Land, like any other real estate asset, is subject to capital gains tax if you sell it at a profit. However, the Internal Revenue Service doesn't calculate your profit by subtracting your purchase price from your selling price. Instead, they allow you to adjust the prices based on your costs of purchasing and selling the land as well based on the costs of any improvements that you make to the land. This reduces your potential gain which reduces your capital gains tax liability.
Your cost basis is the purchase price you paid for your land plus some of your closing costs. The IRS won't let you include the cost of getting a mortgage or the cost of prepaid property taxes, insurance or utility services in your basis. You can, however, include any title fees, escrow fees, closing fees, transfer taxes or legal fees in your basis. Items that you pay for the seller, like their commission, also get included in your cost basis.
When it comes time to sell your land, the IRS doesn't look at your cost basis -- your adjusted basis represents your actual tax basis. To calculate your adjusted basis, take your cost basis and add any costs of improvements that you have made to your land. For example, if you spent $10,000 to prepare your land to build a house on it, you would add that to your cost basis to find your adjusted cost basis.
Your sale basis is the amount you realized from the sale. To calculate this, take your selling price and subtract your sales expenses -- commissions and closing costs. For example, if you sold your land for $100,000 and paid $8,000 in commissions and an additional $1,500 in closing costs, your capital gains liability would get calculated based on the $90,500 in proceeds instead of the $100,000 selling cost.
Capital Gains Taxes
Capital gains taxes get levied on your profit, which get calculated by subtracting your adjusted basis from your amount realized from the sale. If it's a positive number, you may have to pay capital gains tax on it. However, if the land is adjacent to the house where you live, you might be able to use the home-sale exclusion to avoid paying capital gains on up to $500,000 of your gain if you are married or $250,000 if you are single. The IRS rules on this can be a bit complicated, so it's a good idea to talk to an accountant to make sure that you can take advantage of this exclusion.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.