The following discussions describe the kinds of transactions that
are treated as sales or exchanges and explain how to figure gain or
loss. A sale is a transfer of property for money or a
mortgage, note, or other promise to pay money. An exchange
is a transfer of property for other property or services.
Sale or lease.
Some agreements that seem to be leases may really be conditional
sales contracts. The intention of the parties to the agreement can
help you distinguish between a sale and a lease.
There is no test or group of tests to prove what the parties
intended when they made the agreement. You should consider each
agreement based on its own facts and circumstances. For more
information on leases, see chapter 4 in Publication 535,
Cancellation of a lease.
Payments received by a tenant for the cancellation of a lease are
treated as an amount realized from the sale of property. Payments
received by a landlord (lessor) for the cancellation of a lease are
essentially a substitute for rental payments and are taxed as ordinary
Payments you receive for granting the exclusive use of (or right to
exploit) a copyright throughout its life in a particular medium are
treated as received from the sale of property. It does not matter if
the payments are a fixed amount or a percentage of receipts from the
sale, performance, exhibition, or publication of the copyrighted work,
or an amount based on the number of copies sold, performances given,
or exhibitions made. Nor does it matter if they are paid over the same
period as that covering the grantee's use of the copyrighted work.
If the copyright was used in your trade or business and you held it
longer than a year, the gain or loss is a section 1231 gain or loss.
For more information, see Section 1231 Gains and Losses in
The amount received for granting an easement is subtracted from the
basis of the property. If only a specific part of the entire tract of
property is affected by the easement, only the basis of that part is
reduced by the amount received. If it is impossible or impractical to
separate the basis of the part of the property on which the easement
is granted, the basis of the whole property is reduced by the amount
Any amount received that is more than the basis to be reduced is a
taxable gain. The transaction is reported as a sale of property.
If you transfer a perpetual easement for consideration and do not
keep any beneficial interest in the part of the property affected by
the easement, the transaction will be treated as a sale of property.
However, if you make a qualified conservation contribution of a
restriction or easement granted in perpetuity, it is treated as a
charitable contribution and not a sale or exchange, even though you
keep a beneficial interest in the property affected by the easement.
If you grant an easement on your property (for example, a
right-of-way over it) under condemnation or threat of condemnation,
you are considered to have made a forced sale, even though you keep
the legal title. Although you figure gain or loss on the easement in
the same way as a sale of property, the gain or loss is treated as a
gain or loss from a condemnation. See Gain or Loss From
Property transferred to satisfy debt.
A transfer of property to satisfy a debt is an exchange.
Note's maturity date extended.
The extension of a note's maturity date is not treated as an
exchange of an outstanding note for a new and different note. Nor is
it a closed and completed transaction on which gain or loss is
figured. This treatment will not apply when changes in the term of the
note are so significant as to amount virtually to the issuance of a
new security. Also, each case must be determined by its own facts.
Transfer on death.
The transfer of property to an executor or administrator on the
death of an individual is not a sale or exchange.
Generally, a transfer of property from a debtor to a bankruptcy
estate is not treated as a sale or exchange. For more information, see
The Bankruptcy Estate in Publication 908.
Gain or Loss From
Sales and Exchanges
Gain or loss is usually realized when property is sold or
exchanged. A gain is the amount you realize from a sale or
exchange of property that is more than its adjusted basis. A loss
is the adjusted basis of the property that is more than you
The cost or purchase price of property is usually its basis for
figuring the gain or loss from its sale or other disposition. However,
if you acquired the property by gift, inheritance, or in some way
other than buying it, you must use a basis other than its cost. See
Basis Other Than Cost in Publication 551.
The adjusted basis of property is your original cost or other basis
plus certain additions and minus certain deductions, such as
depreciation and casualty losses. See Adjusted Basis in
In determining gain or loss, the costs of
transferring property to a new owner, such as selling expenses, are
added to the adjusted basis of the property.
The amount you realize from a sale or exchange is the total of all
money you receive plus the fair market value of all property or
services you receive. The amount you realize also includes any of your
liabilities that were assumed by the buyer and any liabilities to
which the property you transferred is subject, such as real estate
taxes or a mortgage.
If the liabilities relate to an exchange of multiple properties,
see Treatment of liabilities under Multiple Property
Fair market value.
Fair market value (FMV) is the price at which the property would
change hands between a buyer and a seller when both have reasonable
knowledge of all the necessary facts and neither has to buy or sell.
If parties with adverse interests place a value on property in an
arm's-length transaction, that is strong evidence of FMV. If there is
a stated price for services, this price is treated as the FMV unless
there is evidence to the contrary.
In your business, you used a building that cost you $70,000. You
made certain permanent improvements at a cost of $20,000 and deducted
depreciation totaling $10,000. You sold the building for $100,000 plus
property having an FMV of $20,000. The buyer assumed your real estate
taxes of $3,000 and a mortgage of $17,000 on the building. The selling
expenses were $4,000. Your gain on the sale is figured as follows.
| FMV of property received
| Real estate taxes assumed by
| Mortgage assumed by
| Cost of building
| Minus: Depreciation
| Adjusted basis
| Plus: Selling expenses
|Gain on sale
Your gain or loss realized from a sale or exchange of property is
usually a recognized gain or loss for tax purposes. Recognized gains
must be included in gross income. Recognized losses are deductible
from gross income. However, your gain or loss realized from certain
exchanges of property is not recognized for tax purposes. See
Nontaxable Exchanges, later. Also, a loss from the
disposition of property held for personal use is not deductible.
