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Is Home Equity From a Divorce Taxable?

Question: I was awarded a lump sum of money in my divorce and will be getting it sometime in the beginning of 2012. It clearly states in the divorce decree that it is my share of equity in the house. Is it taxable? And if so, what is the tax percentage rate?

–Cheryl Warren, Conn.

Answer: No, it’s not taxable. There are no income tax consequences to what you receive from a divorce proceeding if it was part of the marital estate, says Christian Badali, partner in the family law group at Philadelphia-headquartered law firm Weber Gallagher LLP.

When a couple divorces, a judge will decide whether one of the spouses can afford to hold onto the home. If they can, the judge will give some percentage of the equity that’s in the home to the spouse who walks away from the property – which sounds like your situation — and that spouse will also be absolved of having to pay the mortgage.

You can do what you want with that money without worrying about a tax hit, says Toby Johnston, a certified public accountant and certified financial planner at Mohler, Nixon & Williams, a tax firm in San Francisco. That includes stashing it in a bank account and becoming a renter, using it to buy a home on your own, or investing it.

On the flip side, the spouse who ends up keeping the home might face tax consequences. The tax hit comes when that spouse sells the property. There might be state and local taxes to consider. The IRS does allow for federal tax-free profits of $250,000 for singles (or up to $500,000 if the sellers’ divorce isn’t finalized) if the seller has lived in and owned the home for at least two of the last five years. But beyond that cap, the seller would get hit with federal taxes.

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