transfer
- File within the timeframe specified by your county (typically 3 years, but file promptly)
Refinancing Realities in 2025
The biggest practical obstacle to divorce buyouts isn't tax. It's whether you can qualify for refinancing on a single income.
In my experience, refinancing is where most buyouts fall apart. I've seen couples spend months negotiating a buyout agreement, only to discover the keeping spouse can't qualify for the mortgage on a single income. That's why I always recommend getting pre-qualified before you finalize anything in your settlement.
Qualifying on Single Income
Lenders will evaluate:
- Your individual income (not combined household income)
- Your debt-to-income ratio
- Your credit score
- Employment stability
For a $1,000,000 mortgage (in our example, $400,000 existing + $500,000 cash-out for buyout + closing costs), you'll typically need documented income sufficient to keep your total debt payments under 43% of gross income.
Not sure if you can qualify?
I work with lenders who specialize in divorce situations. Let me help you understand your options before you commit to anything.
Call or Text: (213) 444-2225Everything we discuss stays between us.
Options If You Can't Qualify
If traditional refinancing isn't feasible:
- Co-signing: Some lenders will allow a co-signer (parent, new partner), though this creates its own complications
- Asset depletion loans: If you have significant liquid assets, some lenders will qualify you based on assets rather than income
- Extended timeline: Negotiate more time in your settlement, though the departing spouse may resist remaining on the mortgage
- Forced sale: If no other option works, selling may be the only path forward
Buyout vs. Selling: Which Is Actually Better?
In some cases, selling and splitting proceeds results in more cash to both parties than a buyout.
| Factor | Selling | Buyout |
|---|---|---|
| Immediate proceeds | ~$391,500 each (after costs/taxes) | $500,000 to departing spouse |
| Keeping spouse net position | $391,500 cash | ~$635,000 (after embedded tax) |
| Future tax liability | Split between both | All on keeping spouse |
| Refinancing required | No | Yes, on single income |
| Stability for kids | Disruption | Maintained |
Run the numbers before committing to a buyout. The emotional pull of staying in your home is real, but so is the math.
Real Example: The Full Picture
Consider a typical situation in Los Angeles:
- Location: Burbank, CA
- Purchase (2012): $600,000
- Current value: $1,400,000
- Mortgage balance: $350,000
- Equity: $1,050,000
- Wife wants to keep the home (kids in school)
- Husband wants his share of equity
- Wife's income: $180,000/year
The Buyout Math:
- Husband's share: $525,000
- New mortgage needed: $350,000 (existing) + $525,000 (buyout) = $875,000
- At 7% rate, 30-year fixed: ~$5,820/month
- Add property tax and insurance: ~$7,000/month total housing cost
- Debt-to-income ratio: 47% (above typical 43% threshold)
The Problem: Wife may not qualify for the refinancing needed to fund the buyout.
The Tax Reality: If she does qualify and keeps the house, her cost basis remains $600,000. When she sells in 10 years at $2,000,000, taxable gain after $250,000 exclusion: $1,150,000. Tax at 33.3%: approximately $383,000.
The Decision: She needs to weigh the value of staying (stability, kids' school) against the true financial cost of $383,000 in deferred taxes plus higher monthly payments.
Frequently Asked Questions
Is the buyout payment taxable income to my spouse?
No. Under IRC Section 1041, property transfers incident to divorce are not taxable events. Your spouse receives their equity share tax-free at the time of the buyout. They will have no capital gains to report from the buyout itself.
Do I get a stepped-up basis when I buy out my spouse?
No. You take over the original cost basis of the entire property, the same basis as when you purchased together. There is no step-up for divorce transfers. This is the "basis trap" that creates future tax liability.
What if I can't refinance within the court's timeline?
Options include negotiating an extension with your spouse, having your spouse remain on the mortgage temporarily (risky for them), or selling the property. If the settlement specifies a sale upon failure to refinance, that provision will control.
Does the buyout payment need to equal exactly 50% of equity?
Not necessarily. The payment can be whatever you negotiate in your settlement, offset by other assets, adjusted for deferred maintenance, or modified based on other factors. Just ensure the agreement is clear and documented.
Your Next Steps
Before committing to a buyout:
- Calculate your true cost including deferred tax liability
- Verify you can qualify for refinancing on your single income
- Compare buyout economics to selling and splitting proceeds
- Consult with a CPA to understand your specific tax implications
- Work with your attorney to document everything properly
- Call or text (213) 444-2225 to discuss your specific situation
The Numbers Matter More Than You Think
Before you commit to keeping the house, let's make sure it actually makes financial sense. I've helped many people realize that selling was the better choice, and many others confirm that staying was right for them.
Call or Text: (213) 444-2225Available 7 days a week. Confidential conversation, no obligation.
Disclaimer
The information provided in this guide is for educational purposes only and does not constitute legal, tax, or financial advice. Tax laws are complex and subject to change. Please consult with a qualified CPA, tax attorney, and family law attorney for guidance specific to your situation. Justin Borges and The Borges Real Estate Team are real estate professionals, not attorneys or tax advisors.
