My wife and I are tearing down our principal residence, subdividing
the lot into 2 parcels.  We will build on  one of the lots and sell
the other.  Do we qualify for any, some or none of the 121 exclusion
for proceeds of vacant lot?

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Clarification of Question by jdgardener-ga on 21 Feb 2006 11:39 PST

The residence straddles both lots.

It would appear that no sale or exchange of your principal residence
has taken place.  First you converted the property (destroyed the
house) and then subdivided it. Then you sold land, not a principal
residence, hence no 121.

It may work better if can still change the transaction and clean it up a bit.
Perhaps reinvest the proceeds from the sale of the land (in a 1031
exchange) in other property.

Some questions I would be interested in are, is the house being torn
down sitting on the portion that would be sold?  Why does it make
sense to give up your investment in the house currently on the
property?  Why not build on another portion of the land and sell the
existing house and qualify for the 121?  You could even reduce the
selling price by the costs to demolish the house if the new buyer
wanted a vacant lot?

Would have to add as well... one aspect of a 1031 exchange is that the
property you are selling has a adjusted cost basis factor to it. 
Basically, if you are selling the investment parcel, you can deduct
your improvement costs from the total sale price.  Doing so would
decrease your cost basis...

Not as familiar with IRS 121, but would think in this situation that
you might be able to sell off the lot as a primary residence sale
during the division of the parcel, then reinvest taxable proceeds into
another primary residence (the other divided parcel) as part of the
building costs...