Selling a home and vacant land 18 months later - Tax Exclusion

[SKB79]

Tax question: (Federal and IL)

We sold our home in late 2023. We lived there as a married couple from 2003-2023 and did not use up all the capital gains ($500k) for married filing jointly. We reported the home sale on our 2023 taxes, and filled out the Form 8949 showing that it was far under the allowable gains. In 2013 we bought the vacant land next to the house. It had been our neighbor's yard, they sold it to us, and then we used it as a yard for 10 years. The new home buyer didn't want the yard, so we sold it, separately, in early 2025 to another buyer. We want to claim the capital gains Section 121 exclusion in 2025 for the land, because the sale was within 2 years of the house sale and it was our yard. How do we go about reporting the land sale? We did receive a 1099-S for the land sale. The combined gain (with the house from 2023) is under $500k. But since we already reported the house sale in 2023, I am concerned that the IRS may not understand that this 2nd transaction was our yard and can also be excluded. The land does have a separate address and PIN, but it's clearly "next door" to the house address. Thank you for any help with this! -SKB

 

[LdiJ]

The capital gains exclusion is for your primary residence only (and the land it sits on). It is not an exclusion that you get to "use up". Each transaction has to be judged on it's own merit.

For example. You lived in your home for at least two of the last 5 years so it qualified. It doesn't matter how much of the exclusion you did or didn't need, you qualified.

Two years later you could have sold another primary residence and again could have taken up to another 500k exclusion. Then you could do it every two years for the rest of your life. Each time you would use as much or as little of the 500k as you needed, since it is not a cumulative exclusion.

The sale of the land is a transaction that stands on it's own merit. It is not a primary residence and never has been. It is just a separate piece of land that you invested in, that you happened to also use. Had you combined that parcel legally with your original home parcel it would have been part of the sale of your principal residence but you did not.

I cannot see how you can exclude any gain now. However, you could certainly consult with a tax attorney for their take on the issue.

 

[Taxing Matters]

We want to claim the capital gains Section 121 exclusion in 2025 for the land, because the sale was within 2 years of the house sale and it was our yard.

You misunderstand the rule. The capital gain exclusion under IRC § 121 is not an amount you get to use to cover the sale of multiple properties until the $500,000 max gain is exclusion is used up. It is instead a cap of the gain you may use for the sale of one personal residence sold during the tax year, assuming that all the other requirements for the deduction are met. Once used, regardless of the exlcusion amount for that sale, you may mot use it again until it has been at least two years from that earlier sale and the new sale meets all the requirements of § 121. The vacant was never your personal residence and thus the sale of the vacant lot failed to quality for any gain exemption under § 121, The fact that the two plots were right next to each other does not allow you to extend any of the gain exclusion not used in the home sale to cover the later sale of the vacant lot. Two separate piece of properties must be each analyzed separately of their date of sale to determine if any § 121 gain exclusion applies. All the requirements of § 121 must be met for each sale. Even if both sales would meet all the other rules, the sale of the second property must occur more than two years after the sale of the first one to be eligible for the exclusion.

Your home and the lot were always separate lots and thus each had to meet ALL the requirements of § 121 for you to get the gain exclusion for both. Whether the lots are side-by-side or across town from each other makes no difference. The vacant lot was never your personal residence and thus it fails the test to be eligible for any amount of § 121 gain. You'll have to include all the gain on the sale of the home as income on your 2025 tax return. It is a long term capital gain, so the the maximum tax rate that will apply to that gain is 20%. If you had capital losses in 2025 you may use those losses to offset some or all of the gain from the vacant lot sale.

You'll find all the rules for the sale of your personal residence explained in depth in IRS Publication 527.