My home has no mortgage. What are my tax consequences to tear down and rebuild my current home to sell?

[gwenstoller]

Tax consequences of construction loan

[Carl]

Not having a mortgage changes nothing really. You will pay taxes on any gain realized from the sale. I would *HIGHLY* suggest you seek advice from a tax professional in your state - especially if your state taxes personal income.

[Opus 17]

You can deduct the interest on a construction loan is if it was a mortgage as long as you finish construction and get a certificate of occupancy and move in within two years of opening the construction loan.

As long as the home has been your main residence for at least the past two years, and you sell it within two years of beginning renovations, you will be able to exclude the first $250,000 of capital gains from taxation, or $500,000 if married filing jointly.  You would get the same exclusion if you sold the home as is, of course.  To calculate the adjusted cost basis, you could include all of the costs you pay for labor and materials for the renovation, but you cannot include any cost basis adjustment for work you perform your self that you don’t pay for it.

Whether it is a better investment to spend a great deal of money to rebuild the home and sell it, over selling it as is for less money but without the added cost, is something that would require a great deal of financial expertise to analyze.  

The only elements that would impact your income taxes would be the requirement to complete the renovations and close on the sale within two years or less of the day you move out of the home and start living someplace else.  (Both for the mortgage interest deduction and for the capital gains exclusion), and a requirement to keep track of all of your renovation costs. 

[Bees]

More of a question to @Opus 17  then an answer. I believe you are going to have to reconsider/reduce the basis of your property by the house value at  purchase since those assets are no longer part of your home. Then add all the construction costs new home to the value. https://www.irs.gov/pub/irs-pdf/p523.pdf  see pages 8 and 9

[Anonymous]

From an IRS tax standpoint, the cost of the house and the demolition costs get added to the basis of the land. 

as for the construction loan interest that's governed by IRS Reg 1.163-10T(p)

(5) Residence under construction -

(i) In general. A taxpayer may treat a residence under construction as a qualified residence for a period of up to 24 months, but only if the residence becomes a qualified residence, without regard to this paragraph (p)(5)(i), as of the time that the residence is ready for occupancy.

(ii) Example. X owns a residential lot suitable for the construction of a vacation home. On April 20, 1987, X obtains a mortgage secured by the lot and any property to be constructed on the lot. On August 9, 1987, X begins construction of a residence on the lot. The residence is ready for occupancy on November 9, 1989. The residence is used as a residence within the meaning of paragraph (p)(3)(iii) of this section during 1989 and X elects to treat the residence as his second residence for the period November 9, 1989, through December 31, 1989. Since the residence under construction is a qualified residence as of the first day that the residence is ready for occupancy (November 9, 1987- sic s/b 1989), X may treat the residence as his second residence under paragraph (p)(5)(i) of this section for up to 24 months of the period during which the residence is under construction, commencing on or after the date that construction is begun (August 9, 1987). If X treats the residence under construction as X's second residence beginning on August 9, 1987, the residence under construction would cease to qualify as a qualified residence under paragraph (p)(5)(i) on August 8, 1989. The residence's status as a qualified residence for future periods would be determined without regard to paragraph (p)(5)(i) of this section.

(p)(3)(iii) If a residence is not rented at any time during the taxable year, it shall be considered to be used as a residence. For purposes of the preceding sentence, a residence will be deemed to be rented during any period that the taxpayer holds the residence out for rental or resale or repairs or renovates the residence with the intention of holding it out for rental or resale.

part of the answer also pertains as to where you are going to live while the house is being constructed since qualified interest can only be for a primary or secondary residence. 

[Carl]

@Opus 17 

As long as the home has been your main residence for at least the past two years, and you sell it within two years of beginning renovations, you will be able to exclude the first $250,000 of capital gains from taxation, or $500,000 if married filing jointly.

I'm not following and totally agreeing with the above. Why do they have to sell it "within two years" of the start of renovations? Why can't they sell it 2 years and 6 months after beginning renovations? They're still within the "2 of last 5" rule if it was they primary residence for at least 2 years before starting the renovations.

[Opus 17]

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@Carl wrote:

@Opus 17 

As long as the home has been your main residence for at least the past two years, and you sell it within two years of beginning renovations, you will be able to exclude the first $250,000 of capital gains from taxation, or $500,000 if married filing jointly.

I'm not following and totally agreeing with the above. Why do they have to sell it "within two years" of the start of renovations? Why can't they sell it 2 years and 6 months after beginning renovations? They're still within the "2 of last 5" rule if it was they primary residence for at least 2 years before starting the renovations.

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I think you're right, I seem to have combined the 2 years needed to convert the construction loan into a mortgage and the 3 years to sell needed to meet the 2 out of 5 rule. 

[Opus 17]

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@Bees wrote:

More of a question to @Opus 17  then an answer. I believe you are going to have to reconsider/reduce the basis of your property by the house value at  purchase since those assets are no longer part of your home. Then add all the construction costs new home to the value. https://www.irs.gov/pub/irs-pdf/p523.pdf  see pages 8 and 9

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In the case of an improvement such as a new roof, the improvement must be part of the home when it is sold to be included in the cost basis.  For example, if you bought a home in 1990 and replace the roof in 1995 and again in 2015, and sold the home in 2020, only the cost of the second roof replacement would add to the cost basis.

However, I've never heard of the need to remove the value of the home entirely if one demolishes it.  (It sounds like a logical extrapolation, but I have never encountered the question before).  I agree below that the cost of demolition and the cost of rebuilding are added to the cost basis—I can't really say if the prior home should be subtracted from the cost basis.  The taxpayer may want to consult a professional.