Determine cost basis on property exchange

[BadgerBoy787]

I own a vacation home on 1.02 acres on a lake. We bought the land for $75000 and made capital improvements of $230000 (built a house, added a boat dock, landscaping, etc). The property owners next to us built a house too close to our property line (12 feet instead of 15 feet as listed in the covenants). After owning the property for a couple years, they decided to sell and could not due to the violation. The only recourse was to do a property exchange of approximately 109 sq ft with them. The property line was redrawn to give them another 3 feet of our property adjacent to their house, and we got the equivalent square footage of their property on the backside (away from the lake). In addition they paid us $25000 because this is a narrow portion of our land and losing that 3 feet of land has impacted what we can do if we want to build a garage. We would no longer be able to build a 2 car garage, we would only be able to build a 1 car garage.

I am trying to determine the cost basis of the land. If I just due the straight math, it would only come to around $200, however that portion of the land had a much larger value to us than that. Would using the delta in property value between a 2 car and 1 car garage be reasonable? Lake property is fairly unique, 1 acre of land that is waterfront is worth the same as 10 acres of land that does not have water access.

[AmyC]

You bought the land for $75,000. Waterfront living goes by the feet on the water usually. Take however many feet you have on the water to determine the price you originally paid per foot. You sold 3 feet, that is your basis. Alternately, you can divide to get the price per square foot. The IRS will accept any reasonable method.

Improvements like a house and boat dock do not affect your basis in the land unless part of the land you sold. Landscaping would increase the value. You are correct that the price difference in the property is significant with waterfront life. 

Did you receive a tax form to have to deal with this?

[BadgerBoy787]

Yes, I received a 1099-S form.  Box 2 shows 25000.00.  Box 4 is checked.

I had not thought about using the amount of water frontage (116' in my case) to determine the cost basis.  However, the section of property I exchanged with the neighbor (Approx 3' x 36') does not contain any water frontage.  But it is a portion of my land that restricts what I can do with my property (will only be able to build a 1 car garage instead of a 2 car garage).  I do not feel like we "profited" $25000 on the sale of the land since we gave up the option to build the garage we would want.

[DianeW777]

It is a sale for tax purposes.  In the process of exchanging land you did receive a payment which is income and reported as an sale of land.  Once you calculate the basis of the land, that will be your cost basis to use against the selling price of $25,000.  If you received the exact same amount of land in acreage, then you may not have a tax cost basis.  However, the taxable amount will become part of the cost basis of your total property which would result in a lower gain in the future when you sell.

If you had only exchanged land for land it wouldn't have created a tax event, however the cash does require a sale on your tax return.

@BadgerBoy787 

[BadgerBoy787]

So if I understand you correctly, whatever I come up with for the cost basis on this sale, can be added to my cost basis when I sell the entire property in the future?

Lets say that of the $25000, I assume $24000 is profit for my taxes this year and I pay tax on that. When I sell the property in the future, I can ADD the $24000 to my cost basis (cost of land + house + boat dock +$24000) to reduce my taxable gain?

[DianeW777]

Yes, that is correct because you're paying tax on funds for property you still own.  It would be part of the cost basis of the land.