Build 3 townhomes, keep 1 for primary residence

[Cary Westerbeck]

Hi there, newbie here with a question I haven't found in my searches on BP. 

I'm an architect, developer, and general contractor. I own a small lot free and clear in the downtown of our small city just outside Seattle, WA. I've been running the numbers on building three townhouses on the lot, selling two and keeping one to live in as a primary residence and as an asset. (We just short platted a larger lot, and own the triplex on the adjoining lot, freeing up the newly created lot for development). 

Does any one have experience with this? What I can't figure out is what the tax implications are for keeping the third unit, if any. Obviously if we sell the first two we pay the standard RE fees, ordinary income tax, etc. But how is the third unit evaluated by the IRS? We'd probably make enough money on the first two sales to offset our mortgage quite a bit on the unit we keep. Does anyone know if we get taxed on any portion of the unit we keep and live in? Or maybe it's just seen as building ourselves a home and there is no tax until we sell later, hopefully after 2+ years to avoid capital gains. I'm not sure how to evaluate what the implications are for keeping the third unit. 

Any insight is appreciated, thanks. 

[Dave Foster]

@Cary Westerbeck, Ah claro.  I didn't see the entity issue.  @Stanley Bronstein's right on with his suggestion of two building entities.  That keeps things separate from the get go yet still gives you a documented starting basis.  

The problem in a sale to yourself as mentioned by Stanley is the opportunity to basis shift so load more profit onto the unit sold to  you.  The IRS would not like that as you'll be eliminating that profit down the road.