Interest in property.
The amount you realize from the disposition of a life interest in
property, an interest in property for a set number of years, or an
income interest in a trust is a recognized gain under certain
circumstances. If you received the interest as a gift, inheritance, or
in a transfer from a spouse or former spouse incident to a divorce,
the amount realized is a recognized gain. Your basis in the property
is disregarded. This rule does not apply if all interests in the
property are disposed of at the same time.
Your father dies and leaves his farm to you for life with a
remainder interest to your younger brother. You decide to sell your
life interest in the farm. The entire amount you receive is a
recognized gain. Your basis in the farm is disregarded.
The facts are the same as in Example 1, except that your brother
joins you in selling the farm. Because the entire interest in the
property is sold, your basis in the farm is not disregarded. Your gain
or loss is the difference between your share of the sales price and
your adjusted basis in the farm.
Canceling a sale of real property.
If you sell real property under a sales contract that allows the
buyer to return the property for a full refund and the buyer does so,
you may not have to recognize gain or loss on the sale. If the buyer
returns the property in the year of sale, no gain or loss is
recognized. This cancellation of the sale in the same year it occurred
places both you and the buyer in the same positions you were in before
the sale. If the buyer returns the property in a later tax year,
however, you must recognize gain (or loss, if allowed) in the year of
the sale. When the property is returned in a later year, you acquire a
new basis in the property. That basis is equal to the amount you pay
to the buyer.
If you sell or exchange property for less than fair market value
with the intent of making a gift, the transaction is partly a sale or
exchange and partly a gift. You have a gain if the amount realized is
more than your adjusted basis in the property. However, you do not
have a loss if the amount realized is less than the adjusted basis of
Bargain sales to charity.
A bargain sale of property to a charitable organization is partly a
sale or exchange and partly a charitable contribution. If a deduction
for the contribution is allowable, you must allocate your adjusted
basis in the property between the part sold and the part contributed
based on the fair market value of each. The adjusted basis of the part
sold is figured as follows.
Table 1-2. Worksheet for Foreclosures and Repossessions
Because of this allocation rule, you will have a gain even if the
amount realized is not more than your adjusted basis in the property.
This allocation rule does not apply if a deduction for the
contribution is not allowable.
See Publication 526,
Charitable Contributions, for
information on figuring your charitable contribution.
You sold property with a fair market value of $10,000 to a
charitable organization for $2,000 and are allowed a deduction for
your contribution. Your adjusted basis in the property is $4,000. Your
gain on the sale is $1,200, figured as follows.
|Minus: Adjusted basis of part sold ($4,000
x ($2,000 x $10,000))
|Gain on the sale
Property Used Partly
for Business or Rental
If you sell or exchange property you used partly for business or
rental purposes and partly for personal purposes, you must figure the
gain or loss on the sale or exchange as though you had sold two
separate pieces of property. You must divide the selling price,
selling expenses, and the basis of the property between the business
or rental part and the personal part. You must subtract depreciation
you took or could have taken from the basis of the business or rental
Gain or loss on the business or rental part of the property may be
a capital gain or loss or an ordinary gain or loss, as discussed in
under Section 1231 Gains and Losses. Any gain on
the personal part of the property is a capital gain. You cannot deduct
a loss on the personal part.
You sold a condominium for $57,000. You had bought the property 9
years earlier for $30,000. You used two-thirds of it as your home and
rented out the other third. You claimed depreciation of $3,272 for the
rented part during the time you owned the property. You made no
improvements to the property. Your expenses of selling the condominium
were $3,600. You figure your gain or loss as follows.
||Minus selling expenses
||Amount realized (adjusted sales price)
||Gain (line 3 minus line 6)
Property Changed to
Business or Rental Use
You cannot deduct a loss on the sale of property you acquired for
use as your home and used as your home until the time of sale.
You can deduct a loss on the sale of property you acquired for use
as your home but changed to business or rental property and used as
business or rental property at the time of sale. However, if the
adjusted basis of the property at the time of the change was more than
its fair market value, the loss you can deduct is limited.
Figure the loss you can deduct as follows.
- Use the lesser of the property's adjusted basis or fair
market value at the time of the change.
- Add to (1) the cost of any improvements and other increases
to basis since the change.
- Subtract from (2) depreciation and any other decreases to
basis since the change.
- Subtract the amount you realized on the sale from the result
in (3). If the amount you realized is more than the result in (3),
treat this result as zero.
The result in (4) is the loss you can deduct.
You changed your main home to rental property 5 years ago. At the
time of the change, the adjusted basis of your home was $75,000 and
the fair market value was $70,000. This year, you sold the property
for $55,000. You made no improvements to the property but you have
depreciation expense of $12,620 over the 5 prior years. Your loss on
the sale is $7,380 [($75,000 - $12,620) -
$55,000)]. The amount you can deduct as a loss is limited to
$2,380, figured as follows.
|Lesser of adjusted basis or fair market value
at time of the change
|Plus: Cost of any improvements and any other
additions to basis after the change
|Minus: Depreciation and any other decreases to
basis after the change
|Minus: Amount you realized from the sale
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