Can I sell part of a parcel and exchange just that part?

A sale of part of your land is its own transaction with its own share of basis

Reg. section 1.61-6(a) says that 'when a part of a larger property is sold, the cost or other basis of the entire property shall be equitably apportioned among the several parts', and that the sale of each part is treated as a separate transaction. Its own example splits a $25,000 purchase between a filling station worth $15,000 and a car lot worth $10,000.

Nothing in section 1031 requires you to dispose of an entire tax parcel. The relinquished property is whatever real property you transfer, and a legally divided lot, a strip of frontage or a fractional acreage block is real property under Reg. section 1.1031(a)-3.

Practically, the piece needs its own legal description, which usually means a survey and a lot split or subdivision approval from the county before closing. Those approvals are local and can take longer than the sale itself.

The piece you sell must have been held for investment or business, not as part of your home

The IRS fact sheet FS-2008-18 states that property used primarily for personal use, like a primary residence, does not qualify. Acreage that surrounds your house as a yard or buffer is part of that personal use, even if it is a separate tax lot. Land leased to a farmer, rented out or held apart from the residence has a far better claim to investment status.

If the carved-off land was part of your residence, the home-sale exclusion may help instead. Reg. section 1.121-1(b)(3) treats vacant land as part of the principal residence only if it is adjacent, was used as part of the residence, and the house itself is sold within two years before or after the land, with one $250,000 or $500,000 limit for both sales.

Where one property genuinely has both uses, such as a farmhouse on working farmland, Rev. Proc. 2005-14 allows section 121 to be applied first and section 1031 to the business portion in the same exchange. See can I 1031 my primary residence or second home for the residence rules.

Splitting one parcel is not dealing, but selling lot after lot can be

Section 1031(a)(2) excludes real property held primarily for sale. In United States v. Winthrop (5th Cir. 1969), the court weighed factors including the purpose and duration of ownership, the number, continuity and substantiality of sales, and the extent of subdividing, developing and advertising, and it taxed a long-time owner's lot sales as ordinary income.

A one-time split of an investment tract sits far from that pattern. Building streets and utilities and selling lots year after year sits close to it. Section 1237 gives individuals a limited capital-gain safe harbor for subdivided land held five years without substantial improvements, but it addresses capital-gain treatment of lot sales, not 1031 eligibility. The replacement side of the same question is land you plan to develop and sell as lots.

Worked example: 10 of 40 acres sold for $500,000

Hypothetical, round figures; run your own numbers with your CPA. You bought 40 acres of investment land for $400,000, and at purchase every acre was worth about the same. You now sell 10 acres for $500,000.

Basis apportioned to the 10 acres is one quarter of $400,000, or $100,000, so the gain on the piece sold is $400,000. Reinvest the full $500,000 through an intermediary in replacement real property and that gain is deferred; the 30 acres you keep carry the remaining $300,000 of basis untouched.

If the acres were not of equal value at purchase, for example road frontage versus back land, apportion by their relative values then, and keep the appraisal or other support in your file; see how to calculate adjusted basis.

• Price of the piece sold: $500,000.
• Basis apportioned to it: $100,000.
• Gain deferred if fully reinvested: $400,000.
• Basis left in the retained 30 acres: $300,000.

What to do before you carve off the piece

Start with the land-use process, because the exchange cannot close until the lot legally exists. Engage the intermediary before that closing, document how the sold portion was used, and decide how you will apportion basis before the return is due.

Proceeds from a partial sale often do not match a convenient replacement property. Fractional interests such as Delaware statutory trust interests, which Rev. Rul. 2004-86 allows as replacement property, can absorb an odd amount, and the raw land and lots page covers what buyers of a carved-off parcel look for.