If I start building a home on vacant land I own, will I owe capital gains tax on the sale of the home?

by Gregory Paulding, CPA | Aug 07, 2018

If I owned vacant land for about four years, and then decided to start building a home on it, will the sale of the home fall under capital gains tax?

Internal Revenue Code Section 121 controls the taxability of the gain on the sale of a home. More specifically, the following must exist to exclude gain on sale of the property:

  • The taxpayer must own the property.
    This need not be concurrent with the use of the property.
  • The taxpayer must occupy (use) the property.
    This need not be concurrent with the ownership of the property.
  • The property must be the principal residence for the taxpayer.
    This cannot be a second home or a vacation home, and it cannot be rental, investment, or trade or business property.
  • The above must exist for at least two of the five years before the sale.
    The two years (24 months) need not be consecutive.

Provided that you are in compliance with this section, then an exclusion of up to $250,000 ($500,000 for taxpayers who file a joint return) will be allowed. Thus, an exclusion may be possible every two years. The gain that is excluded is permanently excluded, rather than deferred, and no replacement property is required for this exclusion.

Circumstances will alter the outcome of this exclusion if you use the property for other than a principal residence, or any part thereof, or if there is a change in employment, health, or certain unforeseen circumstances. Note that various other codified use and time period exceptions may apply.

Now, considering the question asked:

  • If the requirements above are not met, then tax will be assessed on the gain on sale of the property.
    This tax may be assessed at long-term capital gains rates for the land portion, and short-term capital gains rates for the home if sold less than a year after completion.
  • Should you use the home built as a principal residence for at least two years, then no tax will be assessed.

As always, a careful analysis of your circumstances must be performed by you and a tax professional to ensure the proper treatment on your tax return.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: Gregory Paulding, CPA, is president of Paulding & Associates PC in Erie, Pa.

The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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