Whenever you sell a capital asset, such as vacant land, the Internal Revenue Service wants its share of the profit you earn. This is because your profit represents a capital gain that is subject to a separate form of taxation under the income tax laws. However, the amount of tax you will owe on the gain depends on how long you owned the land before selling it.
Capital Asset Guidelines
Every piece of property you own that is not used in a trade or business is a capital asset. Therefore, if you are not in the business of selling land, the profit you earn from its sale is subject to capital gains tax rules. These tax rules require you to calculate the gain or loss as the price you sell it for minus your tax basis in the land. Your tax basis in the land represents the price you paid for it.
The IRS requires you to further classify your capital assets as short term or long term. You evaluate the appropriate classification of your vacant land at the time of the sale. Short-term capital assets include land you hold for one year or less as of the date of sale, while long-term capital assets are owned in excess of one year. The holding period of your vacant land is important because if the sale results in a short-term capital gain, the IRS calculates the tax using the same ordinary rates it imposes on your employment earnings. However, the gains you recognize on long-term assets are subject to lower rates of tax.
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Receiving as Gift
If you receive the vacant land as a gift, you may think that your tax basis is zero. However, for purposes of calculating your gain or loss, you use the same tax basis that the donor has in the land at the time of the gift. Receiving the land as a gift also affects your holding period. For purposes of determining whether the sale results in a short-term or long-term gain or loss, you add the amount of time the donor owns the property to the amount of time you own it before selling it.
Deducting Capital Losses
At the end of the year when you report all of your capital transactions on the Schedule D form, including the sale of the vacant land, the IRS requires that you initially separate all short-term and long-term transactions and calculate the net gain or loss for each category. You then net the two results to arrive at your overall capital gain or loss. If a net loss results, the IRS allows you to claim a deduction for it of only up to $3,000 per year. However, if you calculate an overall gain, you must apply separate tax rates to the short-term and long-term transactions.