Dear Tax Talk,
My wife and I own jointly 600 feet of shoreline on a lake with enough land to form three lots. There is a house on one of the lots where we live. It is zoned as one large lot. If a buyer wanted to purchase one of the vacant lots, can we exclude jointly up to $500,000 of the gain tax exclusions on the sale of that lot? Two years from now, if we sell another lot can we exclude another $500,000? Then, two years after the second sale, we sell the third lot and the house. Is there another $500,000 exclusion available?
Sometimes to get ahead you have to work backward. You can only exclude gain on the sale of your main home. Adjacent land is considered as part of your home if you use it as your home (as opposed to farm land).
If you sell land adjacent to your home within two years of selling your home, you can consider it all one sale and exclude up to $500,000 in gain. However, if you don’t sell your main home within the two years then the gain on the lot is taxable.
You are also limited to one $500,000 exclusion (for married couples, other taxpayers only get $250,000) every two years. You also have to live in your home for two years in order for it to be considered your main home and qualify for the exclusion.
If you build a home, it’s two years from the date of completion. If you have to pay tax on the gain on the sale of the lots and the gain was $500,000, the tax savings from applying the exclusion would be as much as $75,000 using the maximum capital gains rate of 15 percent. State tax savings is also a consideration.
You can sell your home and three lots and claim the $500,000 exclusion. But since you’re asking about $1.5 million in exclusion, I’m assuming the property has appreciated that much.
To get that much in exclusion, you would have to build a primary home on each lot and live in that home for two years. You would start by selling your existing home while you construct a new home on one of the other two lots.
Knowing that you’ll live there two years and save $75,000 in taxes, you can afford to do some nice improvements to that new home. While you occupy the second home and before the two years are up, you would start building the third home where you’ll save another $75,000. After all is said and done you’ll have saved $150,000 or more in additional federal and state taxes and gained some homebuilding experience.
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.