Let's think about this more clearly.
1. You owed a piece of real property (land).
2. You made improvements to the real property (built a garage that is attached to the land).
3. Then you sold the real property (land with garage).
If you are a builder/developer and you do this as an ongoing regular business activity, you may be a schedule C self-employed business. If this was an occasional or one-off activity, you have a simple capital gains transaction.
You pay capital gains tax on the sale of the property. Your gain is the difference between the adjusted cost basis and the selling price. Your cost basis is the original purchase price for the land, plus the cost of the improvements (building the garage). You can include costs you paid for, like materials, labor, permits, inspections, utility hookup, purchasing approved architect's drawings, and so on. You can't include any adjustment for the value of your own labor, or other people's labor that you didn't pay for. You can also reduce the selling price by certain costs, such as a real estate commission, or inspections, deed fees and land transfer taxes that are required to complete the sale. You pay capital gains tax on the gain (profit) which is the difference between the adjusted cost and the adjusted selling price. If you owned the land more than 1 year, it is a long term capital gain which is taxed at a lower rate than regular income. If you owned the land 1 year or less, it is taxed at the same rate as your regular income.
This is reported using form 8949 and schedule D.
