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What are the rules for declaring capital gains and cost basis when selling a portion of a property, not the whole thing?

For example, suppose I buy a property for $1 million and half of that is paid for by a mortgage, then several years later I sell a portion of the propery for $1 million. What are my capital gains? Can I say I "spent" $1 million even though I borrowed half of the purchase price, and therefore claim I had no capital gains, so I owe no taxes?

If I can't declare the full $1 million as my cost because I sold only a portion of the property, then how is it decided what the cost basis is for the portion that was sold?

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  • Was it all one parcel that you subdivided or separate parcels. Sep 3 at 20:00

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What are my capital gains?

It depends on what portion of the property you sold. Let's say the property was just a plot of land with nothing on it. If you sold a quarter of the property for $1M then you'd have a $750k gain because you paid $1M/4 = 250k for the property you sold.

It's conceptually the same as if you bought 100 shares of stock and then sold a portion of them, the capital gain is based on the purchase and sale price of the portion sold.

Can I say I "spent" $1 million even though I borrowed half of the purchase price, and therefore claim I had no capital gains, so I owe no taxes?

It doesn't matter how much you borrowed, your gain is the difference between the sale price and the purchase price. You can't claim that you spent $1M for the portion sold though, because you only spent a fraction of that.

If I can't declare the full $1 million as my cost because I sold only a portion of the property, then how is it decided what the cost basis is for the portion that was sold?

This depends on your situation, if you bought a house with land and later sell just a portion of the land then you could calculate a reasonable basis by using the appropriate percentage of the land value at time of purchase (property tax assessments often separate land and improvement values), the land value could be derived from comparable lot sales at the time, or you could have an appraisal done on the property to determine the percentage of the total value that the sold portion comprises and apply that percentage to the purchase price. It's not an exact science, it just needs to be a defensible calculation.

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  • So, what is the rule? Can I just arbitrarily decide how much I think the subdivided portion "cost"? (Stocks are not a good analogy because the cost basis of a stock share is always clearly known, being the amount paid divided by the number purchased.) Sep 3 at 21:34
  • You wouldn't sell 50 shares of a 100 lot and expect to use the basis for all 100 shares, just like you can't sell part of a property and claim the whole property cost as basis. Conceptually identical. You can't arbitrarily choose a basis, it has to be defensible, added a bit to answer regarding methodology.
    – Hart CO
    Sep 3 at 23:01
  • ??? If I sell stock, I know my cost basis. The problem here is that the cost basis for the sale of property is not clear. Sep 3 at 23:13
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    I'm saying conceptually it's the same in that capital gain is calculated based on the purchase and sale price of the portion sold. If you bought land and are selling a portion of the land then it is very simple and clear just like selling some shares. You didn't provide details about why your specific situation is unclear, but I added to the answer a common scenario with improved land.
    – Hart CO
    Sep 3 at 23:22
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What are my capital gains? Can I say I "spent" $1 million even though I borrowed half of the purchase price, and therefore claim I had no capital gains, so I owe no taxes?

Don't try this. That would make the capital gains when you sell the rest equal to the purchase price. Also the loan doesn't factor into this calculation.

So what do you do? If the numbers are what you give in the example then take the time and effort to gather the evidence. You may have no choice but to get help to determine the value of the land when it was purchased, how the value changed over time and how much is the gain.

I am assume in the the value of the land is uniform. If it was one parcel when you bought the land, and then it was subdivided just prior to selling the land, you might not have enough time to know how it impacted the value of the rest of the property, until the local government reappraises the land.

If the land was either separate parcels when you bought it or you subdivided the land several years ago, use the information from the tax documents to track the value over time. You could use the percentages when the split was made to assign the initial percentages when you bought the land.

The problem can be what happens if the value of the land isn't uniform: if part of the land is more desirable then the other, you may need help to determine the value of the land. Again if the land was separate parcels, then that should be easy, if the split was new you might have to wait until the remaining land is reappraised.

Note: some of this should have been done before agreeing to sell. Otherwise how would you know if you got a good price.

Regarding the presence of the loan, the lender would have been very interested in this transaction. They are a part owner of the property, and would want to know how it impacted their investment. They might insist on a portion of the proceeded, and/or a refinancing of the existing loan. This may be discussed in the loan papers you signed.

Also the local government would have been involved in splitting process. There can be complex zoning processes involved which would require you getting legal help. Because the size of the lot can change what development can be done on that property, either the part you sold, or the part you kept could suffer a loss in value.

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You will have to determine

  1. The exact percentage of what you are selling (which can be easy or hard depending on what exactly you are selling).
  2. The Fair Market Value (FMV) of the property at time of sale

Example: let's say the original purchase price is $200k, the FMV at time of sale is $240k and you sell 25% of the property. The sell price is therefore $240k*5%=$60k and that's the cost basis of the buyer going forward.

Your capital gain is ($240k-$200k)*25% = $10k. You still have another $30k of capital gains, but these will not be realized until you sell the rest of the property. Your new cost basis is $200k*75% = $150k.

Keep in mind that the sell price of the partial property, the percentage and the Fair Market Value are directly related (unless you have a really creative tax advisor). You only get to determine two out of the three. If you sell 80% of the property for $1M, than the FMV of the property is $1.25M.

and half of that is paid for by a mortgage

That's irrelevant for capital gains.

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