| Publication 544 |
2008 Tax Year |
Topics - This chapter discusses:
Useful Items - You may want to see:
Publication
-
523
Selling Your Home
-
537
Installment Sales
-
547
Casualties, Disasters, and Thefts
-
550
Investment Income and Expenses
-
551
Basis of Assets
-
908
Bankruptcy Tax Guide
-
954
Tax Incentives for Distressed Communities
Form (and Instructions)
-
Schedule D (Form 1040)
Capital Gains and Losses
-
1040
U.S. Individual Income Tax Return
-
1040X
Amended U.S. Individual Income Tax Return
-
1099-A
Acquisition or Abandonment of Secured Property
-
1099-C
Cancellation of Debt
-
4797
Sales of Business Property
-
8824
Like-Kind Exchanges
See chapter 5 for information about getting publications and forms.
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. The following discussions describe the kinds of transactions that are treated as sales or exchanges
and explain how to figure
gain or loss.
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 3 in Publication 535, Business Expenses.
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
income in the year in
which they are received.
Copyright.
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 the payments are made 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 may be a
section 1231 gain or loss. For
more information, see Section 1231 Gains and Losses in chapter 3.
Easement.
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 received.
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 Condemnations, later.
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. Also, it is not
considered a closed and completed transaction that would result in a gain or loss. However, an extension will be treated as
a taxable exchange of the
outstanding note for a new and materially different note if the changes in the terms of the note are significant. 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.
Bankruptcy.
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, Bankruptcy Tax Guide.
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 the amount you realize.
Table 1-1. How To Figure Whether You Have a Gain or Loss
|
IF your...
|
THEN you have a...
|
|
Adjusted basis is more than the amount realized,
|
Loss.
|
|
Amount realized is more than the adjusted basis,
|
Gain.
|
Basis.
You must know the basis of your property to determine whether you have a gain or loss from its sale or other disposition.
The basis of property you
buy is usually its cost. 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, Basis of Assets.
Adjusted basis.
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 Publication 551. 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.
Amount realized.
The amount you realize from a sale or exchange is the total of all money you receive plus the fair market value (defined
below) 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 Exchanges,
later.
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.
Example.
You used a building in your business 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.
Amount recognized.
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 sale or other disposition of property held for
personal use is not deductible, except in the case of a casualty or theft.
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.
Example 1.
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.
Example 2.
The facts are the same as in Example 1, except that your brother joins you in selling the farm. The entire interest in the
property is sold, so
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 the property.
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 charitable
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.
Adjusted basis of
entire property ×
|
Amount realized
(fair market value of part sold)
|
| |
Fair market value of entire
property
|
Based on 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 charitable contribution deduction is not allowable.
See Publication 526, Charitable Contributions, for information on figuring your charitable contribution.
Example.
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.
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 allocate 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 part.
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 chapter 3
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.
Example.
You sold a condominium for $57,000. You had bought the property 9 years earlier in January 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 selling expenses for the condominium were $3,600. You figure your gain or loss as follows.
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.
Example.
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. Although 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.
Gain.
If you have a gain on the sale, you generally must recognize the full amount of the gain. You figure the gain by subtracting
your adjusted basis
from your amount realized, as described earlier.
You may be able to exclude all or part of the gain if you owned and lived in the property as your main home for at
least 2 years during the 5-year
period ending on the date of sale. For more information, see Publication 523.
The abandonment of property is a disposition of property. You abandon property when you voluntarily and permanently give up
possession and use of
the property with the intention of ending your ownership but without passing it on to anyone else.
Loss from abandonment of business or investment property is deductible as an ordinary loss, even if the property is a capital
asset. The loss is
the property's adjusted basis when abandoned. This rule also applies to leasehold improvements the lessor made for the lessee
that were abandoned.
However, if the property is later foreclosed on or repossessed, gain or loss is figured as discussed later. The abandonment
loss is deducted in the
tax year in which the loss is sustained.
You cannot deduct any loss from abandonment of your home or other property held for personal use.
Example.
Ann abandoned her home that she bought for $200,000. At the time she abandoned the house, her mortgage balance was $185,000.
She has a
nondeductible loss of $200,000 (the adjusted basis). If the bank later forecloses on the loan or repossesses the house, she
will have to figure her
gain or loss as discussed later under Foreclosures and Repossessions.
Cancellation of debt.
If the abandoned property secures a debt for which you are personally liable and the debt is canceled, you will realize
ordinary income equal to
the canceled debt. This income is separate from any loss realized from abandonment of the property. Individuals, report income
from cancellation of a
debt related to a business or rental activity as business or rental income. Report income from cancellation of a nonbusiness
debt as other income on
Form 1040, line 21. Partnerships, corporations, and other entities, report this income on the comparable line on your tax
return.
However, income from cancellation of debt is not taxed if any of the following conditions apply.
-
The cancellation is intended as a gift.
-
The debt is qualified farm debt (see chapter 3 of Publication 225, Farmer's Tax Guide).
-
The debt is qualified real property business debt (see chapter 5 of Publication 334, Tax Guide for Small Business).
-
You are insolvent or bankrupt (see Publication 908).
-
The debt is qualified principal residence indebtedness.
File Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), to report
the income
exclusion.
Forms 1099-A and 1099-C.
If your abandoned property secures a loan and the lender knows the property has been abandoned, the lender should
send you Form 1099-A showing
information you need to figure your loss from the abandonment. However, if your debt is canceled and the lender must file
Form 1099-C, the lender may
include the information about the abandonment on that form instead of on Form 1099-A. The lender must file Form 1099-C and
send you a copy if the
amount of debt canceled is $600 or more and the lender is a financial institution, credit union, federal government agency,
or any organization that
has a significant trade or business of lending money. For abandonments of property and debt cancellations occurring in 2007,
these forms should be
sent to you by January 31, 2008.
Foreclosures and Repossessions
If you do not make payments you owe on a loan secured by property, the lender may foreclose on the loan or repossess the property.
The foreclosure
or repossession is treated as a sale or exchange from which you may realize gain or loss. This is true even if you voluntarily
return the property to
the lender. You also may realize ordinary income from cancellation of debt if the loan balance is more than the fair market
value of the property.
Buyer's (borrower's) gain or loss.
You figure and report gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale
or exchange. The gain or loss is
the difference between your adjusted basis in the transferred property and the amount realized. See Gain or Loss From Sales and Exchanges,
earlier.
You can use Table 1-2 to figure your gain or loss from a foreclosure or repossession.
Amount realized on a nonrecourse debt.
If you are not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the
amount you realize includes the
full debt canceled by the transfer. The full canceled debt is included even if the fair market value of the property is less
than the canceled debt.
Example 1.
Chris bought a new car for $15,000. He paid $2,000 down and borrowed the remaining $13,000 from the dealer's credit company.
Chris is not
personally liable for the loan (nonrecourse debt), but pledges the new car as security. The credit company repossessed the
car because he stopped
making loan payments. The balance due after taking into account the payments Chris made was $10,000. The fair market value
of the car when repossessed
was $9,000. The amount Chris realized on the repossession is $10,000. That is the debt canceled by the repossession, even
though the car's fair market
value is less than $10,000. Chris figures his gain or loss on the repossession by comparing the amount realized ($10,000)
with his adjusted basis
($15,000). He has a $5,000 nondeductible loss.
Example 2.
Abena paid $200,000 for her home. She paid $15,000 down and borrowed the remaining $185,000 from a bank. Abena is not personally
liable for the
loan (nonrecourse debt), but pledges the house as security. The bank foreclosed on the loan because Abena stopped making payments.
When the bank
foreclosed on the loan, the balance due was $180,000, the fair market value of the house was $170,000, and Abena's adjusted
basis was $175,000 due to
a casualty loss she had deducted. The amount Abena realized on the foreclosure is $180,000, the debt canceled by the foreclosure.
She figures her gain
or loss by comparing the amount realized ($180,000) with her adjusted basis ($175,000). She has a $5,000 realized gain.
Amount realized on a recourse debt.
If you are personally liable for the debt (recourse debt), the amount realized on the foreclosure or repossession
does not include the canceled
debt that is your income from cancellation of debt. However, if the fair market value of the transferred property is less
than the canceled debt, the
amount realized includes the canceled debt up to the fair market value of the property. You are treated as receiving ordinary
income from the canceled
debt for the part of the debt that is more than the fair market value. See Cancellation of debt, later.
Example 1.
Assume the same facts as in the previous Example 1, except Chris is personally liable for the car loan (recourse debt). In
this case, the amount he
realizes is $9,000. This is the canceled debt ($10,000) up to the car's fair market value ($9,000). Chris figures his gain
or loss on the repossession
by comparing the amount realized ($9,000) with his adjusted basis ($15,000). He has a $6,000 nondeductible loss. He also is
treated as receiving
ordinary income from cancellation of debt. That income is $1,000 ($10,000 - $9,000). This is the part of the canceled debt
not included in the
amount realized.
Example 2.
Assume the same facts as in the previous Example 2, except Abena is personally liable for the loan (recourse debt). In this
case, the amount she
realizes is $170,000. This is the canceled debt ($180,000) up to the fair market value of the house ($170,000). Abena figures
her gain or loss on the
foreclosure by comparing the amount realized ($170,000) with her adjusted basis ($175,000). She has a $5,000 nondeductible
loss. She also is treated
as receiving ordinary income from cancellation of debt. (The debt is not exempt from tax as discussed under Cancellation of debt, below.)
