1031/subdividing Into 3 Lots/avoiding Capital Gains
I bought a foreclosure 4 acres on a lake, i new it was a good deal so i moved in for 2 years to avoid capital gains tax, my question is can i subdivide the property, i will have 2 vacant lots on each side of existing house, if i sell all 3 properties after 2 years within the same year can i still avoid capital gains? 
Typically, no. When you subdivide the property the two additional lots created become separate lots with separate APN numbers and separate legal descriptions. This "carves" out the property from your primary residence. The fact that you are also considering selling them in three separate sales would be the last nail in the coffin. I have not seen any rulings on this next idea, but you might try to take an aggressive position of sub dividing, but continue to report the total acreage as one primary residence and when you sell make sure that you sell the whole acreage to one buyer and claim the 121 exclusion. It is all about how you position it and whether you feel comfortable in "defending" the position.
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Section 121 does allow you to exclude all of the capital gain on property that is your primary residence and is also used as rental or investment property provided the properties are the same. Once you subdivide, you would lose this ability to elect 121 exclusion treatment because the sub division has created separate lots.
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If the land is used for your primary residence, then the sale of the land does not qualify for 1031 exchange, since it had no investment use. It does appear that you can sell parcels of the land along with the sale of your primary residence AND still exclude the profits from capital gains under Section 121.
Here is an exerpt from IRS Pub 523 that may be on point.
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Vacant land. The sale of vacant land is not a sale of your main home unless: The vacant land is adjacent to land containing your home,
You owned and used the vacant land as part of your main home,
The sale of your home satisfies the requirements for exclusion and occurs within 2 years before or 2 years after the date of the sale of the vacant land, and
The other requirements for excluding gain from the sale of the vacant land have been satisfied.If these requirements are met, the sale of the home and the sale of the vacant land are treated as one sale and only one maximum exclusion can be applied to any gain.
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I most strongly suggest you confirm your eligibility for this exclusion with your personal tax advisor before undertaking any action that may compromise your eligibility.[ Edited by NewKidinTown2 on Date 02/09/2005 ]