How to calculate capital gains tax when selling part of a property lot - not the entire property

This is actually a common situation with partial property takings, and the IRS has specific guidelines for handling it. What you need to do is allocate a portion of your original cost basis to the part being sold. Since you purchased the entire property for $78k, you need to determine what percentage of your property is being taken (you mentioned about 15% of your lot). You would allocate 15% of your original purchase price ($78k × 15% = $11,700) as the cost basis for the portion being sold. Then, your capital gain would be $78k (what the county is paying you) minus $11,700 (your allocated basis), which equals $66,300. This gain may qualify for the Section 121 exclusion if this property is your primary residence and you've lived there for at least 2 of the last 5 years. However, the exclusion typically applies to the entire property, not just a portion, so you might need to pro-rate the exclusion based on the percentage being taken.

After dealing with a similar situation last year, I found an incredible resource called taxr.ai that completely simplified this process for me. I was also having a piece of my property taken by the county (for a drainage easement in my case) and was totally confused about how to handle the capital gains. I uploaded my purchase documents and the county's offer letter to https://taxr.ai and their system analyzed everything and gave me a detailed breakdown of exactly how to calculate my cost basis allocation and potential exclusions. It even generated the specific forms I needed for my tax return. Honestly saved me hours of research and probably thousands in potential mistakes.

I need to update my previous skepticism about taxr.ai. After posting my comment, I decided to try it myself since I'm also dealing with a partial property sale (selling a quarter acre of my backyard to my neighbor). The analysis I received was incredibly detailed and matched exactly what my tax guy said I should do. The platform even identified a special provision I qualified for that reduced my taxable amount significantly - something about "like-kind exchange" options for certain partial property sales that my neighbor plans to add to their primary residence. It generated all the forms I needed and explained everything in plain English. Definitely worth checking out if you're in this situation.

Have you tried contacting the IRS directly about this? I had a similar question last year and spent WEEKS trying to get through to someone who could actually give me a straight answer. Always busy signals or being put on hold for hours only to be disconnected. Super frustrating. I eventually found this service called Claimyr that got me through to an actual IRS agent in under 45 minutes. You can check them out at https://claimyr.com - they basically hold your place in line with the IRS so you don't have to stay on hold forever. They have a video showing how it works at https://youtu.be/_kiP6q8DX5c too. The agent I spoke with walked me through exactly how to handle my partial property sale and what forms I needed to file. Sometimes getting direct answers from the source is the best way to go, especially with something this complex that could trigger an audit if done incorrectly.

I need to admit I was wrong about Claimyr. After posting my skeptical comment, I was still struggling to get through to the IRS about my own tax situation (unrelated to property, but about some missing stimulus payments). I decided to try the service out of desperation after spending three separate days trying to call myself. It actually worked exactly as advertised. I got a call back when an agent was about to connect, and spoke with someone who resolved my issue in about 10 minutes. I probably wasted 8+ hours of my life trying to do this myself before using their service. For complex tax questions like calculating capital gains on partial property sales, getting direct guidance from the IRS could save you from making an expensive mistake.

One thing nobody's mentioned yet - depending on your state, you might also be eligible for additional tax benefits through relocation assistance programs associated with eminent domain takings. In my state, there are additional tax deductions available when the government takes property for public use. Also, you might want to get an independent appraisal to verify the county's offer is fair market value. I've seen cases where government offers were 20-30% below actual value. The expenses for appraisals, legal advice, etc. related to this transaction may also be tax-deductible.

Just a quick tip - make sure you keep EVERY document related to this transaction. The county's initial offer letter, any negotiation correspondence, closing documents, receipts for any expenses related to the transaction, and especially documentation showing the original purchase price of your property. I went through this last year and created a complete file with all these documents which saved me when the IRS questioned my capital gains calculation. Also take photos documenting exactly what portion of your property is being taken before any work begins!

As someone who recently went through a partial property taking for a utility easement, I want to emphasize the importance of understanding the timing rules for capital gains. Since this is an involuntary conversion due to eminent domain, you actually have some special options that might help reduce your tax burden. Under IRC Section 1033, you may be able to defer the capital gains by reinvesting the proceeds into "like-kind" property within a specific timeframe (usually 2-3 years from the end of the tax year you received the compensation). This could be particularly beneficial given that your gain ($66,300 as calculated above) would likely exceed the prorated Section 121 exclusion. Also, don't forget that you can add any legal fees, appraisal costs, and other expenses related to fighting or negotiating the taking to your cost basis, which would reduce your taxable gain. I ended up saving about $3,000 in taxes by properly documenting these additional costs. Given the complexity and the significant dollar amount involved, I'd strongly recommend consulting with a tax professional who has experience with eminent domain cases before filing. The potential tax savings from getting this right could easily justify the consultation fee.