That income is $10,000 ($180,000 - $170,000). This is the part of the canceled debt not included in the amount realized.
Seller's (lender's) gain or loss on repossession.
If you finance a buyer's purchase of property and later acquire an interest in it through foreclosure or repossession,
you may have a gain or loss
on the acquisition. For more information, see Repossession in Publication 537.
Table 1-2. Worksheet for Foreclosures and Repossessions
Part 1. Figure your income from cancellation of debt. (Note: If you are
not personally liable for the debt, you do not have income
from cancellation of debt. Skip Part 1 and go to Part 2.) |
|
| 1. Enter the amount of debt canceled by the transfer of property
|
|
| 2. Enter the fair market value of the transferred property
|
|
3.Income from cancellation of debt.* Subtract line 2 from line 1. If
less than zero, enter zero
|
|
| Part 2. Figure your gain or loss from foreclosure or repossession.
|
|
4. Enter the smaller of line 1 or line 2. Also include any proceeds you
received from the foreclosure sale. (If you are not personally liable
for the debt, enter the amount of debt canceled by the transfer of
property.)
|
|
| 5. Enter the adjusted basis of the transferred property
|
|
6. Gain or loss from foreclosure or repossession. Subtract line 5
from line 4
|
|
| * The income may not be taxable. See Cancellation of debt. |
Cancellation of debt.
If property that is repossessed or foreclosed on secures a debt for which you are personally liable (recourse debt),
you generally must report as
ordinary income the amount by which the canceled debt is more than the fair market value of the property. This income is separate
from any gain or
loss realized from the foreclosure or repossession. Report the income from cancellation of a debt related to a business or
rental activity as business
or rental income. Individuals, report the income from cancellation of a nonbusiness debt as other income on Form 1040, line
21. Partnerships,
corporations, and other entities, report the income on the comparable line on your tax return.
You can use Table 1-2 to figure your income from cancellation of debt.
However, income from cancellation of debt is not taxed if any of the following conditions apply.
-
The cancellation is intended as a gift.
-
The debt is qualified farm debt (see chapter 3 of Publication 225).
-
The debt is qualified real property business debt (see chapter 5 of Publication 334).
-
You are insolvent or bankrupt (see Publication 908).
-
The debt is qualified principal residence indebtedness.
File Form 982 to report the income exclusion.
Forms 1099-A and 1099-C.
A lender who acquires an interest in your property in a foreclosure or repossession should send you Form 1099-A showing
the information you need to
figure your gain or loss. However, if the lender also cancels part of your debt and must file Form 1099-C, the lender may
include the information
about the foreclosure or repossession on that form instead of on Form 1099-A. The lender must file Form 1099-C and send you
a copy if the amount of
debt canceled is $600 or more and the lender is a financial institution, credit union, federal government agency, or any organization
that has a
significant trade or business of lending money. For foreclosures or repossessions occurring in 2007, these forms should be
sent to you by January 31,
2008.
An involuntary conversion occurs when your property is destroyed, stolen, condemned, or disposed of under the threat of condemnation
and you
receive other property or money in payment, such as insurance or a condemnation award. Involuntary conversions are also called
involuntary exchanges.
Gain or loss from an involuntary conversion of your property is usually recognized for tax purposes unless the property is
your main home. You
report the gain or deduct the loss on your tax return for the year you realize it. You cannot deduct a loss from an involuntary
conversion of property
you held for personal use unless the loss resulted from a casualty or theft.
However, depending on the type of property you receive, you may not have to report a gain on an involuntary conversion. Generally,
you do not
report the gain if you receive property that is similar or related in service or use to the converted property. Your basis
for the new property is the
same as your basis for the converted property. This means that the gain is deferred until a taxable sale or exchange occurs.
If you receive money or property that is not similar or related in service or use to the involuntarily converted property
and you buy qualifying
replacement property within a certain period of time, you can elect to postpone reporting the gain.
This publication explains the treatment of a gain or loss from a condemnation or disposition under the threat of condemnation.
If you have a gain
or loss from the destruction or theft of property, see Publication 547.
A condemnation is the process by which private property is legally taken for public use without the owner's consent. The property
may be taken by
the federal government, a state government, a political subdivision, or a private organization that has the power to legally
take it. The owner
receives a condemnation award (money or property) in exchange for the property taken. A condemnation is like a forced sale,
the owner being the seller
and the condemning authority being the buyer.
Example.
A local government authorized to acquire land for public parks informed you that it wished to acquire your property. After
the local government
took action to condemn your property, you went to court to keep it. But, the court decided in favor of the local government,
which took your property
and paid you an amount fixed by the court. This is a condemnation of private property for public use.
Threat of condemnation.
A threat of condemnation exists if a representative of a government body or a public official authorized to acquire
property for public use informs
you that the government body or official has decided to acquire your property. You must have reasonable grounds to believe
that, if you do not sell
voluntarily, your property will be condemned.
The sale of your property to someone other than the condemning authority will also qualify as an involuntary conversion,
provided you have
reasonable grounds to believe that your property will be condemned. If the buyer of this property knows at the time of purchase
that it will be
condemned and sells it to the condemning authority, this sale also qualifies as an involuntary conversion.
Reports of condemnation.
A threat of condemnation exists if you learn of a decision to acquire your property for public use through a report
in a newspaper or other news
medium, and this report is confirmed by a representative of the government body or public official involved. You must have
reasonable grounds to
believe that they will take necessary steps to condemn your property if you do not sell voluntarily. If you relied on oral
statements made by a
government representative or public official, the Internal Revenue Service (IRS) may ask you to get written confirmation of
the statements.
Example.
Your property lies along public utility lines. The utility company has the authority to condemn your property. The company
informs you that it
intends to acquire your property by negotiation or condemnation. A threat of condemnation exists when you receive the notice.
Related property voluntarily sold.
A voluntary sale of your property may be treated as a forced sale that qualifies as an involuntary conversion if the
property had a substantial
economic relationship to property of yours that was condemned. A substantial economic relationship exists if together the
properties were one economic
unit. You also must show that the condemned property could not reasonably or adequately be replaced. You can elect to postpone
reporting the gain by
buying replacement property. See Postponement of Gain, later.
Gain or Loss From Condemnations
If your property was condemned or disposed of under the threat of condemnation, figure your gain or loss by comparing the
adjusted basis of your
condemned property with your net condemnation award.
If your net condemnation award is more than the adjusted basis of the condemned property, you have a gain. You can postpone
reporting gain from a
condemnation if you buy replacement property. If only part of your property is condemned, you can treat the cost of restoring
the remaining part to
its former usefulness as the cost of replacement property. See Postponement of Gain, later.
If your net condemnation award is less than your adjusted basis, you have a loss. If your loss is from property you held for
personal use, you
cannot deduct it. You must report any deductible loss in the tax year it happened.
You can use Part 2 of Table 1-3 to figure your gain or loss from a condemnation award.
Main home condemned.
If you have a gain because your main home is condemned, you generally can exclude the gain from your income as if
you had sold or exchanged your
home. You may be able to exclude up to $250,000 of the gain (up to $500,000 if married filing jointly). For information on
this exclusion, see
Publication 523. If your gain is more than you can exclude but you buy replacement property, you may be able to postpone reporting
the rest of the
gain. See Postponement of Gain, later.
Table 1-3. Worksheet for Condemnations
Part 1. Gain from severance damages.
(If you did not receive severance damages, skip Part 1 and go to Part 2.)
|
|
|
1.
|
Enter severance damages received
|
|
|
2.
|
Enter your expenses in getting severance damages
|
|
|
3.
|
Subtract line 2 from line 1. If less than zero, enter -0-
|
|
|
4.
|
Enter any special assessment on remaining property taken out of your award
|
|
|
5.
|
Net severance damages. Subtract line 4 from line 3. If less than zero, enter -0-
|
|
|
6.
|
Enter the adjusted basis of the remaining property
|
|
|
7.
|
Gain from severance damages. Subtract line 6 from line 5. If less than zero, enter -0-
|
|
|
8.
|
Refigured adjusted basis of the remaining property. Subtract line 5 from line 6. If less than zero, enter
-0-
|
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Part 2. Gain or loss from condemnation award.
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9.
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Enter the condemnation award received
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10.
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Enter your expenses in getting the condemnation award
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11.
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If you completed Part 1, and line 4 is more than line 3, subtract line 3 from line 4. Otherwise, enter -0-
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12.
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Add lines 10 and 11
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13.
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Net condemnation award. Subtract line 12 from line 9
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14.
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Enter the adjusted basis of the condemned property
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15.
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Gain from condemnation award. If line 14 is more than line 13, enter -0-. Otherwise, subtract line 14 from
line 13 and skip line 16
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16.
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Loss from condemnation award. Subtract line 13 from line 14
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(Note: You cannot deduct the amount on line 16 if the condemned property was held for
personal use.)
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Part 3. Postponed gain from condemnation.
(Complete only if line 7 or line 15 is more than zero and you bought qualifying replacement property or made expenditures
to restore the usefulness
of your remaining property.)
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17.
