Selling a homethe original property is an

[Rodthabod]

in 2002 I built my own home. I bought property and subbed it out myself. I did have to borrow money from the bank and the mortgage was $115,000. The 2013 I built a second home that is now on my primary residence,. the original property is now an investment property. I am thinking about selling the property in the next few years. Obviously I will have to pay long-term capital gains. I can’t remember exactly what the total cost of the house was in 2002. There is no record of it anywhere but I think it was around $220,000. Let’s just say I sell the house for $520,000. That will give me a long-term capital gains of $300,000. do I need to have proof of that or is it a situation where the IRS will not challenge it?

[Mike9241]

The value of your labor cannot be added to the cost basis. We can't say whether the IRS will audit you. If they do, they might ask for proof as to your cost. if you can't prove it the IRS can disallow it. Then your options are to take it to appeals or tax court where they might be more generous or pay the bill.  

[Opus 17]

The IRS can challenge anything at any time for any reason.  All income is deemed to be taxable unless you can prove otherwise.  

Of course, the county has records of what you paid for the property in 2002, or a real estate agent through the multiple listing service.  

I'm not clear on what you are selling, both properties or only the one you don't live on.

You need to determine the cost basis of the property you are selling.  If you are selling the original house with the original lot, your cost basis probably be the purchase price, minus the value of the land that you subdivided.  (The value of the land that you subdivided becomes the cost basis of the second lot where your main residence is now, plus the cost of building that residence.)  Then, your capital gains are the difference between the selling price and the cost basis.  You can increase the cost basis by certain closing costs and by the cost of any permanent improvements made to the home.  There is some guidance here.

https://www.irs.gov/forms-pubs/about-publication-523

https://www.irs.gov/forms-pubs/about-publication-551

You also said the first home became "investment property."  Does that mean you rented it?  Then your capital gains transaction includes paying depreciation recapture tax on any depreciation you took or could have taken while it was a rental.  Also, up until 2017, it was possible to "capitalize" carrying costs on investment property.  If you did this, that also adds to the cost basis.  If you did not, or you don't know what I mean, don't worry about it because it is too late to change anything now.  

If you are selling the lot that contains your primary home you can claim the personal capital gains exclusion of up to $250,000 (or $500,000 for married filing jointly).  You can also claim the exclusion if you sell both lots within 2 years of each other (not two separate exclusions, but you can extend one exclusion over both sales).  If you only sell the lot you don't live on and keep living in the other house, you can't use the exclusion on the sale of the first house. 

You don't submit proof with your tax return, but keep your proof and other documents for 6 years after you sell.  If you are audited the IRS does not have to credit any cost basis that you can't prove with adequate reliable records. 

[Rodthabod]

Yes I purchased the property in 2002 for $7500. I borrowed $116,000 for the mortgage. Since I didn’t buy it from a real estate company my question is where is my proof that the total purchase price? The total purchase price was around $150,000 to $175,000 .but like I said before let’s just say I tell the IRS that the total purchase price is $160,000? I can’t be a 100% sure of the exact price, but that is the ballpark. 

[Opus 17]

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@Rodthabod wrote:

Yes I purchased the property in 2002 for $7500. I borrowed $116,000 for the mortgage. Since I didn’t buy it from a real estate company my question is where is my proof that the total purchase price? The total purchase price was around $150,000 to $175,000 .but like I said before let’s just say I tell the IRS that the total purchase price is $160,000? I can’t be a 100% sure of the exact price, but that is the ballpark. 

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In most states, your county clerk's office has a record of the transaction.  It sounds like the purchase price was $7500 cash down plus $116,000 = $123,500.  But there may be other things I don't know about.

If audited, the IRS will allow what you can prove with reliable records.  They are not required to accept a "ballpark" unless the auditor is feeling particularly generous.  That's all I can tell you--most people aren't audited, but if you are audited, the IRS is allowed to assume the entire sales proceeds is taxable capital gain unless you can prove your basis.  

[Rodthabod]

2002 I bought the property for $7500. No house on it. Bought plans and went to the bank. They appraised the home at around 185,000. Good friend of mine was a builder and advised me along the way. First Bank had the construction loan. After the home was completed , Wells Fargo did the mortgage. Financed $116,000. I put down about 30,000 to 40,000 down. Total build was in the 160,000 to 175,000 range. Paid for other things out of pocket. This is a vacation home now because I didn't want to sell it. Thinking of selling it now. House is valued at around $525,000. If I sell it , ( and I believe in paying the proper amount of capital gains ) how do I prove to the IRS that the original basis is in the 160,000 range? 

[Rodthabod]

2002 I bought the property for $7500. No house on it. Bought plans and went to the bank. They appraised the home at around 185,000. Good friend of mine was a builder and advised me along the way. First Bank had the construction loan. After the home was completed , Wells Fargo did the mortgage. Financed $116,000. I put down about 30,000 to 40,000 down. Total build was in the 160,000 to 175,000 range. Paid for other things out of pocket. This is a vacation home now because I didn't want to sell it. Thinking of selling it now. House is valued at around $525,000. If I sell it , ( and I believe in paying the proper amount of capital gains ) how do I prove to the IRS that the original basis is in the 160,000 range? 

