Interesting question. We have a rule that excludes up to $250,000 in gain from selling a home if you meet requirements. What if you sell part of the property you’re using as a home at a gain? Can you exclude that gain even though you didn’t sell the home?
I suspect the IRS would say no, and take the position you need to determine determine how much of the basis of the home is attributable to the tree. Then, use that basis to determine whether you have a gain on this sale, and if so, how much. For example, if the home originally cost $200,000, and its value without the tree is 5% less than its value with the tree, then $10,000 of the basis is attributable to the tree. If you sold it for more than $10,000, you have a gain. Also, when you eventually sell your home for, say, $250,000, your gain is $60,000, not just $50,000, because you’ve already recovered $10,000 of your basis from selling the tree. Usually this wouldn’t matter because of the rule excluding gain from selling a home if you meet the requirements.
As a practical matter, I would just ignore this if the dollar amount of the profit is small. If it’s large enough to matter, it might make sense to have your return prepared by a professional so that someone else signs off on the tax treatment of this item.