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If you completed Part 1, and line 7 is more than zero, enter the amount from line 5. Otherwise, enter -0-
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18.
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If line 15 is more than zero, enter the amount from line 13. Otherwise, enter -0-
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19.
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Add lines 17 and 18*
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20.
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Enter the total cost of replacement property and any expenses to restore the usefulness of your remaining
property |
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21.
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Subtract line 20 from line 19. If less than zero, enter -0-
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22.
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If you completed Part 1, add lines 7 and 15. Otherwise, enter the amount from line 15
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23.
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Recognized gain. Enter the smaller of line 21 or line 22.
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24.
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Postponed gain. Subtract line 23 from line 22. If less than zero, enter -0-
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| *If the condemned property was your main home, subtract from this total the gain you excluded from your income and enter the
result.
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Condemnation award.
A condemnation award is the money you are paid or the value of other property you receive for your condemned property.
The award is also the amount
you are paid for the sale of your property under threat of condemnation.
Payment of your debts.
Amounts taken out of the award to pay your debts are considered paid to you. Amounts the government pays directly
to the holder of a mortgage or
lien against your property are part of your award, even if the debt attaches to the property and is not your personal liability.
Example.
The state condemned your property for public use. The award was set at $200,000. The state paid you only $148,000 because
it paid $50,000 to your
mortgage holder and $2,000 accrued real estate taxes. You are considered to have received the entire $200,000 as a condemnation
award.
Interest on award.
If the condemning authority pays you interest for its delay in paying your award, it is not part of the condemnation
award. You must report the
interest separately as ordinary income.
Payments to relocate.
Payments you receive to relocate and replace housing because you have been displaced from your home, business, or
farm as a result of federal or
federally assisted programs are not part of the condemnation award. Do not include them in your income. Replacement housing
payments used to buy new
property are included in the property's basis as part of your cost.
Net condemnation award.
A net condemnation award is the total award you received, or are considered to have received, for the condemned property
minus your expenses of
obtaining the award. If only a part of your property was condemned, you also must reduce the award by any special assessment
levied against the part
of the property you retain. This is discussed later under Special assessment taken out of award.
Severance damages.
Severance damages are not part of the award paid for the property condemned. They are paid to you if part of your
property is condemned and the
value of the part you keep is decreased because of the condemnation.
For example, you may receive severance damages if your property is subject to flooding because you sell flowage easement
rights (the condemned
property) under threat of condemnation. Severance damages also may be given to you if, because part of your property is condemned
for a highway, you
must replace fences, dig new wells or ditches, or plant trees to restore your remaining property to the same usefulness it
had before the
condemnation.
The contracting parties should agree on the specific amount of severance damages in writing. If this is not done,
all proceeds from the condemning
authority are considered awarded for your condemned property.
You cannot make a completely new allocation of the total award after the transaction is completed. However, you can
show how much of the award both
parties intended for severance damages. The severance damages part of the award is determined from all the facts and circumstances.
Example.
You sold part of your property to the state under threat of condemnation. The contract you and the condemning authority signed
showed only the
total purchase price. It did not specify a fixed sum for severance damages. However, at settlement, the condemning authority
gave you closing papers
showing clearly the part of the purchase price that was for severance damages. You may treat this part as severance damages.
Treatment of severance damages.
Your net severance damages are treated as the amount realized from an involuntary conversion of the remaining part
of your property. Use them to
reduce the basis of the remaining property. If the amount of severance damages is based on damage to a specific part of the
property you kept, reduce
the basis of only that part by the net severance damages.
If your net severance damages are more than the basis of your retained property, you have a gain. You may be able
to postpone reporting the gain.
See Postponement of Gain, later.
You can use Part 1 of Table 1-3 to figure any gain from severance damages and to refigure the adjusted basis of the remaining
part of
your property.
Net severance damages.
To figure your net severance damages, you first must reduce your severance damages by your expenses in obtaining the
damages. You then reduce them
by any special assessment (described later) levied against the remaining part of the property and retained out of the award
by the condemning
authority. The balance is your net severance damages.
Expenses of obtaining a condemnation award and severance damages.
Subtract the expenses of obtaining a condemnation award, such as legal, engineering, and appraisal fees, from the
total award. Also, subtract the
expenses of obtaining severance damages, that may include similar expenses, from the severance damages paid to you. If you
cannot determine which part
of your expenses is for each part of the condemnation proceeds, you must make a proportionate allocation.
Example.
You receive a condemnation award and severance damages. One-fourth of the total was designated as severance damages in your
agreement with the
condemning authority. You had legal expenses for the entire condemnation proceeding. You cannot determine how much of your
legal expenses is for each
part of the condemnation proceeds. You must allocate one-fourth of your legal expenses to the severance damages and the other
three-fourths to the
condemnation award.
Special assessment retained out of award.
When only part of your property is condemned, a special assessment levied against the remaining property may be retained
by the governing body out
of your condemnation award. An assessment may be levied if the remaining part of your property benefited by the improvement
resulting from the
condemnation. Examples of improvements that may cause a special assessment are widening a street and installing a sewer.
To figure your net condemnation award, you must reduce the amount of the award by the assessment retained out of the
award.
Example.
To widen the street in front of your home, the city condemned a 25-foot deep strip of your land. You were awarded $5,000 for
this and spent $300 to
get the award. Before paying the award, the city levied a special assessment of $700 for the street improvement against your
remaining property. The
city then paid you only $4,300. Your net award is $4,000 ($5,000 total award minus $300 expenses in obtaining the award and
$700 for the special
assessment retained).
If the $700 special assessment was not retained out of the award and you were paid $5,000, your net award would be $4,700
($5,000 - $300).
The net award would not change, even if you later paid the assessment from the amount you received.
Severance damages received.
If severance damages are included in the condemnation proceeds, the special assessment retained out of the severance
damages is first used to
reduce the severance damages. Any balance of the special assessment is used to reduce the condemnation award.
Example.
You were awarded $4,000 for the condemnation of your property and $1,000 for severance damages. You spent $300 to obtain the
severance damages. A
special assessment of $800 was retained out of the award. The $1,000 severance damages are reduced to zero by first subtracting
the $300 expenses and
then $700 of the special assessment. Your $4,000 condemnation award is reduced by the $100 balance of the special assessment,
leaving a $3,900 net
condemnation award.
Part business or rental.
If you used part of your condemned property as your home and part as business or rental property, treat each part
as a separate property. Figure
your gain or loss separately because gain or loss on each part may be treated differently.
Some examples of this type of property are a building in which you live and operate a grocery, and a building in which
you live on the first floor
and rent out the second floor.
Example.
You sold your building for $24,000 under threat of condemnation to a public utility company that had the authority to condemn.
You rented half the
building and lived in the other half. You paid $25,000 for the building and spent an additional $1,000 for a new roof. You
claimed allowable
depreciation of $4,600 on the rental half. You spent $200 in legal expenses to obtain the condemnation award. Figure your
gain or loss as follows.
Do not report the gain on condemned property if you receive only property that is similar or related in service or use to
the condemned property.
Your basis for the new property is the same as your basis for the old.
Money or unlike property received.
You ordinarily must report the gain if you receive money or unlike property. You can elect to postpone reporting the
gain if you buy property that
is similar or related in service or use to the condemned property within the replacement period, discussed later. You also
can elect to postpone
reporting the gain if you buy a controlling interest (at least 80%) in a corporation owning property that is similar or related
in service or use to
the condemned property. See Controlling interest in a corporation, later.
To postpone reporting all the gain, you must buy replacement property costing at least as much as the amount realized
for the condemned property.
If the cost of the replacement property is less than the amount realized, you must report the gain up to the unspent part
of the amount realized.
The basis of the replacement property is its cost, reduced by the postponed gain. Also, if your replacement property
is stock in a corporation that
owns property similar or related in service or use, the corporation generally will reduce its basis in its assets by the amount
by which you reduce
your basis in the stock. See Controlling interest in a corporation, later.
You can use Part 3 of Table 1-3 to figure the gain you must report and your postponed gain.
Postponing gain on severance damages.
If you received severance damages for part of your property because another part was condemned and you buy replacement
property, you can elect to
postpone reporting gain. See Treatment of severance damages, earlier. You can postpone reporting all your gain if the replacement property
costs at least as much as your net severance damages plus your net condemnation award (if resulting in gain).
You also can make this election if you spend the severance damages, together with other money you received for the
condemned property (if resulting
in gain), to acquire nearby property that will allow you to continue your business. If suitable nearby property is not available
and you are forced to
sell the remaining property and relocate in order to continue your business, see Postponing gain on the sale of related property, next.
If you restore the remaining property to its former usefulness, you can treat the cost of restoring it as the cost
of replacement property.
Postponing gain on the sale of related property.
If you sell property that is related to the condemned property and then buy replacement property, you can elect to
postpone reporting gain on the
sale. You must meet the requirements explained earlier under Related property voluntarily sold. You can postpone reporting all your gain if
the replacement property costs at least as much as the amount realized from the sale plus your net condemnation award (if
resulting in gain) plus your
net severance damages, if any (if resulting in gain).
Buying replacement property from a related person.
Certain taxpayers cannot postpone reporting gain from a condemnation if they buy the replacement property from a related
person. For information on
related persons, see Nondeductible Loss under Sales and Exchanges Between Related Persons in chapter 2.
