Capital Gains on House Lots Divided

from www.yahoo.finance.com

Bankrate.com Divided lot limits tax breakFriday August 17, 6:00 am ET George Saenz
Dear Tax Talk:We purchased a house on a large parcel 13 years ago. We have just completed a "lot split," dividing the property approximately in half. We wish to sell the lot with no dwelling on it and pay off most of our mortgage on the other half. Would we have to pay capital gains tax? If so, at what rate?-- DaphneDear Daphne,You only want to sell the vacant lot. However, the law requires that you sell it all to get a break from the capital gains tax.
A married couple that sells their principal residence that they have owned and lived in for two of the last five years does not have to pay tax on the first $500,000 in gain. The regulations consider adjacent vacant land as part of your principal residence, qualifying for the exclusion if sold within two years before or after the main home is sold. If the main home is not sold within this time frame, the gain on the vacant land is subject to the 15 percent long-term capital gains tax rate.
In order to calculate the taxable gain on the land sale, you have to allocate your original cost of the property 13 years ago to the house and land. Of the original cost of the land, you have to allocate between the portion you're selling and the portion remaining with your home.
Suppose the home originally cost you $100,000 and at that time the land and the house were roughly equal in value, so that you allocate $50,000 of the cost to the land. Now in 2007, you're selling the vacant lot for $150,000 and you estimate half of the original land is being sold, so that your cost in the half is $25,000. You'll have to pay capital gains of 15 percent on the $125,000 in gain.
If you sold your home and the vacant land for up to $600,000, you wouldn't owe any tax, but then you wouldn't have your home either. Alternatively, you can build a new main home on the vacant land and sell your old dwelling and qualify for the exclusion.
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