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Building a home to get two capital-gains tax breaks

Dear Tax Talk,

I have lived for the last eight years in a single family home on 20 acres in a market where the land values have risen sharply in the last two years. I believe I will exceed the tax-free profit threshold and will owe taxes on profit in excess of $250,000 if I sell the entire 20-acre parcel (I am single).

If I subdivide my 20 acres and sell off 10 acres with the house, then build a house on the other 10, and live in the new house for at least two years, could I utilize the $250,000 exclusion for both parcels? Wouldn't the cost basis for the 10-acre vacant parcel be what I paid for it back when it was originally purchased, and that amount deducted from the cost basis on the 10 acres that contain the house? -- Lynne

Dear Lynne,
Your plan should work under current regulations. The regulations state:

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;

The key here is that you have to have used the 10 acres that you are first planning to sell as part of your principal residence. This condition would mean that you're not using the land for a commercial purpose, such as farming. You would also have to occupy the newly constructed house for two years after it is built in order to once again claim the exclusion.

You would need to allocate part of the original cost of the 20 acres to the 10 you are selling. If the property is identical, then half of the cost would be allocated. If one parcel is more valuable for some reason, then you would make an allocation based on the relative values.

You said you were single, but people contemplating marriage have it easier: Marriage doubles the exclusion to $500,000.

Bankrate.com's corrections policy
-- Posted: July 6, 2005
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