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This is a narrower question than a question about the sale of land adjacent to a PRIMARY residence.

Can I take the $250,000 tax exemption on the sale of my land adjacent to my rental property (not my primary residence in the U.S.) if I am not going to sell the rental property in the near future or in the next two years?

I sold land adjacent to my rental house in 2022. Since the house is a rental, can I take the $250,000 tax exemption on the land sale?

I bought the house in 1991 on two acres. In 2009 I subdivided the property into three lots. The house (rental) is now on one acre and I sold the two adjacent 1/2 acre lots in 2022. The house was my primary residence until 5 years ago. I have lived in the house 2 out of the last 5 years. (The last 3 years it has been a rental.)

I'm not going to sell the house. I'm going to continue renting it. In 6 years I plan to do a 1031 exchange.

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If you're referring to the Sec. 121 exemption, then no. It is explicitly for principal residence:

Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.

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  • Thank you very much for responding and sending the link to Sec 121
    – T White
    Commented Mar 25, 2023 at 23:07
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Lets look at it from a simplified case. Lets assume it never was a rental property, and you have lived in the house for many years.

From IRS publication 523 Selling Your Home

Vacant land next to home. You can include the sale of vacant land adjacent to the land on which your home sits as part of a sale of your home if ALL of the following are true.

  • You owned and used the vacant land as part of your home.
  • The sale of the vacant land and the sale of your home occurred within 2 years of each other.
  • Both sales either meet the Eligibility Test or qualify for partial tax benefits, as described earlier.

Also, if your sale of vacant land meets all these requirements, you must treat that sale and the sale of your home as a single transaction for tax purposes, meaning that you may apply the exclusion only once.

In your case you will have several issues. You plan to sell the house 6 years from now. but the two transactions have to be within two years.

Even if you do change your plan to meet the two year time frame your plan doesn't meet the requirements because:

I'm not going to sell the house. I'm going to continue renting it. In 6 years I plan to do a 1031 exchange.

So there won't be a sale of of non-rental property to combine the land sale to.

Even if you decided to sell now, and you did convert the home back into your residence, and then sold it and met all the deadlines you would still only have $250,000 exclusion split among the two transactions. Plus all the complexities regarding the period it was a rental, and the recapture of the of depreciation.

In the short term the IRS will be expecting you to claim on your return you will be filing by April 2023, that you sold the land for a profit and you will be paying taxes on that profit.

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