Capital Gains Tax on a Land Sale

Investment land is a capital asset, and with no depreciation the whole gain gets the capital gains rates

Section 1221 defines a capital asset as any property except, among other things, property held primarily for sale to customers and depreciable or real property used in a trade or business. Land you bought and held for appreciation fits the definition, so after more than a year it is taxed under section 1(h). Rev. Proc. 2025-32 puts the 2026 top of the 0% band at $98,900 joint and $49,450 single, and the top of the 15% band at $613,700 and $545,500.

A building sale carries an unrecaptured section 1250 layer taxed up to 25%. Bare land has none, because land cannot be depreciated, so every dollar of long-term gain goes into the 0%, 15% and 20% bands. If the parcel carries depreciated improvements such as fencing, wells or drainage, the Form 4797 instructions require you to allocate the price between the land and the improvements by fair market value and figure any recapture on the improvements separately; depreciating land improvements covers that part.

The 3.8% net investment income tax in section 1411 reaches net gain from property not held in a nonpassive trade or business. Investment land is squarely inside it, and the gain itself counts toward the $250,000 joint and $200,000 single thresholds.

Land used in a farm or business is section 1231 property, which keeps the gain capital and makes a loss ordinary

Section 1231(b) covers real property used in a trade or business and held more than a year, other than inventory or property held for sale to customers. Cropland you farm, a lot used as your company's yard or a parking lot you operate falls here. Net section 1231 gains for the year are treated as long-term capital gain, and net losses are ordinary.

Two catches apply. Under section 1231(c), net section 1231 losses deducted in the five most recent preceding years turn an equal amount of this year's gain into ordinary income. And the Form 4797 instructions require ordinary income on farmland sold after more than one year but less than ten if soil and water conservation costs were deducted under section 175, at 100% of those deductions through the fifth year and stepping down 20 points a year to zero in the tenth.

Subdividing and selling lots can turn the gain into ordinary income, and section 1237 is a narrow way out

Land held primarily for sale to customers in the ordinary course of business is excluded from capital asset status by section 1221(a)(1). In Boree v. Commissioner the Eleventh Circuit in 2016 upheld ordinary income treatment for a landowner who subdivided a tract, built roads, sold lots over several years and then sold the remainder in bulk. The court applied seven factors, including the purpose of acquisition, the extent of subdividing, developing and advertising, and the frequency and substantiality of sales, which it called the most important.

Section 1237 gives a taxpayer other than a C corporation a limited safe harbor: subdividing alone does not make you a dealer if you were not otherwise a dealer in real estate that year, made no substantial improvement that substantially enhanced the lot's value, and held each lot five years unless inherited. Even then, once more than five lots from the same tract are sold, gain on each lot sold in or after the year of the sixth sale is ordinary to the extent of 5% of its selling price. Publication 544 summarizes the rule: subdivided land normally produces ordinary income unless these requirements are met.

The safest pattern for a long-held parcel is a single sale of the whole tract to a developer, before you do the entitlement and road work yourself. Selling to a developer compares the options.

Worked example: a 20-year-old parcel sold for $650,000

Hypothetical, round figures. A married couple bought 40 acres in 2006 for $150,000 and sells in 2026 for $650,000, paying $40,000 in commissions and closing costs. Gain is $460,000. Their other taxable income is $150,000, already above the $98,900 top of the 0% band, so the gain stacks from $150,000 to $610,000, entirely inside the 15% band that ends at $613,700. Capital gains tax: $69,000.

Assume modified AGI without the sale is $180,000. With the gain it is $640,000, and NIIT is 3.8% of the lesser of $460,000 or $390,000 over the threshold, so $14,820. Federal total: $83,820, or 18.2% of the gain, before state tax. If the same couple were treated as dealers, the $460,000 would be ordinary income stacked on $150,000, and the 2026 joint brackets in Rev. Proc. 2025-32 would put the tax on it at about $128,600 before any self-employment tax. Run your own numbers with your CPA.

Carrying costs matter to the basis. Under Reg. section 1.266-1 an owner of unimproved and unproductive real property may elect, year by year with the original return, to capitalize annual property taxes and mortgage interest instead of deducting them. Capitalized amounts raise basis and cut the gain; deducted ones do not.

A 1031 exchange can move land into income property, and the state layer follows the same deferral in most states

Reg. section 1.1031(a)-1(b) says whether real estate is improved or unimproved relates only to grade or quality, not kind, and lists exchanging improved for unimproved real estate as a like-kind exchange. Investment land can therefore be exchanged for an apartment building, a net-leased store or a fractional interest in a traditional DST, turning non-income land into property that pays. Section 1031(a)(2) excludes real property held primarily for sale, so a dealer's lots cannot be exchanged.

The exchange defers the federal capital gains tax and the NIIT, and in conforming states the state tax as well; the state capital gains rates page lists what each state charges. The raw land and lots page covers the exchange mechanics for land specifically.