Q: In 1992 we bought a second home, a mountain cabin, for $58,000 and have put in about $11,000 in improvements. We are currently adding on to our mountain cabin to double its size.

In 1995 we bought a different piece of vacant land for $22,000 that is now worth over $81,000. We are going to trade this vacant piece of land to our builder plus an additional $3,000 for his work on our cabin.

Can we roll the capital gain from the sale of the vacant land into the value of the improvements on our mountain cabin and defer capital gains until we sell our mountain cabin sometime in the next 20 years?

A: The easy answer is that upon your transfer of the title to the vacant land to the builder, you will have to pay a tax. The good news is that the tax should only be a capital gains tax at a rate of no more than fifteen percent.

You generally have two choices when you sell a piece of vacant land that has appreciated in value: you can pay tax on the sale or you can defer the gain by using a certain type of trust allowed under the tax code to defer gains on the sale of property. Most people call this type of trust a “Starker Trust” or a 1031 Exchange Trust.

In a 1031 Exchange Trust, you sell a property and place the money from the sale in the trust until you buy a replacement property. While the rules can be complicated, the basic rule is that the replacement property must be of equal or greater value and must be done within very specific dates.

In your case, you already own the property that you want to put the funds into from the sale of the vacant land. Unfortunately, you would not be eligible for the benefits of a 1031 Exchange Trust.

You should probably talk to a good tax accountant with extensive knowledge on real estate exchanges and sales to help you work through your issues.

Published: Jul 23, 2004