This rule applies to the following taxpayers.
-
C corporations.
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Partnerships in which more than 50% of the capital or profits interest is owned by
C corporations.
-
All others (including individuals, partnerships (other than those in (2)), and S corporations) if the total realized gain
for the tax year
on all involuntarily converted properties on which there are realized gains is more than $100,000.
For taxpayers described in (3) above, gains cannot be offset with any losses when determining whether the total gain
is more than $100,000. If the
property is owned by a partnership, the $100,000 limit applies to the partnership and each partner. If the property is owned
by an S corporation, the
$100,000 limit applies to the S corporation and each shareholder.
Exception.
This rule does not apply if the related person acquired the property from an unrelated person within the replacement
period.
Advance payment.
If you pay a contractor in advance to build your replacement property, you have not bought replacement property unless
it is finished before the
end of the replacement period (discussed later).
Replacement property.
To postpone reporting gain, you must buy replacement property for the specific purpose of replacing your condemned
property. You do not have to use
the actual funds from the condemnation award to acquire the replacement property. Property you acquire by gift or inheritance
does not qualify as
replacement property.
Similar or related in service or use.
Your replacement property must be similar or related in service or use to the property it replaces.
If the condemned property is real property you held for use in your trade or business or for investment (other than
property held mainly for sale),
but your replacement property is not similar or related in service or use, it will be treated as such if it is like-kind property
to be held for use
in a trade or business or for investment. For a discussion of like-kind property, see Like-Kind Property under Like-Kind Exchanges,
later.
Owner-user.
If you are an owner-user, similar or related in service or use means that replacement property must function in the
same way as the property it
replaces.
Example.
Your home was condemned and you invested the proceeds from the condemnation in a grocery store. Your replacement property
is not similar or related
in service or use to the condemned property. To be similar or related in service or use, your replacement property must also
be used by you as your
home.
Owner-investor.
If you are an owner-investor, similar or related in service or use means that any replacement property must have the
same relationship of services
or uses to you as the property it replaces. You decide this by determining all the following information.
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Whether the properties are of similar service to you.
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The nature of the business risks connected with the properties.
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What the properties demand of you in the way of management, service, and relations to your tenants.
Example.
You owned land and a building you rented to a manufacturing company. The building was condemned. During the replacement period,
you had a new
building built on other land you already owned. You rented out the new building for use as a wholesale grocery warehouse.
The replacement property is
also rental property, so the two properties are considered similar or related in service or use if there is a similarity in
all the following areas.
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Your management activities.
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The amount and kind of services you provide to your tenants.
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The nature of your business risks connected with the properties.
Leasehold replaced with fee simple property.
Fee simple property you will use in your trade or business or for investment can qualify as replacement property that
is similar or related in
service or use to a condemned leasehold if you use it in the same business and for the identical purpose as the condemned
leasehold.
A fee simple property interest generally is a property interest that entitles the owner to the entire property with
unconditional power to dispose
of it during his or her lifetime. A leasehold is property held under a lease, usually for a term of years.
Outdoor advertising display replaced with real property.
You can elect to treat an outdoor advertising display as real property. If you make this election and you replace
the display with real property in
which you hold a different kind of interest, your replacement property can qualify as like-kind property. For example, real
property bought to replace
a destroyed billboard and leased property on which the billboard was located qualifies as property of a like kind.
You can make this election only if you did not claim a section 179 deduction for the display. You cannot cancel this
election unless you get the
consent of the IRS.
An outdoor advertising display is a sign or device rigidly assembled and permanently attached to the ground, a building,
or any other permanent
structure used to display a commercial or other advertisement to the public.
Substituting replacement property.
Once you designate certain property as replacement property on your tax return, you cannot substitute other qualified
property. But, if your
previously designated replacement property does not qualify, you can substitute qualified property if you acquire it within
the replacement period.
Controlling interest in a corporation.
You can replace property by acquiring a controlling interest in a corporation that owns property similar or related
in service or use to your
condemned property. You have controlling interest if you own stock having at least 80% of the combined voting power of all
classes of stock entitled
to vote and at least 80% of the total number of shares of all other classes of stock of the corporation.
Basis adjustment to corporation's property.
The basis of property held by the corporation at the time you acquired control must be reduced by your postponed gain,
if any. You are not required
to reduce the adjusted basis of the corporation's properties below your adjusted basis in the corporation's stock (determined
after reduction by your
postponed gain).
Allocate this reduction to the following classes of property in the order shown below.
-
Property that is similar or related in service or use to the condemned property.
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Depreciable property not reduced in (1).
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All other property.
If two or more properties fall in the same class, allocate the reduction to each property in proportion to the adjusted basis
of all the
properties in that class. The reduced basis of any single property cannot be less than zero.
Main home replaced.
If your gain from a condemnation of your main home is more than you can exclude from your income (see Main home condemned under
Gain or Loss From Condemnations, earlier), you can postpone reporting the rest of the gain by buying replacement property that is similar
or related in service or use. To postpone reporting all the gain, the replacement property must cost at least as much as the
amount realized from the
condemnation minus the excluded gain.
You must reduce the basis of your replacement property by the postponed gain. Also, if you postpone reporting any
part of your gain under these
rules, you are treated as having owned and used the replacement property as your main home for the period you owned and used
the condemned property as
your main home.
Replacement period.
To postpone reporting your gain from a condemnation, you must buy replacement property within a certain period of
time. This is the replacement
period.
The replacement period for a condemnation begins on the earlier of the following dates.
The replacement period generally ends 2 years after the end of the first tax year in which any part of the gain on
the condemnation is realized.
However, see the exceptions below.
If real property held for use in a trade or business or for investment (not including property held primarily for
sale) is condemned, the
replacement period ends 3 years after the end of the first tax year in which any part of the gain on the condemnation is realized.
However, this
3-year replacement period cannot be used if you replace the condemned property by acquiring control of a corporation owning
property that is similar
or related in service or use.
Extended replacement period for property located in the Hurricane Katrina disaster area.
If property in the Hurricane Katrina disaster area is compulsorily or involuntarily converted after August 24, 2005,
the replacement period ends 5
years after the end of the first tax year in which any part of the gain is realized on the involuntary conversion. This 5-year
replacement period
applies only if substantially all of the use of the replacement property is in the Hurricane Katrina disaster area. See Publication
4492, Information
for Taxpayers Affected by Hurricanes Katrina, Rita, and Wilma.
New York Liberty Zone property condemned.
If property in the New York Liberty Zone was condemned as a result of the September 11, 2001, terrorist attacks, the
replacement period ends 5
years after the end of the first tax year in which any part of the gain on the condemnation is realized. This 5-year replacement
period applies only
if substantially all of the use of the replacement property is in New York City. See Publication 547.
Weather-related sales of livestock in an area eligible for federal assistance.
For the sale or exchange of livestock due to drought, flood, or other weather-related conditions in an area eligible
for federal assistance, the
replacement period ends 4 years after the close of the first tax year in which you realize any part of your gain from the
sale or exchange. The IRS
may extend the replacement period on a regional basis if the weather-related conditions continue for longer than 3 years.
For information on extensions of the replacement period because of persistent drought, see Notice 2006-82. You can
find Notice 2006-82 on page 529
of Internal Revenue Bulletin 2006-39 at
www.irs.gov/pub/irs-irbs/irb06-39.pdf.
For a list of counties, districts, cities, or parishes for which exceptional, extreme, or severe drought was reported
during the 12-month period
ending August 31, 2007, see Notice 2007-80. You can find Notice 2007-80 on page 867 of Internal Revenue Bulletin 2007-43 at
www.irs.gov/pub/irs-irbs/irb07-43.pdf. If you
qualified for a 4-year replacement period for livestock sold or exchanged on account of drought and your replacement period
is scheduled to expire at
the end of 2007 (or at the end of the tax year that includes August 27, 2007), the replacement period will be extended under
Notice 2006-82 if the
applicable region is on the list.
Determining when gain is realized.
If you are a cash basis taxpayer, you realize gain when you receive payments that are more than your basis in the
property. If the condemning
authority makes deposits with the court, you realize gain when you withdraw (or have the right to withdraw) amounts that are
more than your basis.
This applies even if the amounts received are only partial or advance payments and the full award has not yet been
determined. A replacement will
be too late if you wait for a final determination that does not take place in the applicable replacement period after you
first realize gain.
For accrual basis taxpayers, gain (if any) accrues in the earlier year when either of the following occurs.
For example, if you have an absolute right to a part of a condemnation award when it is deposited with the court, the amount
deposited accrues
in the year the deposit is made even though the full amount of the award is still contested.
Replacement property bought before the condemnation.
If you buy your replacement property after there is a threat of condemnation but before the actual condemnation and
you still hold the replacement
property at the time of the condemnation, you have bought your replacement property within the replacement period. Property
you acquire before there
is a threat of condemnation does not qualify as replacement property acquired within the replacement period.
Example.
On April 3, 2006, city authorities notified you that your property would be condemned. On June 5, 2006, you acquired property
to replace the
property to be condemned. You still had the new property when the city took possession of your old property on September 4,
2007. You have made a
replacement within the replacement period.
Extension.
