capital gains issues if subdividing a lot...

[Joe Smith]

OK, this is a situation that I saw on another board and it got me thinking about it...just my brain working here.

It's a 9 acre single parcel of land, that has 2 single-family homes on it, and a fourplex. He lives in one of the houses and has for 8 years. He bought the property in 1999 for $330,000 and has lived in one of the SFR's ever since.

Here's the question...since it will be far easier financing-wise to split off the property into three seperate deeds/parcels and sell each individually, how would the capital gains tax issue be solved if he did so?

If he could sell each SFR for $110,000, and the fourplex for $220,000 (for example), how would the tax issue be dealt with?

I presume if he sold the WHOLE thing, he'd pay no tax as it would be his primary residence (except for depreciation recapture on the rented portions). However, if he split them up, and sold the one he lived in, how would he document that tax-wise?

For the other two, would the capital gains tax be determined by taking their portion of the value of the original purchase?

[Account Closed]

Originally posted by Joe Smith:

It's a 9 acre single parcel of land, that has 2 single-family homes on it, and a fourplex. He lives in one of the houses and has for 8 years. He bought the property in 1999 for $330,000 and has lived in one of the SFR's ever since.

So from day one this property has been used personally and as investment property.

Originally posted by Joe Smith:

Here's the question...since it will be far easier financing-wise to split off the property into three seperate deeds/parcels and sell each individually, how would the capital gains tax issue be solved if he did so?

Not sure what you mean by splitting, but I agree that dividing up the property would make good business sense. Sometimes it can be done as easily as a lot line adjustment. Most of the time it would require platting the property. In either case you will need to talk to your city or county planning department to determine what you can do and what is required to get it done. Short platting can be a little time consuming an will require an investment. Not sure what that investment might be in your neck of the woods though. If I did something like you described in the Seattle, WA area I would expect to pay 20-25K maybe more. A survey would be required, notices must be prepared, the city collects a number of different fees and often surprises you with somethings like a "park fee"

Originally posted by Joe Smith:

I presume if he sold the WHOLE thing, he'd pay no tax as it would be his primary residence (except for depreciation recapture on the rented portions). However, if he split them up, and sold the one he lived in, how would he document that tax-wise?

For the other two, would the capital gains tax be determined by taking their portion of the value of the original purchase?

Actually your assumption would not be correct. Which makes me wonder how the various property costs have been allocated every year.

Based on the scenario you describe only the SFR that is owner occupied would be eligible for capital gains exemption. The investment portion would be subject to capital gains and depreciation recapture rules.

I'm hoping that property taxes, property insurance, mortgage interest and any other expenses that might apply to the entire parcel have been allocated based on some reasonable rational in the past. If so you should be able to use the same rational to figure out what your capital gains would be.

It sounds like you have calculated a basis for the investment properties which should mean you have a basis starting point for the owner occupied SFR. I would suggest that you may want to use this allocation to determine the capital gains.

If you divide the parcel you situation for tax purposes will not really change. Though there are obvious benefits to subdividing regardless.

Originally posted by Joe Smith:

If he could sell each SFR for $110,000, and the fourplex for $220,000 (for example), how would the tax issue be dealt with?

Once the land is subdivided, I would not be inclined to use the potential sales price as the means for allocating basis between the newly created parcels. I would be more inclined to use the original allocation based on appreciable basis. Otherwise I think you would be challenged based on a change in accounting methods.

I would consider getting a tax professional on board to advise you. This is a tricky scenario and many tax professionals are not going to even get it right. You want a professional that understands real estate issues.