Capital Gains Tax Exemption When Selling Adjacent Lot to Primary Residence?

The capital gains exclusion rules for your primary residence and adjacent lot are a bit nuanced, but I can help clarify. The good news is that you can potentially treat both properties as your primary residence for capital gains purposes. The IRS allows you to include an adjacent lot as part of your "qualified home" if you've been using it as part of your residence (gardening, recreation, etc. as you described). To qualify for the full $500K exclusion (for married filing jointly), you need to have owned and used both properties as your main home for at least 2 out of the 5 years before the sale. It sounds like you've met this requirement easily with 10+ years of ownership. The key point: you don't necessarily have to sell to the same buyer. What matters is that both properties are sold within a reasonable timeframe and both were used as part of your primary residence. However, there are some important considerations and potential limitations.

I had almost the exact same situation last year and found a great resource that really helped me navigate all the tax implications. I used https://taxr.ai to analyze my property documents and tax situation. They have this tool that specifically looks at capital gains on property sales including adjacent lots. What I liked was that they explained exactly how the IRS views adjacent lots in relation to primary residences - they analyzed my deed, property tax statements, and even some photos I had of how I was using the lot. They confirmed I could sell to different buyers (which I ended up doing) and still claim the exclusion. They even provided documentation I could keep with my tax records in case of an audit.

Just wanted to follow up - I went ahead and tried taxr.ai after reading about it here. My situation with my adjacent wooded lot turned out to be more complicated than I thought because part of it had been rented to a neighbor for a garden plot. The team at taxr.ai was able to determine exactly what percentage of the property qualified for the capital gains exemption. They even found a deduction related to land maintenance I hadn't considered. They provided a detailed report I can keep with my tax records that specifically addresses the IRS rules about adjacent lots and primary residences. Definitely worth it for the peace of mind alone!

Hey, just wanted to share something that might help with the IRS if you need clarification directly from them. I had a similar situation last year and ended up needing to speak with someone at the IRS to confirm my understanding before selling. I was on hold FOREVER trying to reach them until I found https://claimyr.com - they have this service where they wait on hold with the IRS for you and then call you when an agent is actually on the line. I was super skeptical at first but I was desperate after trying to reach someone for 3 weeks. I used the service (you can see how it works at https://youtu.be/_kiP6q8DX5c) and got a call back in about 2 hours with an actual IRS representative on the line. The agent confirmed the adjacent lot rules and gave me specific guidance for my situation that saved me thousands in taxes.

I have to come back and eat my words about Claimyr. After posting my skeptical comment, I decided to try it myself since I've been trying to reach the IRS about an audit issue for weeks. I'm honestly shocked - it actually worked exactly as described. I got a call back in about 90 minutes with an IRS agent ready to talk. I asked specifically about the adjacent lot question while I had them on the phone. The agent confirmed that you CAN sell to different buyers and still claim the capital gains exclusion on both properties as long as you can demonstrate the adjacent lot was used as part of your residence. They recommended keeping photographic evidence of how you used the property and documentation showing both properties sharing utilities, landscaping, etc. if applicable. The agent also mentioned that timing matters - selling both properties in the same tax year makes the exemption claim much cleaner, but it's not strictly required.

One thing that nobody has mentioned is that you still need to allocate the $500k MFJ exemption proportionally across both properties. My accountant explained that you can't claim the full $500k on each property - the total exclusion across both sales can't exceed the $500k limit. So if you sell both properties for a total gain of $600k, you'll still owe capital gains tax on the $100k that exceeds your exemption, regardless of whether you sell to the same buyer or different buyers.

Has anyone dealt with selling just the adjacent lot while keeping their main home? My neighbor wants to buy my extra lot but I'm keeping my house. Would I still get some capital gains exemption on just the lot?

Just wanted to add something that might be helpful - if you're planning to sell both properties, consider getting them appraised together as one unit first. This can help establish that they were truly functioning as a single residential property for tax purposes. I went through a similar situation a few years ago and my tax preparer recommended this approach. The appraiser noted in the report how the adjacent lot contributed to the overall residential use and value of the main property. This documentation was really valuable when I filed my taxes and helped support my position that both properties should be treated as one primary residence for the capital gains exclusion. Also, if you do end up selling to different buyers at different times, make sure to keep detailed records of the marketing process. If you listed them together initially or marketed them as a package deal, that can also help demonstrate they were intended to be treated as one residential unit, even if they ultimately sold separately. The key is building a strong paper trail that shows the IRS these weren't separate investment properties, but rather one integrated residential property that happened to span two lots.

