People whose homes are on large tracts of land may sell a portion of the land with or without also selling their homes. Selling only a portion of the land without also selling their principal residence will be a taxable transaction. However, selling the vacant land and, within a certain period of time, selling their principal residence may lead to tax-free treatment of the land sale if certain requirements are met.
Meeting the Tax-Free Principal Residence Requirements
Generally, gain from the sale of a principal residence will be excluded from income (up to $500,000 on a joint return) if three requirements are met:
• The taxpayer owns the property for at least two of the past five years
• The taxpayer uses the property for at least two of the past five years
• The taxpayer has not excluded gain from the sale of a principal residence within the past two years prior to the sale of the current principal residence
When someone lives on a large tract of land on which her principal residence lies, the tract of land is part of the principal residence. Taxpayers in this situation often wonder if selling only the vacant land will qualify for the gain exclusion.
When the Land Sale Qualifies for Tax-Free Treatment
The answer is generally “no,” unless the actual home is also sold within a certain period of time. Specifically, excludable gain from the sale of a principal residence can include gain attributable to vacant land, if
• The vacant land is adjacent to the land containing the dwelling unit of the taxpayer’s principal residence
• The taxpayer owned and used the vacant land as part of her principal residence
• The taxpayer sells the dwelling unit within two years before or two years after the date the vacant land is sold and
• The other principal residence gain exclusion requirements are met with respect to the vacant land
Example: In 2010, Michael buys a home on a 1 acre plot of land. Later the same year, he buys an adjacent 29-acre plot of land. In January 2016, Michael sells the 29-acre plot of land. In December 2016, Michael sells the 1 acre plot containing his home. His total gain is $200,000 ($50,000 gain on the house and $150,000 gain on the vacant land). Since Michael sold the vacant land within 2 years of selling his principal residence and the other gain exclusion requirements are met, Michael can exclude the $150,000 gain on the vacant land as well as the $50,000 gain on his principal residence.
Example 2: Same facts as above except that Michael waits until February 2018 to sell the land containing his principal residence. In this scenario, Michael does not qualify for the gain exclusion on the sale of the vacant land because the sale of his principal residence occurred more than two years after the sale of the vacant land. Michael has a taxable gain of $150,000 on the land sale in 2016. Michael will qualify for the gain exclusion on the sale of his principal residence in 2018.
Example 3: Same facts as example 1 except that Michael sells his principal residence in February 2017. In this situation, the sale of the vacant land in 2016 qualifies for the gain exclusion because the sale of the principal residence was within 2 years. When Michael filed his 2016 tax return, he reported the $150,000 gain and paid tax on it. Since he later sold his principal residence within the required time period, the gain on the vacant land sale qualified for gain exclusion. Michael may amend his 2016 tax return to exclude the gain on the vacant land.
To see how this applies to you, give us a call at 248-538-5331.
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.