Tax implications when selling home after subdividing property - capital gains question

The subdivision doesn't reset your ownership clock for capital gains purposes. What matters is that you've owned AND used the home as your primary residence for at least 2 out of the last 5 years (which you have). For your cost basis question, you need to allocate the original purchase price between the portion you're selling and the portion you're keeping. This isn't as simple as just using construction costs. The IRS expects a reasonable allocation method - typically based on relative fair market values or acreage. Since you're selling the house with 1.5 acres, you'd determine what percentage of the total value that represents, then apply that percentage to your original land cost, and add the construction costs. For example, if the 1.5 acres represents 60% of the total property value, your basis would be: 60% of $480,000 (land cost) + $450,000 (house construction) = $738,000.

I actually went through something similar last year and found taxr.ai super helpful for my situation. I was subdividing a larger property and selling just the portion with my house, and I was completely lost on how to handle the tax implications. I uploaded my closing documents from the original purchase, some documentation about the subdivision process, and information about my construction costs to https://taxr.ai and their system analyzed everything. They broke down exactly how to allocate the basis between the portions of land and gave me a detailed report explaining why the subdivision doesn't reset the 2-year clock for the primary residence exemption. The best part was they showed me exactly how to document everything properly in case of an audit. Saved me a ton of stress and probably thousands in potential tax issues.

I have to eat my words about taxr.ai. After our discussion, I decided to try it with my own property subdivision situation (was splitting a 5-acre lot with a rental on it). The analysis it provided was surprisingly comprehensive - it even caught an issue with my deed recording that my real estate attorney missed! The service broke down multiple allocation methods and explained which one would be most defensible for my specific situation. It also provided a complete report showing how the subdivision affects depreciation recapture on the rental portion, which I hadn't even thought about. What I appreciated most was getting a clear explanation of how the IRS typically views these transactions without having to wade through tax code myself. Definitely worth it for the peace of mind alone.

If you're dealing with IRS questions about your subdivision and property sale, you might want to try Claimyr. I was in a similar situation last year and needed clarification directly from the IRS, but kept getting stuck in phone limbo. After trying for days to reach someone, I found https://claimyr.com and their service had me talking to an actual IRS agent within 45 minutes. The agent walked me through exactly how to document my cost basis allocation and confirmed that the subdivision doesn't reset the 2-year primary residence clock. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c It was especially helpful because my situation had a few unusual aspects that weren't clearly addressed in the IRS publications, and getting that direct confirmation gave me confidence I was filing correctly.

I need to apologize about my skepticism regarding Claimyr. After my frustrated comment, I decided to give it a shot as a last resort because I'd been trying for TWO WEEKS to reach someone at the IRS about my own property subdivision issue. The service actually worked exactly as described. I signed up, and about 27 minutes later (I timed it), I got a call connecting me directly to an IRS representative. The agent was able to answer all my questions about allocating basis between subdivided parcels and confirmed I was using an acceptable method. I still think it's ridiculous that we need services like this just to talk to a government agency we fund with our taxes, but I can't deny it worked perfectly and saved me hours of frustration. For anyone dealing with complex tax situations like property subdivisions where you need official clarification, it's definitely worth it.

One thing nobody's mentioned yet - make sure you check with your local tax assessor about how the subdivision affects your property taxes going forward. When I subdivided my property a few years back, I was so focused on the federal capital gains implications that I completely overlooked the local property tax reassessment. In some counties, the subdivision can trigger a complete reassessment of both the new parcel and the remaining land. In my case, it increased my property taxes significantly on the portion I kept because they reassessed it as a "new property" despite no physical changes.

Has anyone used a qualified intermediary for a situation like this? I'm wondering if you could potentially structure this as a 1031 exchange if you're planning to reinvest in another property. Might be a way to defer the capital gains altogether.

One thing to consider - if the subdivision process isn't complete by the time you sell, you might run into additional complications. I tried to do something similar last year but got caught in a timing issue where I had to sell before the subdivision was officially recorded. The title company required me to sell the entire property to the buyer and then have them deed back the portion I wanted to keep. This created a much more complex tax situation since technically I sold everything and then repurchased part of it. Make sure your subdivision is completely finalized with all the proper recordings at the county before you close on any sale!

Great point about timing! I learned this the hard way when I subdivided my property in 2022. The subdivision approval process took 6 months longer than expected due to county backlog, and I had already committed to a sale date with my buyer. We ended up having to extend the closing twice, which cost me about $2,000 in additional carrying costs and almost lost the sale entirely. The buyer was getting frustrated with the delays and started looking at other properties. My advice would be to get your subdivision completely approved and recorded before you even list the property for sale. Don't rely on estimated timelines from the county - they're almost always overly optimistic. Factor in potential delays for things like utility easements, environmental reviews, and neighbor notifications that can pop up unexpectedly. Also, make sure your real estate agent understands the subdivision situation upfront. Some agents aren't familiar with selling subdivided parcels and it can create confusion during the listing and negotiation process.

I went through a similar subdivision process in 2022 and there's one aspect that might affect your calculation that hasn't been mentioned yet - improvements you made to the land portion you're selling versus the portion you're keeping. When allocating your basis, don't forget to factor in any land improvements like grading, utilities installation, septic systems, wells, or landscaping that specifically benefit the 1.5-acre parcel you're selling. These costs should be added to that portion's basis rather than split proportionally. For example, if you spent $15,000 on a septic system that serves only the house parcel, that full amount goes toward the basis of the land you're selling. Same with driveway costs, electrical service runs, or any other improvements that specifically enhance the saleable portion. I made the mistake of not tracking these improvements separately and ended up with a higher tax liability than necessary. Keep detailed records of what improvements benefit which portion of the property - it can make a significant difference in your final calculation. Also, consider getting a survey done if you haven't already. The surveyor can often provide valuable documentation about the relative values of different portions of your property that the IRS would find acceptable for allocation purposes.

This is a complex situation that touches on several important tax considerations. Based on your timeline, you should qualify for the Section 121 exclusion since you've lived in the home as your primary residence for 2 years. The subdivision itself doesn't restart this clock - what matters is your continuous ownership and use of the property. For the cost basis allocation, you'll need to split your original $480K land purchase between the portion you're selling (1.5 acres with house) and what you're keeping. The most defensible approach is usually based on relative fair market values at the time of sale, not just acreage percentages, since developed land typically has higher per-acre value. Your total basis for the sold portion would be: (allocated portion of land cost) + $450K construction + any improvements specific to that parcel (septic, driveway, utilities serving the house, etc.). A few practical tips: Document your allocation method thoroughly, consider getting at least informal comparable sales data to support your valuation approach, and make sure your subdivision is completely recorded before closing. Also check with your county assessor about potential property tax impacts on the remaining land. Given the amounts involved and complexity of the allocation, you might want to consult with a tax professional to ensure you're maximizing your exclusion and properly documenting everything for potential IRS review.