Capital Gains on property build

[aloveitt]

Hello All,

We are trying to figure out the most tax advantaged way of going about this. Over a year ago we purchased a property consisting of 4 adjacent lots, we will call them lots 1,2,3 and 4.  Lots 1 and 2 currently have an old house on them. We paid $1,225,000 for the entire property. After review of the appraisal and discussion with our CPA she is considered the current capital cost as $175,000 for each lot plus a value of $525,000 for the house. Our plan is to build on two of the lots and sell the other two either now or in the future. We are looking at a lot of options and there are additional factors at play but our question comes down to a capital gains scenario:

 Our thought is that right now the vacant lots 3 and 4 are undervalued from a capital basis at $175,000 a piece. We could sell them for $400,000 a piece but would take a huge hit on any profit with capital gains. Instead we would like to build the new house on those lots then could eventually take advantage of the capital invested with the new build plus the 2/5 rule if it ever became time to sell. This leaves us with lots 1 and 2 which have the old house on it (which is currently being valued at $525,000).  If currently our CPA is calculating the capital we have invested in lots 1+2+house as $875,000 and we were to tear down the house, does the amount we have "invested" change for future calculation of capital gains? Or could we tear down the house and then sell those lots for say $400,000 a piece in the future and use the original $875,000 for our basis of "capital invested".

Thanks in advance!

[Mike9241]

when you tear down a building on property its tax basis gets added to the tax basis of the land along with the demolition costs. 

as to the "vacant land sale" that's covered by reg 1.121-1(b) so you need to discuss this with your CPA

(3) Vacant land—(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.

(ii) Limitations—(A) Maximum limitation amount. For purposes of section 121(b)(1) and (2) (relating to the maximum limitation amount of the section 121 exclusion), the sale or exchange of the dwelling unit and the vacant land are treated as one sale or exchange. Therefore, only one maximum limitation amount of $250,000 ($500,000 for certain joint returns) applies to the combined sales or exchanges of vacant land and the dwelling unit. In applying the maximum limitation amount to sales or exchanges that occur in different taxable years, gain from the sale or exchange of the dwelling unit, up to the maximum limitation amount under section 121(b)(1) or (2), is excluded first and each spouse is treated as excluding one-half of the gain from a sale or exchange to which section 121(b)(2)(A) and § 1.121–2(a)(3)(i) (relating to the limitation for certain joint returns) apply.