You can request an extension of the replacement period from the IRS director for your area. You should apply before
the end of the replacement
period. Your request should explain in detail why you need an extension. The IRS will consider a request filed within a reasonable
time after the
replacement period if you can show reasonable cause for the delay. An extension of the replacement period will be granted
if you can show reasonable
cause for not making the replacement within the regular period.
Ordinarily, requests for extensions are granted near the end of the replacement period or the extended replacement
period. Extensions are usually
limited to a period of 1 year or less. The high market value or scarcity of replacement property is not a sufficient reason
for granting an extension.
If your replacement property is being built and you clearly show that the replacement or restoration cannot be made within
the replacement period, you
will be granted an extension of the period.
Send your request to the address where you filed your return, addressed as follows:
Extension Request for Replacement Period of Involuntarily Converted Property
Area Director
Attention: Area Technical Services, Compliance Function
Election to postpone gain.
Report your election to postpone reporting your gain, along with all necessary details, on a statement attached to
your return for the tax year in
which you realize the gain.
If a partnership or a corporation owns the condemned property, only the partnership or corporation can elect to postpone
reporting the gain.
Replacement property acquired after return filed.
If you buy the replacement property after you file your return reporting your election to postpone reporting the gain,
attach a statement to your
return for the year in which you buy the property. The statement should contain detailed information on the replacement property.
Amended return.
If you elect to postpone reporting gain, you must file an amended return for the year of the gain (individuals file
Form 1040X) in either of the
following situations.
-
You do not buy replacement property within the replacement period. On your amended return, you must report the gain and pay
any additional
tax due.
-
The replacement property you buy costs less than the amount realized for the condemned property (minus the gain you excluded
from income if
the property was your main home). On your amended return, you must report the part of the gain you cannot postpone reporting
and pay any additional
tax due.
Time for assessing a deficiency.
Any deficiency for any tax year in which part of the gain is realized may be assessed at any time before the expiration
of 3 years from the date
you notify the IRS director for your area that you have replaced, or intend not to replace, the condemned property within
the replacement period.
Changing your mind.
You can change your mind about reporting or postponing the gain at any time before the end of the replacement period.
Example.
Your property was condemned and you had a gain of $5,000. You reported the gain on your return for the year in which you realized
it, and paid the
tax due. You buy replacement property within the replacement period. You used all but $1,000 of the amount realized from the
condemnation to buy the
replacement property. You now change your mind and want to postpone reporting the $4,000 of gain equal to the amount you spent
for the replacement
property. You should file a claim for refund on Form 1040X. Explain on Form 1040X that you previously reported the entire
gain from the condemnation,
but you now want to report only the part of the gain equal to the condemnation proceeds not spent for replacement property
($1,000).
Reporting a Condemnation Gain or Loss
Generally, you report gain or loss from a condemnation on your return for the year you realize the gain or loss.
Personal-use property.
Report gain from a condemnation of property you held for personal use (other than excluded gain from a condemnation
of your main home or postponed
gain) on Schedule D (Form 1040).
Do not report loss from a condemnation of personal-use property. But, if you received a Form 1099-S, Proceeds From
Real Estate Transactions (for
example, showing the proceeds of a sale of real estate under threat of condemnation), you must show the transaction on Schedule
D (Form 1040) even
though the loss is not deductible. Complete columns (a) through (e), and enter -0- in column (f).
Business property.
Report gain (other than postponed gain) or loss from a condemnation of property you held for business or profit on
Form
4797. If you had a gain, you may have to report all or part of it as ordinary income. See Like-Kind Exchanges and
Involuntary Conversions in chapter 3.
Certain exchanges of property are not taxable. This means any gain from the exchange is not recognized, and any loss cannot
be deducted. Your gain
or loss will not be recognized until you sell or otherwise dispose of the property you receive.
The exchange of property for the same kind of property is the most common type of nontaxable exchange. To be a like-kind exchange,
the property
traded and the property received must be both of the following.
-
Qualifying property.
-
Like-kind property.
These two requirements are discussed later.
Additional requirements apply to exchanges in which the property received is not received immediately upon the transfer of
the property given up.
See Deferred Exchange, later.
If the like-kind exchange involves the receipt of money or unlike property or the assumption of your liabilities, you may
have to recognize gain.
See Partially Nontaxable Exchanges, later.
Multiple-party transactions.
The like-kind exchange rules also apply to property exchanges that involve three- and four-party transactions. Any
part of these multiple-party
transactions can qualify as a like-kind exchange if it meets all the requirements described in this section.
Receipt of title from third party.
If you receive property in a like-kind exchange and the other party who transfers the property to you does not give
you the title, but a third
party does, you still can treat this transaction as a like-kind exchange if it meets all the requirements.
Basis of property received.
If you acquire property in a like-kind exchange, the basis of that property is generally the same as the basis of
the property you transferred.
For the basis of property received in an exchange that is only partially nontaxable, see Partially Nontaxable Exchanges, later.
Example.
You exchanged real estate held for investment with an adjusted basis of $25,000 for other real estate held for investment.
The fair market value of
both properties is $50,000. The basis of your new property is the same as the basis of the old ($25,000).
Money paid.
If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized
gain or loss. The basis of the
property received is the basis of the property given up, increased by the money paid.
Example.
Bill Smith trades an old cab for a new one. The new cab costs $30,000. He is allowed $8,000 for the old cab and pays $22,000
cash. He has no
recognized gain or loss on the transaction regardless of the adjusted basis of his old cab. If Bill sold the old cab to a
third party for $8,000 and
bought a new one, he would have a recognized gain or loss on the sale of his old cab equal to the difference between the amount
realized and the
adjusted basis of the old cab.
Sale and purchase.
If you sell property and buy similar property in two mutually dependent transactions, you may have to treat the sale
and purchase as a single
nontaxable exchange.
Example.
You used your car in your business for 2 years. Its adjusted basis is $3,500 and its trade-in value is $4,500. You are interested
in a new car that
costs $20,000. Ordinarily, you would trade your old car for the new one and pay the dealer $15,500. Your basis for depreciation
of the new car would
then be $19,000 ($15,500 plus $3,500 adjusted basis of the old car).
You want your new car to have a larger basis for depreciation, so you arrange to sell your old car to the dealer for $4,500.
You then buy the new
one for $20,000 from the same dealer. However, you are treated as having exchanged your old car for the new one because the
sale and purchase are
reciprocal and mutually dependent. Your basis for depreciation for the new car is $19,000, the same as if you traded the old
car.
Reporting the exchange.
Report the exchange of like-kind property, even though no gain or loss is recognized, on Form
8824, Like-Kind Exchanges. The instructions for the form explain how to report the details of the exchange.
If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040)
or Form
4797, whichever applies. See chapter 4. You may have to report the recognized gain as ordinary income from depreciation
recapture. See Like-Kind Exchanges and Involuntary Conversions in chapter 3.
Exchange expenses.
Exchange expenses are generally the closing costs you pay. They include such items as brokerage commissions, attorney
fees, and deed preparation
fees. Subtract these expenses from the consideration received to figure the amount realized on the exchange. Also, add them
to the basis of the
like-kind property received. If you receive cash or unlike property in addition to the like-kind property and realize a gain
on the exchange, subtract
the expenses from the cash or fair market value of the unlike property. Then, use the net amount to figure the recognized
gain. See Partially
Nontaxable Exchanges, later.
In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or
for productive use in
your trade or business. Machinery, buildings, land, trucks, and rental houses are examples of property that may qualify.
The rules for like-kind exchanges do not apply to exchanges of the following property.
-
Property you use for personal purposes, such as your home and your family car.
-
Stock in trade or other property held primarily for sale, such as inventories, raw materials, and real estate held by dealers.
-
Stocks, bonds, notes, or other securities or evidences of indebtedness, such as accounts receivable.
-
Partnership interests.
-
Certificates of trust or beneficial interest.
-
Choses in action.
However, you may have a nontaxable exchange under other rules. See Other Nontaxable Exchanges, later.
An exchange of the assets of a business for the assets of a similar business cannot be treated as an exchange of one property
for another property.
Whether you engaged in a like-kind exchange depends on an analysis of each asset involved in the exchange. However, see Multiple Property
Exchanges, later.
There must be an exchange of like-kind property. Like-kind properties are properties of the same nature or character, even
if they differ in grade
or quality. The exchange of real estate for real estate and the exchange of personal property for similar personal property
are exchanges of like-kind
property. For example, the trade of land improved with an apartment house for land improved with a store building, or a panel
truck for a pickup
truck, is a like-kind exchange.
An exchange of personal property for real property does not qualify as a like-kind exchange. For example, an exchange of a
piece of machinery for a
store building does not qualify. Also, the exchange of livestock of different sexes does not qualify.
Real property.
An exchange of city property for farm property, or improved property for unimproved property, is a like-kind exchange.
The exchange of real estate you own for a real estate lease that runs 30 years or longer is a like-kind exchange.
However, not all exchanges of
interests in real property qualify. The exchange of a life estate expected to last less than 30 years for a remainder interest
is not a like-kind
exchange.
An exchange of a remainder interest in real estate for a remainder interest in other real estate is a like-kind exchange
if the nature or character
of the two property interests is the same.
Foreign real property exchanges.
Real property located in the United States and real property located outside the United States are not considered
like-kind property under the
like-kind exchange rules. If you exchange foreign real property for property located in the United States, your gain or loss
on the exchange is
recognized. Foreign real property is real property not located in a state or the District of Columbia.
