Tax implications of building an addition & selling it as a condo?

[Alex Asen]

I own a 2,000 sq ft single-family outside of Boston, which has been my wife's and my primary residence for 2+ years.  I have ZBA approval  to create a two-family by building a 2,000 sq ft addition mostly in my current driveway, but there will be some overlap between the two units.

After construction, I plan to split the units into two condos.  I will continue to live in my current space and sell the second unit.  

Is there any way to structure things so that that sale of the second unit qualifies for the home sale exclusion? 

If not, is there a way to at least qualify for treating the sale of the new unit as a capital gain?

Thank you so much for your help!  I am clearly in need of a good accountant, but have been struggling to find one...

[Eamonn McElroy]

David A. Gates and Christine A. Gates v. Commissioner (Dec. 58,259 , 135 TC 1)

You won't be able to use the Sec 121 exclusion on the new structure/unit/dwelling as you never used it as a primary residence.

That's not to say you don't have tax mitigation options.  If you were to subdivide and sell the land to a controlled S Corp you could use Treasury Reg §1.121-1(b)(3) to exempt the gain of sale on the land.  A promissory note could be executed to match up cash flows.  The S Corp would then receive the land at stepped-up basis, develop the land, and finally sell the property.

Alternatively you could build the new dwelling, move into the new dwelling unit, and sell your old one.  Generally you would meet Sec 121 requirements with respect to the old property in this scenario.

Highly encourage you to work with your tax CPA/EA.  It's easier to mitigate tax burden prospectively rather than retrospectively.