When calculating your property cost basis, it is recommended you speak with an accountant to correctly determine the purchase price between the land and home.
Q: We purchased a single 22-acre parcel in late 2004. In order to refinance this year, we had to split the single parcel into a 4-acre parcel that contains our house and an 18-acre agricultural parcel.
We’ve just sold the 18-acre parcel. I don’t know how to determine its true cost basis since it was just part of a single parcel in 2004.
A: On this issue, you should talk to an accountant who can help you determine how to correctly allocate the purchase price between the land and the home. But we want to be able to give you an idea how this conversation might go.
In general it might be fair to say that the home had a value in 2004 and agricultural land would also have some value back then.
If you search the local land and sales records for 2004, you may be able to find out what agricultural land, similar to yours, sold for in that year. Let’s say you find out that agricultural land in 2004 sold for $5,000 an acre. If land was going for $5,000 an acre, the basis for your 18 acres land might have been around $90,000. Your accountant might be able to back you up on that figure depending on the circumstances of the purchase.
You can also calculate in the other direction. You can also consider the price that you paid for the property as a whole, determine what homes were selling for in your area in 2004, and set a value for the home and it’s improvements. You’d then allocate the balance of the value to the land.
There are probably several ways to determine the value in your circumstances which takes us back to our recommendation that you should talk to an accountant. Because there are some other questions you’ll want answered.
Now that you’ve sold the land, you might have a profit on that sale. If you have a profit, you will have federal income tax to pay, and possibly even state income tax. You might think that real estate values today are lower than real estate values in 2004. In some parts of the country that reduction in values is certainly true. But the value of agricultural land has actually gone up in many parts of the country since the housing crisis.
The price of land is very locally drawn, based on what the land may be used for. Since you sold off the 18-acre parcel recently, you certainly know the value of the land. You know that finding the value of the land separately from the home is tricky and you’ll need to find someone you know and trust locally that can help you determine that value.
While you’re at it, the land as sold was an investment to you. You held that investment for some time and you may find that the sale of the land can be classified as a sale of an investment property, allowing you to pay federal income taxes on that profit at the lower tax rates afforded to long term investments in capital. Given where capital gains tax rates are this year, you might only pay 15 percent federal taxes on the profits from the sale of the land.
Don’t forget that when you talk about the profit on the sale of the land, you had expenses on the purchase of the land and expenses for the sale. Those expenses count to reduce the amount of profit you had on the sale and reduce the amount you’ll pay the federal government.
Again, an accountant, enrolled agent or tax preparer will be able to guide you further.