This foreign real property exchange rule does not apply to the replacement of condemned real property. Foreign and
U.S. real property can still be
considered like-kind property under the rules for replacing condemned property to postpone reporting gain on the condemnation.
See Postponement
of Gain under Involuntary Conversions, earlier.
Personal property.
Depreciable tangible personal property can be either like kind or like class to qualify for nonrecognition treatment.
Like-class properties are
depreciable tangible personal properties within the same General Asset Class or Product Class. Property classified in any
General Asset Class may not
be classified within a Product Class.
General Asset Classes.
General Asset Classes describe the types of property frequently used in many businesses. They include the following
property.
-
Office furniture, fixtures, and equipment (asset class 00.11).
-
Information systems, such as computers and peripheral equipment (asset class 00.12).
-
Data handling equipment except computers (asset class 00.13).
-
Airplanes (airframes and engines), except planes used in commercial or contract carrying of passengers or freight, and all
helicopters
(airframes and engines) (asset class 00.21).
-
Automobiles and taxis (asset class 00.22).
-
Buses (asset class 00.23).
-
Light general purpose trucks (asset class 00.241).
-
Heavy general purpose trucks (asset class 00.242).
-
Railroad cars and locomotives except those owned by railroad transportation companies (asset class 00.25).
-
Tractor units for use over the road (asset class 00.26).
-
Trailers and trailer-mounted containers (asset class 00.27).
-
Vessels, barges, tugs, and similar water-transportation equipment, except those used in marine construction (asset class 00.28).
-
Industrial steam and electric generation or distribution systems (asset class 00.4).
Product Classes.
Product Classes include property listed in a 6-digit product class (except any ending in 9) in sectors 31 through
33 of the North American Industry
Classification System (NAICS) of the Executive Office of the President, Office of Management and Budget, United States, 2007
(NAICS Manual). It can be
accessed at
http://www.census.gov/naics. Copies of the hard cover manual may be obtained from the National Technical
Information Service (NTIS) at
http://www.ntis.gov or by calling 1-800-553-NTIS (1-800-553-6847) or (703) 605-6000. The cost of the manual is $59
(plus handling) and the order number is PB2007100002 (which must be typed into the NTIS website search box). A CD-ROM version
with search and
retrieval software is also available from NTIS. The CD-ROM disc comes in three versions: 1) single concurrent network use;
2) up to 5 users; and, 3)
unlimited concurrent users. The cost of the CD-ROM is respectively $79, $179, and $358 (plus handling) and the order number
is PB2007500023 (which
must be typed into the NTIS website search box).
Example 1.
You transfer a personal computer used in your business for a printer to be used in your business. The properties exchanged
are within the same
General Asset Class and are of a like class.
Example 2.
Trena transfers a grader to Ron in exchange for a scraper. Both are used in a business. Neither property is within any of
the General Asset
Classes. Both properties, however, are within the same Product Class and are of a like class.
Intangible personal property and nondepreciable personal property.
If you exchange intangible personal property or nondepreciable personal property for like-kind property, no gain or
loss is recognized on the
exchange. (There are no like classes for these properties.) Whether intangible personal property, such as a patent or copyright,
is of a like kind to
other intangible personal property generally depends on the nature or character of the rights involved. It also depends on
the nature or character of
the underlying property to which those rights relate.
Example.
The exchange of a copyright on a novel for a copyright on a different novel can qualify as a like-kind exchange. However,
the exchange of a
copyright on a novel for a copyright on a song is not a like-kind exchange.
Goodwill and going concern.
The exchange of the goodwill or going concern value of a business for the goodwill or going concern value of another
business is not a like-kind
exchange.
Foreign personal property exchanges.
Personal property used predominantly in the United States and personal property used predominantly outside the United
States are not like-kind
property under the like-kind exchange rules. If you exchange property used predominantly in the United States for property
used predominantly outside
the United States, your gain or loss on the exchange is recognized.
Predominant use.
You determine the predominant use of property you gave up based on where that property was used during the 2-year
period ending on the date you
gave it up. You determine the predominant use of the property you acquired based on where that property was used during the
2-year period beginning on
the date you acquired it.
But if you held either property less than 2 years, determine its predominant use based on where that property was
used only during the period of
time you (or a related person) held it. This does not apply if the exchange is part of a transaction (or series of transactions)
structured to avoid
having to treat property as unlike property under this rule.
However, you must treat property as used predominantly in the United States if it is used outside the United States
but, under section 168(g)(4) of
the Internal Revenue Code, is eligible for accelerated depreciation as though used in the United States.
A deferred exchange is one in which you transfer property you use in business or hold for investment and later you receive
like-kind property you
will use in business or hold for investment. (The property you receive is replacement property.) The transaction must be an
exchange (that is,
property for property) rather than a transfer of property for money used to buy replacement property.
If, before you receive the replacement property, you actually or constructively receive money or unlike property in full payment
for the property
you transfer, the transaction will be treated as a sale rather than a deferred exchange. In that case, you must recognize
gain or loss on the
transaction, even if you later receive the replacement property. (It would be treated as if you bought it.)
You constructively receive money or unlike property when the money or property is credited to your account or made available
to you. You also
constructively receive money or unlike property when any limits or restrictions on it expire or are waived.
Whether you actually or constructively receive money or unlike property, however, is determined without regard to certain
arrangements you make to
ensure that the other party carries out its obligation to transfer the replacement property to you. For example, if you have
that obligation secured
by a mortgage or by cash or its equivalent held in a qualified escrow account or qualified trust, that arrangement will be
disregarded in determining
whether you actually or constructively receive money or unlike property. For more information, see section 1.1031(k)-1(g)
of the regulations. Also,
see Like-Kind Exchanges Using Qualified Intermediaries, later.
Identification requirement.
You must identify the property to be received within 45 days after the date you transfer the property given up in
the exchange. This period of time
is called the identification period. Any property received during the identification period is considered to have been identified.
If you transfer more than one property (as part of the same transaction) and the properties are transferred on different
dates, the identification
period and the receipt period begin on the date of the earliest transfer.
Identifying replacement property.
You must identify the replacement property in a signed written document and deliver it to the other person involved
in the exchange. You must
clearly describe the replacement property in the written document. For example, use the legal description or street address
for real property and the
make, model, and year for a car. In the same manner, you can cancel an identification of replacement property at any time
before the end of the
identification period.
Identifying alternative and multiple properties.
You can identify more than one replacement property. Regardless of the number of properties you give up, the maximum
number of replacement
properties you can identify is the larger of the following.
-
Three.
-
Any number of properties whose total fair market value (FMV) at the end of the identification period is not more than double
the total fair
market value, on the date of transfer, of all properties you give up.
If, as of the end of the identification period, you have identified more properties than permitted under this rule,
the only property that will be
considered identified is:
-
Any replacement property you received before the end of the identification period, and
-
Any replacement property identified before the end of the identification period and received before the end of the receipt
period, but only
if the fair market value of the property is at least 95% of the total fair market value of all identified replacement properties.
Fair market value is
determined on the earlier of the date you received the property or the last day of the receipt period.
Disregard incidental property.
Do not treat property incidental to a larger item of property as separate from the larger item when you identify replacement
property. Property is
incidental if it meets both the following tests.
Replacement property to be produced.
Gain or loss from a deferred exchange can qualify for nonrecognition even if the replacement property is not in existence
or is being produced at
the time you identify it as replacement property. If you need to know the fair market value of the replacement property to
identify it, estimate its
fair market value as of the date you expect to receive it.
Receipt requirement.
The property must be received by the earlier of the following dates.
-
The 180th day after the date on which you transfer the property given up in the exchange.
-
The due date, including extensions, for your tax return for the tax year in which the transfer of the property given up occurs.
You must receive substantially the same property that met the identification requirement, discussed earlier.
Replacement property produced after identification.
In some cases, the replacement property may have been produced after you identified it (as described earlier in Replacement property to be
produced.) In that case, to determine whether the property you received was substantially the same property that met the identification
requirement, do not take into account any variations due to usual production changes. Substantial changes in the property
to be produced, however,
will disqualify it.
If your replacement property is personal property that had to be produced, it must be completed by the date you receive
it to qualify as
substantially the same property you identified.
If your replacement property is real property that had to be produced and it is not completed by the date you receive
it, it still may qualify as
substantially the same property you identified. It will qualify only if, had it been completed on time, it would have been
considered to be
substantially the same property you identified. It is considered to be substantially the same only to the extent it is considered
real property under
local law. However, any additional production on the replacement property after you receive it does not qualify as like-kind
property. (To this
extent, the transaction is treated as a taxable exchange of property for services.)
Like-Kind Exchanges Using Qualified Intermediaries
If you transfer property through a qualified intermediary, the transfer of the property given up and receipt of like-kind
property is treated as an
exchange. This rule applies even if you receive money or other property directly from a party to the transaction other than
the qualified
intermediary.
A qualified intermediary is a person who enters into a written exchange agreement with you to acquire and transfer the property
you give up and to
acquire the replacement property and transfer it to you. This agreement must expressly limit your rights to receive, pledge,
borrow, or otherwise
obtain the benefits of money or other property held by the qualified intermediary.
