Assigning 1031 basis in a subdivided property used as a home

[Braath Waate]

25 years ago I bought an income producing farm with land and a house.  I used a 1031 exchange from another business property to pay for it partially.  I lived in the house.

Skip ahead to today.  I subdivided the house off from the land.  But how to assign the original 1031 exchange basis to prepare for sale?

Do I have the freedom to assign the 1031 exchange basis between properties as I determine? If so, I think I should assign the entire 1031 basis to the house, and the rest of the money I spent to the the subdivided land.  Because I lived in the house for more than 5 years, the IRS rules seem to allow the 1031 exchange capital gain to disappear in the home sale capital gains exclusion ($250,000/$500,000), which is a nice loophole.

Or would the IRS require me to allocate the original 1031 exchange basis between both properties?  If so, how?

Caveat.  The sale of the subdivided land and the house will probably not occur within 2 years of each other, so the IRS will not consider the appreciated land as part of the home sale.

[Dave Foster]

@Braath Waate, You'll had some flexibility when you purchased the property.  But you probably wont skate free on the land sale.  All of the real estate has to have a basis.  When you bought the property in the 1031 your basis in the old property was carried forward into the new property and it would have been allocated between land (not depreciable) and building (depreciable) by your accountant.  That land basis will be divided now between the land under the house and the rest of the land.  

That will be your starting basis.  And your gain will be the difference between the net sales price of the land and the adjusted cost basis of the land.

Your tax returns will have already reflected this.