Primary residence with extra lots

We live in Massachusetts. Our home was purchased in 1976 and 7 years later we bought 4 lots around our home which we used to extend the size of our primary residence. The lots were left with separate deeds. We are now selling 2+ lots to a home builder and a lawyer did not think we need to pay capital gains tax because the lots were used as our residential property for over 20 years. Is he right?

[Snipes5]

While you did use the property for personal purposes, I do not believe this sale would be eligible for Capital Gains exclusion unless you were also selling the dwelling, since although it is adjacent, it is still considered separate property.

Snipes

[abezon]

You will have to pay taxes on the capital gain. The gain is the difference between what you paid for the lots and what you sell them for. The max capital gains tax rate is 5%, 15% if you're in the 25% tax bracket or higher. You might consider doing the deal as 2 sales: one in 2004 & one in 2005. This way your income won't be bumped up all in 1 year.

If you had bought the lots with the house, you could play around with the basis a bit & assign some of the "house" basis to the lots, but since you bought the lots separately, you have to use purchase price as your basis.

The only way for you to avoid the gains taxes would be for you to build a house on one lot, then move into it for 2 years (probably renting out your old house). You could then sell the new house and exclude up to $250,000/owner in gains. You can sell your main home & exclude $250,000 of gain every 2 years, as long as you owned & lived in the home for 2 of the 5 years prior to sale. Would it be possible to sell only 1 lot & use that money to build on the second lot?

See a tax pro for help deciding whether it's better to sell both lots in 2004 or one in 2004 & one in 2005. Good luck.

I was directed to IRS Pub. 523 which has a section concerning the sale of vacant lots adjacent to a primary residence. As the Publication reads, apparently if I sold the house separate from the lots up to 2 years prior or up to 2 years after the sale of the vacant lots, the lots will be excluded from capital gains taxes. My new questions are:

Is there any restriction as to whom I sell my home?
Can I rent my home from the new owners after I sell it (until my new house is ready)?
Is the house considered sold if I put it into a trust with other assets?

[abezon]

You can sell your house to anyone, but if you transfer it to atrust you control, there is no sale as far as the IRS is concerned. You'd need to sell the house to a 3rd party who was not immediate family (related party rules apply). I don't know if you can find someone who will do a buy & lease back.