Multiple-party transactions involving related persons.
A taxpayer who transfers property given up to a qualified intermediary in exchange for replacement property formerly
owned by a related person is
not entitled to nonrecognition treatment if the related person receives cash or unlike property for the replacement property.
(See Like-Kind
Exchanges Between Related Persons, later.)
A qualified intermediary cannot be either of the following.
-
Your agent at the time of the transaction. This includes a person who has been your employee, attorney, accountant, investment
banker or
broker, or real estate agent or broker within the 2-year period before the transfer of property you give up.
-
A person who is related to you or your agent under the rules discussed in chapter 2 under Nondeductible Loss, substituting
“10%” for “50%.”
An intermediary is treated as acquiring and transferring property if all the following requirements are met.
-
The intermediary acquires and transfers legal title to the property.
-
The intermediary enters into an agreement with a person other than you for the transfer to that person of the property you
give up and that
property is transferred to that person.
-
The intermediary enters into an agreement with the owner of the replacement property for the transfer of that property and
the replacement
property is transferred to you.
An intermediary is treated as entering into an agreement if the rights of a party to the agreement are assigned to the intermediary
and all parties
to that agreement are notified in writing of the assignment by the date of the relevant transfer of property.
Like-Kind Exchanges Using Qualified Exchange Accommodation Arrangements (QEAAs)
The like-kind exchange rules generally do not apply to an exchange in which you acquire replacement property (new property)
before you transfer
relinquished property (property you give up). However, if you use a qualified exchange accommodation arrangement (QEAA), the
transfer may qualify as a
like-kind exchange.
Under a QEAA, either the replacement property or the relinquished property is transferred to an exchange accommodation titleholder
(EAT), discussed
later, who is treated as the beneficial owner of the property. However, for transfers of qualified indications of ownership
(defined later) on or
after July 20, 2004, the replacement property held in a QEAA may not be treated as property received in an exchange if you
previously owned it within
180 days of its transfer to the EAT. If the property is held in a QEAA, the IRS will accept the qualification of property
as either replacement
property or relinquished property and the treatment of an EAT as the beneficial owner of the property for federal income tax
purposes.
Requirements for a QEAA.
Property is held in a QEAA only if all the following requirements are met.
-
You have a written agreement.
-
The time limits for identifying and transferring the property are met.
-
The qualified indications of ownership of property are transferred to an EAT.
Written agreement.
Under a QEAA, you and the EAT must enter into a written agreement no later than 5 business days after the qualified
indications of ownership
(discussed later) are transferred to the EAT. The agreement must provide all the following.
-
The EAT is holding the property for your benefit in order to facilitate an exchange under the like-kind exchange rules and
Revenue Procedure
2000-37, as modified by Revenue Procedure 2004-51.
-
You and the EAT agree to report the acquisition, holding, and disposition of the property on your federal income tax returns
in a manner
consistent with the agreement.
-
The EAT will be treated as the beneficial owner of the property for all federal income tax purposes.
Property can be treated as being held in a QEAA even if the accounting, regulatory, or state, local, or foreign tax
treatment of the arrangement
between you and the EAT is different from the treatment required by the list above.
Bona fide intent.
When the qualified indications of ownership of the property are transferred to the EAT, it must be your bona fide
intent that the property held by
the EAT represents either replacement property or relinquished property in an exchange intended to qualify for nonrecognition
of gain (in whole or in
part) or loss under the like-kind exchange rules.
Time limits for identifying and transferring property.
Under a QEAA, the following time limits for identifying and transferring the property must be met.
-
No later than 45 days after the transfer of qualified indications of ownership of the replacement property to the EAT; you
must identify the
relinquished property in a manner consistent with the principles for deferred exchanges. See Identification requirement earlier under
Deferred Exchange.
-
One of the following transfers must take place no later than 180 days after the transfer of qualified indications of ownership
of the
property to the EAT.
-
The replacement property is transferred to you (either directly or indirectly through a qualified intermediary, defined earlier
under
Like-Kind Exchanges Using Qualified Intermediaries).
-
The relinquished property is transferred to a person other than you or a disqualified person. A disqualified person is either
of the
following.
-
Your agent at the time of the transaction. This includes a person who has been your employee, attorney, accountant, investment
banker or
broker, or real estate agent or broker within the 2-year period before the transfer of the relinquished property.
-
A person who is related to you or your agent under the rules discussed in chapter 2 under Nondeductible Loss, substituting
“10%” for “50%.”
-
The combined time period the relinquished property and replacement property are held in the QEAA cannot be longer than 180
days.
Exchange accommodation titleholder (EAT).
The EAT must meet all the following requirements.
-
Hold qualified indications of ownership (defined next) at all times from the date of acquisition of the property until the
property is
transferred (as described in (2), earlier).
-
Be someone other than you or a disqualified person (as defined in 2(b), earlier).
-
Be subject to federal income tax. If the EAT is treated as a partnership or S corporation, more than 90% of its interests
or stock must be
owned by partners or shareholders who are subject to federal income tax.
Qualified indications of ownership.
Qualified indications of ownership are any of the following.
-
Legal title to the property.
-
Other indications of ownership of the property that are treated as beneficial ownership of the property under principles of
commercial law
(for example, a contract for deed).
-
Interests in an entity that is disregarded as an entity separate from its owner for federal income tax purposes (for example,
a single
member limited liability company) and that holds either legal title to the property or other indications of ownership.
Other permissible arrangements.
Property will not fail to be treated as being held in a QEAA as a result of certain legal or contractual arrangements,
regardless of whether the
arrangements contain terms that typically would result from arm's-length bargaining between unrelated parties for those arrangements.
For a list of
those arrangements, see Revenue Procedure 2000-37 in Internal Revenue Bulletin 2000-40.
Partially Nontaxable Exchanges
If, in addition to like-kind property, you receive money or unlike property in an exchange on which you realize a gain, you
have a partially
nontaxable exchange. You are taxed on the gain you realize, but only to the extent of the money and the fair market value
of the unlike property you
receive.
A loss is never deductible in a nontaxable exchange in which you receive unlike property or cash.
Figuring taxable gain.
To figure the taxable gain, first determine the fair market value of any unlike property you receive and add it to
any money you receive. Reduce
that total by any exchange expenses (closing costs) you paid. The result is the maximum gain that can be taxed. Next, figure
the gain on the whole
exchange as discussed earlier under Gain or Loss From Sales and Exchanges. Your recognized (taxable) gain is the lesser of these two
amounts.
Example.
You exchange real estate held for investment with an adjusted basis of $8,000 for other real estate you want to hold for investment.
The fair
market value of the real estate you receive is $10,000. You also receive $1,000 in cash. You paid $500 in exchange expenses.
Although the total gain
realized on the transaction is $2,500, only $500 ($1,000 cash received minus the $500 exchange expenses) is recognized (included
in your income).
Assumption of liabilities.
If the other party to a nontaxable exchange assumes any of your liabilities, you will be treated as if you received
cash in the amount of the
liability. For more information on the assumption of liabilities, see section 357(d) of the Internal Revenue Code.
Example.
The facts are the same as in the previous example, except the property you give up is subject to a $3,000 mortgage for which
you were personally
liable. The other party in the trade has agreed to pay off the mortgage. Figure the gain realized as follows.
The realized gain is taxed only up to $3,500, the sum of the cash received ($1,000 - $500 exchange expenses) and the mortgage
($3,000).
Unlike property given up.
If, in addition to like-kind property, you give up unlike property, you must recognize gain or loss on the unlike
property you give up. The gain or
loss is equal to the difference between the fair market value of the unlike property and the adjusted basis of the unlike
property.
Example.
You exchange stock and real estate you held for investment for real estate you also intend to hold for investment. The stock
you transfer has a
fair market value of $1,000 and an adjusted basis of $4,000. The real estate you exchange has a fair market value of $19,000
and an adjusted basis of
$15,000. The real estate you receive has a fair market value of $20,000. You do not recognize gain on the exchange of the
real estate because it
qualifies as a nontaxable exchange. However, you must recognize (report on your return) a $3,000 loss on the stock because
it is unlike property.
Basis of property received.
The total basis for all properties (other than money) you receive in a partially nontaxable exchange is the total
adjusted basis of the properties
you give up, with the following adjustments.
-
Add both the following amounts.
-
Any additional costs you incur.
-
Any gain you recognize on the exchange.
-
Subtract both the following amounts.
-
Any money you receive.
-
Any loss you recognize on the exchange.
Allocate this basis first to the unlike property, other than money, up to its fair market value on the date of the exchange.
The rest is the
basis of the like-kind property.
Multiple Property Exchanges
Under the like-kind exchange rules, you generally must make a property-by-property comparison to figure your recognized gain
and the basis of the
property you receive in the exchange. However, for exchanges of multiple properties, you do not make a property-by-property
comparison if you do
either of the following.
In these situations, you figure your recognized gain and the basis of the property you receive by comparing the properties
within each exchange
group.
Exchange groups.
Each exchange group consists of properties transferred and received in the exchange that are of like kind or like
class. (See Like-Kind
Property, earlier.) If property could be included in more than one exchange group, you can include it in any one of those groups. However,
the
following may not be included in an exchange group.
-
Money.
-
Stock in trade or other property held primarily for sale.