One thing I'd add that hasn't been mentioned yet - make sure you understand the timing requirements for the Section 121 exclusion. Even though you don't need to sell to the same buyer, both sales should ideally happen within the same 2-year period to maintain the strongest position that they're part of the same primary residence transaction. I learned this the hard way when I sold my main house in 2019 but didn't sell my adjacent lot until 2022. The IRS questioned whether the lot still qualified for the primary residence exclusion since so much time had passed. I was able to defend it successfully, but it created extra paperwork and stress during the audit process. Also, consider the order of your sales carefully. If you sell the lot first while still living in the main house, it's easier to demonstrate that the lot was part of your primary residence at the time of sale. If you sell the house first and then the lot later, you'll need stronger documentation showing the lot was integral to your residential use. Document everything now while you're still using both properties - take photos showing how you use the space, save utility bills if you have any shared services, and keep records of any maintenance or improvements you've done to the lot that support its residential character.

This is such a helpful thread! I'm in a very similar situation with my primary residence and an adjacent lot that we've been using for recreational purposes for about 8 years. One thing I wanted to add based on my research is that the IRS Publication 523 specifically addresses the "vacant land" rules for adjacent lots. According to the publication, the key factors they look at are: (1) the land is adjacent to land containing your home, (2) you owned and used the vacant land as part of your main home, and (3) you sell the vacant land in a transaction that's related to the sale of your main home. The "related transaction" part is what's been confusing me - it sounds like from everyone's experiences here, selling to different buyers can still qualify as long as the timing is reasonable and you can document the residential use. I'm definitely going to follow the advice about getting both properties appraised together and starting to document our current use patterns. The point about taking photos while we're still actively using the space is really smart - much better to have that evidence ready than try to recreate it later. Has anyone here worked with a tax professional who specifically specializes in real estate transactions? I'm wondering if it's worth the cost to get professional guidance upfront rather than trying to navigate this on my own and potentially making mistakes.

This thread has been incredibly helpful! I'm dealing with a similar situation where my wife and I own our primary residence plus two adjacent lots that we've been using as extended yard space for the past 12 years. One lot has our pool and patio area, the other is mostly wooded but we use it for hiking trails and our kids built a treehouse there. Based on everything discussed here, it sounds like both lots should qualify for the capital gains exclusion along with our main house as long as we can document the residential use and sell within a reasonable timeframe. The advice about getting everything appraised together as one unit is brilliant - I'm definitely going to do that. One question I haven't seen addressed: does it matter that our lots are technically on separate parcels with separate property tax assessments? We receive three different tax bills each year, which makes me worry the IRS might view them as separate investment properties rather than part of our primary residence. Has anyone dealt with this situation where the adjacent land was on completely separate legal parcels? Also, for those who mentioned working with tax professionals specializing in real estate - any recommendations for finding qualified specialists? I want to make sure I get proper guidance before we start the selling process.

This has been such an informative discussion! I'm actually a tax preparer and wanted to add a few technical points that might help everyone here. First, regarding the separate parcel question - the IRS uses the "functional test" rather than just legal boundaries. As long as you can show the parcels were used together as your residence (which your pool, patio, trails, and treehouse clearly demonstrate), the separate tax assessments won't hurt you. In fact, I've seen cases where separate parcels actually helped establish clear ownership timelines. One thing I haven't seen mentioned is the importance of Form 8949 reporting when you do sell. You'll need to report each property separately on the form, but you can apply the Section 121 exclusion to the combined gain. I always recommend my clients include a statement explaining that the properties were used as an integrated primary residence - this proactive disclosure can prevent future IRS questions. Also, for those considering the timing of sales - while selling in the same tax year is cleanest, I've successfully handled cases where properties sold up to 18 months apart with proper documentation. The key is maintaining your narrative that they were always one residential unit, not separate investments. One last tip: if any of you have made capital improvements to the adjacent lots (landscaping, fencing, pool installation, etc.), make sure to include those in your cost basis calculations. These improvements can significantly reduce your capital gain and might even keep you under the $500K threshold if you're close to the limit.