Cost Basis of Land

[JohnH]

It's probably silly of me to ask, but that usually doesn't stop me so here goes.  Client bought 15 acres 20+ years ago. They fenced it in, built a long driveway, and built a house on the property.  Last year they carved out and sold 6 acres with the right to use the driveway to an unrelated party.  I'm calculating cost basis as the original proportional cost of the land, plus half the proportional cost of the fencing, plus half the cost of the driveway.  

Here's the odd part.  They built a pond on the 6 acres at one point, but had problems with it so they eventually got rid of the pond.  Can the cost of the pond and its subsequent demolition be added to the cost basis of the 6 acres they sold in 2018?

[Abby Normal]

Wow. That sounds like a question from the EA or CPA exam! I have no clue but look forward to some of tax heroes on this board to chime in.

[Roberts]

In a very simplified manner it sounds like they dug a hole, filled in the hole and now want to claim it increased the value of the land?

[RitaB]

Agree,  my off the cuff answer is the pond didn't improve the land so I'm going with nah. 

[BHoffman]

I’ll opine that the cost of the pond and the demolition could be added to the total original cost of the 15 acres, and then apportion that total to the 6 acres.  I would not apportion the pond cost solely to the 6 acres unless those acres don’t share a boundary with the remaining nine.

[JohnH]

Hey, I like the Solomonic approach ( except instead of 1/2 we're using 6/15ths).  

[Abby Normal]

24 minutes ago, Roberts said:

In a very simplified manner it sounds like they dug a hole, filled in the hole and now want to claim it increased the value of the land?

Not the value, the cost basis.

[JohnH]

I think we're hitting on the part that confuses me.   Does basis mean only consist of the cost of land improvements that add value, or is a cost of a "failed" improvement still a part of the basis? 

[Lee B]

Demolition costs or in this case, costs of land restoration is always added to basis.

The bigger question for me is which part of the land was the pond related work done on resulting in :

1, Pond related costs added to remaining 9 acres?

2. Pond related costs added to the 6 acres sold?

3.  Pond costs apportioned on a per acre basis ?

As to the question of whether the pond related costs should be added to basis, it's no different than any other expenditure performed with the intent

of increasing property values which doesn't work.

 Example: Property owner makes extensive flood control improvements. Next year, big flood  changes river channel, rendering prior flood control improvements useless.

 

[Max W]

I would apportion it to the entire 15 acres, because at the time the improvement was done it benefitted the entire property.

[Lee B]

A better example quite common in the western U S:

Well is drilled intended to supply the whole property, subsequently goes dry and has to be filled in.

Another deeper well is drilled which is successful. All costs added to basis.

[BulldogTom]

I agree with cbslee.  

But I also would also make my decision on how to allocate based on the questions he posted. 

Tom
Modesto, CA

[DANRVAN]

My question is whether you can support the position that will yield the greatest tax benefit.  

Are there other water sources on the remaining acres?  If it had been successful, would the pond added a proportionate benefit to the remaining acres?

Also look at the other side of it.  If he had sold the remaining acres and kept the 6, is there a reasonable  position to allocate a portion of the cost to the basis of those acres?

The only fact given was that a portion of land was sold that had a direct cost of development and demolition upon it.  

[Roberts]

20 hours ago, JohnH said:

I think we're hitting on the part that confuses me.   Does basis mean only consist of the cost of land improvements that add value, or is a cost of a "failed" improvement still a part of the basis? 

A capital improvement is any addition or alteration to real property that meets all three of the following conditions:

• It substantially adds to the value of the real property, or appreciably prolongs the useful life of the real property.
• It becomes part of the real property or is permanently affixed to the real property so that removal would cause material damage to the property or article itself.
• It is intended to become a permanent installation.

 

JMO but a pond is a capital improvement. If you remove a pond it's a capital improvement. If you install and remove a pond because it is faulty - it is a capital improvement. If you install and remove based upon personal preference I have a hard time thinking it's a capital improvement. 

 

[joanmcq]

Was the pond on the 6 acres sold? 

[JohnH]

Great questions and ongoing discussion.  Thanks for all the interest, especially at this time of year.  Yes, the pond was on the 6 acres sold.  They paid about $8K to have the pond developed, then about 3 years later they decided it had some problems.  They then paid someone about $3K to break the dam and do some grading to level out & re-landscape the area where the pond had existed.  The 6 acres has lots of road frontage and the "intent" all along was to carve it out of the total acreage and sell it at some point in the future. (at least that's the client's story and they're sticking to it)  

The client is very likely to sell the remaining land & home in the next 2-4 years. and will probably not exceed the $250K profit on sale of primary residence.  So essentially any cost basis that does not get folded into the sale of the 6 acres evaporates in terms of tax benefit.  

[joanmcq]

If they sell the rest of the property within, I believe, 2 years, the entire amount will qualify for the exclusion.  I researched this quite a bit when thinking of doing the same with a property I owned.

[JohnH]

Interesting thought.  Thanks for mentioning it, Joan.  Since the sale of the 6 acres took place in 2018, I have to deal with it as a stand-alone transaction right now.  But if you're suggesting we could revisit it and amend the 2018 if the remainder is sold to another buyer within 2 years, that would be very useful info.  At $12K in taxes, Probably not enough tax savings to drastically alter their plans, but if they were otherwise ready to sell within 2 years, it might affect their willingness to accept an offer if it could close quickly.

[jklcpa]

Joan is correct.  Here is the NOLO site that explains that rule: https://www.nolo.com/legal-encyclopedia/tax-exclusion-vacant-land-around-home.html

[DANRVAN]

4 hours ago, JohnH said:

  The 6 acres has lots of road frontage and the "intent" all along was to carve it out of the total acreage and sell it at some point in the future. 

Case closed.