Help! Complicated capital gains question for experts

[Jess Anderson]

Ok help me! I have a very complicated capital gains tax question. We purchased 2 duplexes (bldg A and B)  on the same lot for $500k in Loveland CO. We have since been going through the approval process to split off one of the building onto its own lot. We plan on selling one of the buildings (bldg B) as it’s older and just way too much work. We purchased this as a fixer upper and renovated the snot out of it. The one duplex building (bldg B) we want to sell is valued at $425K now. 
So here’s the question- how does capital gains work on this? We purchased for $500k (bldg A and B) and we are selling one bldg (bldg B) for $425k. So technically we aren’t “profiting”, therefore no capital gains (I hope). A friend said that I would need to calculate the square footage of each building in order to know how much of the $500k (bldg A and B original purchase price) was actually spent on the older building we want to sell. If I do that calculation that puts the original purchase value at $222k (bldg B). How does the IRS view this situation? I thought as long as you sell for less than you paid, you’re free and clear of capital gains. Let’s say my friend is right- we sell bldg B for $425k and we use the imaginary made up sales price of just one of the buildings based on square footage which is $222K of the $500k we spent on both buildings. So I would be taxed for capital gains on $203K? ($425K minus $222K). 
Gah!!! Please let someone on here be smarter than me. Even tax professionals are stumped on this one. 
PS we actually lived in this duplex 9 months of the last 5 years.... not that that helps since I believe the capital gains exclusion is only for 2 of 5 years. 

[Dave Foster]

@Jess Anderson, When you split the property into two distinct properties you are creating two properties.  So your original basis has to be split as well.  Square footage is one way.  Condition, lot size, and other things could also affect where you allocate your basis.  For sake of example though assume that each half is allocated 50% of the original starting basis.  You would add to that the amount of capital improvements made on each of the two and then subtract the depreciation taken (using the same percentage allocations as the original basis allocation).

So you're original "Gah" thought is probably correct.  there's a heap of gain in there.  And @Natalie Kolodij is exactly right there's no gains exclusion because you must have lived in the property for 2 out of the 5 years prior to sale.

So your option to get out of taxes on that sale will be to do a 1031 exchange purchasing more investment real estate.  You've got a nice problem to have.  The lot split has worked well for you.  Time to move that gain into another asset and maybe asset class to keep it going.

And @Josh Hopwood is right on, Ken Palmen's great!