Without residence, land is subject to gains tax
In 1992 I purchased a house on a lake which included a total of 11 lots. This house and property was sold to me under one title. For two years I tried to sell this residence and property as one piece, as I had bought it, but no one wanted that much property. Finally the realtor told me that I should sell the house with the four lots that encompassed the house, garage and septic field, and sell the other seven lots separately. This is what I did. Now here's my question: I realize had I sold everything, the house and all the lots, as one parcel, I would be exempt from paying a capital gains tax, but since I sold it in pieces, am I still exempt from paying a capital gains tax, or will I have to pay tax on all the lots except those I sold with the house?
The part of the tax law that permits homeowners to sell their primary residence without paying tax on the gain applies to sales where the gain is no more than $250,000 (or $500,000 for a married couple), and applies to no more than one sale every two years. The homeowner must have lived in the house for at least two of the previous five years in order to take advantage of this tax break.
Although you meet the requirements that will enable you to avoid tax on the gain portion of the sale of your home, the fact that you divided the property into lots in order to expedite the sale may work against you. The favorable tax law relates to the sale of a personal residence. Technically, the residence is the house, and not the land underneath it. Typically the land is included in the house sale and therefore the tax break applies to the entire parcel. If you separate the land that you own, selling part of the land and keeping your house, you haven't sold your personal residence, only a piece of land, and the sale of the land by itself would not qualify for the special tax treatment for primary residences.
In your case, even though the sales presumably occurred in close proximity to one another, you did break the land into lots. In selling an individual lot, without a house on it, you haven. t sold your personal residence, therefore you will be required to pay tax on the gain that applies to that lot.
The tax laws may work in your favor if most of the appreciation of your property that occurred in the six years in which you owned it relates to your house. Find out how much land in the area was selling for in 1992 and compare that to the sales price on the land you sold in 1998. You may find that there is not a lot of appreciation on the land itself, and therefore the tax may be lower than you anticipated.
For example, if you purchased the entire parcel for $250,000 and sold it for a total of $350,000, your gain from the sale of the house and all the land is $100,000. Determine the original value of the acreage and calculate the cost you paid for each lot of land. Perhaps the house was originally worth $175,000 and the land worth $75,000. You would allocate a portion of the $75,000 land cost to each lot. Of the $350,000 selling price, determine how much relates to the house and how much relates to the land. If $100,000 of the selling price relates to the land, you would have a gain of $25,000 for all the land. The gain on the portion of the land that was sold with the house will not be taxed under the special tax rules for homeowners. The gain on the land sold separately will be subject to capital gain tax at a maximum rate of 20%.
If it turns out that you actually lost money on the sale of the land, and only the house appreciated in value over the years in which you owned it, you will be able to deduct a capital loss on the sale of all of the lots of land that were sold separately from your house. If this loss is more than $3,000, you may have to carry some of it over to future tax years. There is no deduction for the loss of value of the land sold with your personal residence.