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Tricky Capital Gains question

I purchased a property, which I live in, and plan to sell a portion of the property prior to owning it for 2 years. After 2 years I will sell the house and the remaining. What am I responsible for capital gains? for simplicity sake: I paid $200k for a house and land. I plan to split the land off and sell for $50k before 2 years of ownership. After 2 years of ownership I will sell the remaining land/home. What are the tax implications of this?

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6 Replies

Tricky Capital Gains question

This is actually set forth in the Regulations (Treas. Reg. §1.121-1(b)(3)):

 

(i) In general. The sale or exchange of vacant land is not a sale or exchange of the taxpayer 's principal residence unless -

(A) The vacant land is adjacent to land containing the dwelling unit of the taxpayer's principal residence;

(B) The taxpayer owned and used the vacant land as part of the taxpayer's principal residence;

(C) The taxpayer sells or exchanges the dwelling unit in a sale or exchange that meets the requirements of section 121 within 2 years before or 2 years after the date of the sale or exchange of the vacant land; and

(D) The requirements of section 121 have otherwise been met with respect to the vacant land.

 

Therefore, you initially have to pay capital gains tax on the land (if you have a gain) since the sale does not meet the requirements of Section 121 for exclusion but, if you sell your principal residence within 2 years after the date of the sale of the land, you can go back and amend the return to exclude the capital gain on the land.

Carl
Level 15

Tricky Capital Gains question

If you sell land only, then it's considered an investment sale. Period. If you owned it less than a year then you'll be taxed at the higher short term capital gains rate. If you owned it more than a year, then your gains will be taxed at the lower, long term capital gains rate.

 

Tricky Capital Gains question

Thank you. Clarifying statement. The property is 5 acres with a house. I plan to sell 2.5 acres of it as a separate parcel (without a house) between year 1 and 2 but then the sell the house after the 2nd year. 

 

Are you saying no matter what if I parcel off the land and sell it separate from the house after 2 years it will be considered an investment property (vs primary residence) and I’ll be responsible for capital gains?

 

If I play out sample math...

 

Purchase price for house with 5 acres - $200k

 

Scenario 1

Sell 2.5 acres after year 1 (but not the house) for $50k, responsible for long term capital gains on the $50k. Then sell the house after 2 years for $200k, no capital gains liability. Correct?

 

Scenario 2

Sell 2.5 acres after year 2 (but not the house) for $50k, responsible for long term capital gains on the $50k. Then sell the house after 2 years for $200k, no capital gains liability. Correct?

 

Scenario 3

Sell house with all 5 after 2 years for $250k after 2 years no capital gains liability. Correct?

Carl
Level 15

Tricky Capital Gains question

Are you saying no matter what if I parcel off the land and sell it separate from the house after 2 years it will be considered an investment property (vs primary residence) and I’ll be responsible for capital gains?

 

If you parcel out the property and sell any part of it that was not your primary residence for at least two of the last 5 years you owned it, then you will pay taxes on any capital gain. Doesn't matter if you owned it for 1 day or 100 years. You're paying taxes on the gain. Weather it's a short term or long term capital gain is decided by the period of ownership counting back from the closing date of the sale.

 

Sell 2.5 acres after year 1 (but not the house) for $50k, responsible for long term capital gains on the $50k

Nope. Your taxable gain will be less. You didn't get that land for free. Take a look at your most recent tax property bill. There's a tax value for the land and a tax value for the structure (your house) on that land.

So if the tax value of the structure is 50K and the value of the land is $30 that's a total tax value of $80K. Doing the math the land value is 37.5% of the total tax value.

So if you paid $200K for the entire property, 30% of that is $60K. That's how much of the total you paid for the property, was paid for the land. So if you divide the land into 2 parcels of equal size and sell the parcel without your primary residence on it (assuming no other structures are on that land) your cost basis in that parcel is $30K. If you sell it for $50K then  you have a $20K taxable gain.

But lets say you parcel out 8 acres of the 10 acres you presently own and sell those 8 acres which do not contain your primary residence or any other structures on it. That's 80% of the land. So 80% of the $60K you paid for the land is $48K. If you sell that 8 acres for $50K then you only have a $2K taxable gain.

Then sell the house after 2 years for $200k, no capital gains liability. Correct?

Correct,provided you live in that house as your primary residence for at least 2 years of the last 5 years you own it, again counting backwards from the date you close on the sale. But know the limits.

If married filing joint and *BOTH* you and your spouse lived in the house for 2 of the last 5, then  you get a maximum $250K exclusion for each of you.

Tricky Capital Gains question

Thank you!!

Tricky Capital Gains question


@Jlinden7 wrote:

Are you saying no matter what if I parcel off the land and sell it separate from the house after 2 years it will be considered an investment property (vs primary residence) and I’ll be responsible for capital gains?


If you parcel out the land and sell it, you will pay capital gains tax. However, if you then sell your house (principal residence) within 2 years after you sell the land, the gain on the prior land sale will qualify for the Section 121 exclusion (you can amend your previous tax return so you have no gain on the land sale).

 

 

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