[Opus 17]

I can't follow your story.  You first said you bought a property with one home, then subdivided the property, and built a second home.  You now live in the second home, and want to sell the first home.   Now you say you bought a property with no house on it?  You built a house and it later appraised for some value?

Please confirm the details of what happened and when.

In any case, the cost basis of a house you built is the cost of the land, plus the cost of things you did to build the home.  For example, you can include the cost of architect plans, required permits and inspections, and labor and materials that you paid for.  You can't include anything for the value of your time and labor.  The appraised value and mortgage amount are not useful for this determination.  What counts is what you can prove your costs were.  And as I have said already, if you are audited, the IRS does not have to allow any basis that you can't prove.  They might allow a reasonable estimate (you can't build a house for $1), but if you have no proof, you have no influence with the IRS as to what basis they allow you, it will be whatever they determine is proper.  

[Rodthabod]

Saying I subbed it out was subbing it out to subcontractors. Not subdividing the property. I basically did it without a builder. Called on the individuals. One guy cleared the lot , then one guy did the foundation , then one guy did the framing , then so on and so forth. 

[Rodthabod]

Very possible , they could look back at what houses were built for in that area in 2002? Get a pretty good idea? If I sell the house for 525,000 and my basis that I claim is $160,000 , I don't think they would argue with that as opposed to me saying my basis was say $300,000? Then claim $365,000 long term capital gains. The main question is this , if I didn't buy the house through a real state company , how will the IRS know the true basis? 

[rjs · Accepted solution]

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@Opus 17 wrote:

I can't follow your story.  You first said you bought a property with one home . . . 

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@Opus 17 

The OP did not buy a property with one home. He bought an empty lot and built a home on it in 2002. He lived in the home for some years, then moved to a new primary home that he built in 2013. He did not sell the 2002 home. He says it is now a vacation home and he is thinking of selling it now. He has not said whether he ever rented it out. He is only selling one home: the one that he built in 2002, lived in, then moved out of.

He did not subdivide the lot. The two homes are on entirely separate lots.

@Rodthabod  If you never rented out the home that you built in 2002, and you consider it a vacation home, then it's a second home, not an investment property.

The primary problem seems to be that @Rodthabod  has no records of how much he spent to build the 2002 home, so he has no way to prove his basis. He's not even sure what his basis is, because he has no records. He can only make a ballpark guess.

I see a couple of possible secondary problems.

• It's not clear whether the entire amount of the mortgage was used to build the home. If not, there could be issues with mortgage interest deductions taken in previous years.
• If it was ever a rental, it's not clear whether proper depreciation was claimed.

[Rodthabod · Accepted solution]

The OP did not buy a property with one home. He bought an empty lot and built a home on it in 2002. He lived in the home for some years, then moved to a new primary home that he built in 2013. He did not sell the 2002 home. He says it is now a vacation home and he is thinking of selling it now. He has not said whether he ever rented it out. He is only selling one home: the one that he built in 2002, lived in, then moved out of.

He did not subdivide the lot. The two homes are on entirely separate lots.

@Rodthabod  If you never rented out the home that you built in 2002, and you consider it a vacation home, then it's a second home, not an investment property.

The primary problem seems to be that @Rodthabod  has no records of how much he spent to build the 2002 home, so he has no way to prove his basis. He's not even sure what his basis is, because he has no records. He can only make a ballpark guess.

I see a couple of possible secondary problems.

• It's not clear whether the entire amount of the mortgage was used to build the home. If not, there could be issues with mortgage interest deductions taken in previous years.
• If it was ever a rental, it's not clear whether proper depreciation was claimed.

100% Spot on!

[rjs]

@Rodthabod  Please note that we cannot tell what post you are replying to unless you quote it or otherwise indicate what you are referring to. Clicking Reply on a post does not in any way link your reply to the post that you replied to.

[Opus 17]

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@rjs wrote:

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@Opus 17 wrote:

I can't follow your story.  You first said you bought a property with one home . . . 

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@Opus 17 

The OP did not buy a property with one home. He bought an empty lot and built a home on it in 2002. He lived in the home for some years, then moved to a new primary home that he built in 2013.

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I read "subbed" as subdivided, not subcontracted. 

In any case, everything I said (and you said) about basis is still true.  If the basis can't be proven, they are rolling the dice that they won't get audited.  If audited, the IRS probably can't assign a zero basis (since you can't build a house without paying something for materials), but they don't have to accept the taxpayer's guess, either.  

[rjs]

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@Opus 17 wrote:
If the basis can't be proven, they are rolling the dice that they won't get audited.

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The OP doesn't seem to have any choice. That's the only thing he can do, since there are no records.