Cost basis on subdividing

[Pearce G.]

I have a commercial zone property under contract that includes a building that I intend to hold for rental income and some additional vacant land that I intend to subdivide from the building and then flip.

For tax purposes, how is the cost basis allocated?  Is it split evenly between all the subdivided parcels?  Or is one of them deemed to be the original parcel with full cost basis and the other parcel(s) have zero cost basis?  If so, can I decide which parcel retains the cost basis?  Or is cost basis allocated by rule or appraisal or some other formula out of my control?

If the cost basis on the vacant land is zero, then I probably need to plan for a 1031 exchange when I sell it.  On the other hand, if I can assign the entire cost basis to the vacant land, then I will have little or no profit on the sale, and a 1031 is not necessary.

[Dave Foster]

@Pearce G., Yes different than broker-dealer.  This is more a distinction between investor/dealer.  Property used in a 1031 must be property which you intend to hold for productive use in business, trade or investment.  Property bought with the primary intent of reselling becomes inventory, is not eligible for 1031 and is taxed at ordinary income rates.

When you buy this property it is one property and easy to demonstrate your intent for the whole by how you treat the part - renting the building.  However, if you immediately spin off and sell the second parcel you're creating a new piece of real estate and it could very easily appear that your intent from the beginning was to resale that parcel.  This would make it inventory and not eligible for 1031.

Now, if you bought this piece thinking it was a great investment hold value and it came with some extra land you could use some day maybe then that reflects a different intent doesn't it?  You can demonstrate that intent by leaving it attached, or performing only a legal subdivision with no construction activity and holding on to it for a bit.  Then change your intent, decide to sell it and do a 1031.  

Your use of the word "flip" coupled with the actions of a quick subdivide and sale indicate that your intent is that of a dealer so your 1031 might be at risk if audited.