-
Stocks, bonds, notes, or other securities or evidences of debt or interest.
-
Interests in a partnership.
-
Certificates of trust or beneficial interests.
-
Choses in action.
Example.
Ben exchanges computer A (asset class 00.12), automobile A (asset class 00.22), and truck A (asset class 00.241) for computer
R (asset class
00.12), automobile R (asset class 00.22), truck R (asset class 00.241), and $400. All properties transferred were used in
Ben's business. Similarly,
all properties received will be used in his business.
The first exchange group consists of computers A and R, the second exchange group consists of automobiles A and R, and the
third exchange group
consists of trucks A and R.
Treatment of liabilities.
Offset all liabilities you assume as part of the exchange against all liabilities of which you are relieved. Offset
these liabilities whether they
are recourse or nonrecourse and regardless of whether they are secured by or otherwise relate to specific property transferred
or received as part of
the exchange.
If you assume more liabilities than you are relieved of, allocate the difference among the exchange groups in proportion
to the total fair market
value of the properties you received in the exchange groups. The difference allocated to each exchange group may not be more
than the total fair
market value of the properties you received in the exchange group.
The amount of the liabilities allocated to an exchange group reduces the total fair market value of the properties
received in that exchange group.
This reduction is made in determining whether the exchange group has a surplus or a deficiency. (See Exchange group surplus and deficiency,
later.) This reduction is also made in determining whether a residual group is created. (See Residual group, later.)
If you are relieved of more liabilities than you assume, treat the difference as cash, general deposit accounts (other
than certificates of
deposit), and similar items when making allocations to the residual group, discussed later.
The treatment of liabilities and any differences between amounts you assume and amounts you are relieved of will be
the same even if the like-kind
exchange treatment applies to only part of a larger transaction. If so, determine the difference in liabilities based on all
liabilities you assume or
are relieved of as part of the larger transaction.
Example.
The facts are the same as in the preceding example. In addition, the fair market value of and liabilities secured by each
property are as follows.
All liabilities assumed by Ben ($1,000) are offset by all liabilities of which he is relieved ($500), resulting in a difference
of $500. The
difference is allocated among Ben's exchange groups in proportion to the fair market value of the properties received in the
exchange groups as
follows.
-
$131 ($500 × $1,600 ÷ $6,100) is allocated to the first exchange group (computers A and R). The fair market value of computer
R
is reduced to $1,469 ($1,600 - $131).
-
$254 ($500 × $3,100 ÷ $6,100) is allocated to the second exchange group (automobiles A and R). The fair market value of
automobile R is reduced to $2,846 ($3,100 - $254).
-
$115 ($500 × $1,400 ÷ $6,100) is allocated to the third exchange group (trucks A and R). The fair market value of truck R
is
reduced to $1,285 ($1,400 - $115).
In each exchange group, Ben uses the reduced fair market value of the properties received to figure the exchange group's surplus
or deficiency
and to determine whether a residual group has been created.
Residual group.
A residual group is created if the total fair market value of the properties transferred in all exchange groups differs
from the total fair market
value of the properties received in all exchange groups after taking into account the treatment of liabilities (discussed
earlier). The residual group
consists of money or other property that has a total fair market value equal to that difference. It consists of either money
or other property
transferred in the exchange or money or other property received in the exchange, but not both.
Other property includes the following items.
-
Stock in trade or other property held primarily for sale.
-
Stocks, bonds, notes, or other securities or evidences of debt or interest.
-
Interests in a partnership.
-
Certificates of trust or beneficial interests.
-
Choses in action.
Other property also includes property transferred that is not of a like kind or like class with any property received, and
property received
that is not of a like kind or like class with any property transferred.
For asset acquisitions occurring after March 15, 2001, money and properties allocated to the residual group are considered
to come from the
following assets in the following order.
-
Cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). Also, include
here excess
liabilities of which you are relieved over the amount of liabilities you assume.
-
Certificates of deposit, U.S. Government securities, foreign currency, and actively traded personal property, including stock
and
securities.
-
Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes.
However,
see section 1.338-6(b)(2)(iii) of the regulations for exceptions that apply to debt instruments issued by persons related
to a target corporation,
contingent debt instruments, and debt instruments convertible into stock or other property.
-
Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by
the taxpayer
primarily for sale to customers in the ordinary course of business.
-
Assets other than those listed in (1), (2), (3), (4), (6), and (7).
-
All section 197 intangibles except goodwill and going concern value.
-
Goodwill and going concern value.
Within each category, you can choose which properties to allocate to the residual group. If an asset described in any of the
categories above,
except (1), is includible in more than one category, include it in the lower number category. For example, if an asset is
described in both (3) and
(4), include it in (3).
Example.
Fran exchanges computer A (asset class 00.12) and automobile A (asset class 00.22) for printer B (asset class 00.12), automobile
B (asset class
00.22), corporate stock, and $500. Fran used computer A and automobile A in her business and will use printer B and automobile
B in her business.
This transaction results in two exchange groups: (1) computer A and printer B, and (2) automobile A and automobile B.
The fair market values of the properties are as follows.
The total fair market value of the properties transferred in the exchange groups ($5,000) is $1,250 more than the total fair
market value of
the properties received in the exchange groups ($3,750), so there is a residual group in that amount. It consists of the $500
cash and the $750 worth
of corporate stock.
Exchange group surplus and deficiency.
For each exchange group, you must determine whether there is an “ exchange group surplus” or “ exchange group deficiency.” An exchange
group surplus is the total fair market value of the properties received in an exchange group (minus any excess liabilities
you assume that are
allocated to that exchange group) that is more than the total fair market value of the properties transferred in that exchange
group. An exchange
group deficiency is the total fair market value of the properties transferred in an exchange group that is more than the total
fair market value of
the properties received in that exchange group (minus any excess liabilities you assume that are allocated to that exchange
group).
Example.
Karen exchanges computer A (asset class 00.12) and automobile A (asset class 00.22), both of which she used in her business,
for printer B (asset
class 00.12) and automobile B (asset class 00.22), both of which she will use in her business. Karen's adjusted basis and
the fair market value of the
exchanged properties are as follows.
The first exchange group consists of computer A and printer B. It has an exchange group surplus of $1,050 because the fair
market value of
printer B ($2,050) is more than the fair market value of computer A ($1,000) by that amount.
The second exchange group consists of automobile A and automobile B. It has an exchange group deficiency of $1,050 because
the fair market value of
automobile A ($4,000) is more than the fair market value of automobile B ($2,950) by that amount.
Recognized gain.
Gain or loss realized for each exchange group and the residual group is the difference between the total fair market
value of the transferred
properties in that exchange group or residual group and the total adjusted basis of the properties. For each exchange group,
recognized gain is the
lesser of the gain realized or the exchange group deficiency (if any). Losses are not recognized for an exchange group. The
total gain recognized on
the exchange of like-kind or like-class properties is the sum of all the gain recognized for each exchange group.
For a residual group, you must recognize the entire gain or loss realized.
For properties you transfer that are not within any exchange group or the residual group, figure realized and recognized
gain or loss as explained
under Gain or Loss From Sales and Exchanges, earlier.
Example.
Based on the facts in the previous example, Karen recognizes gain on the exchange as follows.
For the first exchange group, the gain realized is the fair market value of computer A ($1,000) minus its adjusted basis ($375),
or $625. The gain
recognized is the lesser of the gain realized, $625, or the exchange group deficiency, $-0-.
For the second exchange group, the gain realized is the fair market value of automobile A ($4,000) minus its adjusted basis
($1,500), or $2,500.
The gain recognized is the lesser of the gain realized, $2,500, or the exchange group deficiency, $1,050.
The total gain recognized by Karen in the exchange is the sum of the gains recognized with respect to both exchange groups
($-0- + $1,050), or
$1,050.
Basis of properties received.
The total basis of properties received in each exchange group is the sum of the following amounts.
-
The total adjusted basis of the transferred properties within that exchange group.
-
Your recognized gain on the exchange group.
-
The excess liabilities you assume that are allocated to the group.
-
The exchange group surplus (or minus the exchange group deficiency).
You allocate the total basis of each exchange group proportionately to each property received in the exchange group according
to the property's
fair market value.
The basis of each property received within the residual group (other than money) is equal to its fair market value.
Example.
Based on the facts in the two previous examples, the bases of the properties received by Karen in the exchange, printer B
and automobile B, are
determined in the following manner.
The basis of the property received in the first exchange group is $1,425. This is the sum of the following amounts.
-
Adjusted basis of the property transferred within that exchange group ($375).
-
Gain recognized for that exchange group ($-0-).
-
Excess liabilities assumed allocated to that exchange group ($-0-).
-
Exchange group surplus ($1,050).
Printer B is the only property received within the first exchange group, so the entire basis of $1,425 is allocated to printer
B.
The basis of the property received in the second exchange group is $1,500. This is figured as follows.
First, add the following amounts.
-
Adjusted basis of the property transferred within that exchange group ($1,500).
-
Gain recognized for that exchange group ($1,050).
-
Excess liabilities assumed allocated to that exchange group ($-0-).
Then subtract the exchange group deficiency ($1,050).
Automobile B is the only property received within the second exchange group, so the entire basis ($1,500) is allocated to
automobile B.
Like-Kind Exchanges Between Related Persons
Special rules apply to like-kind exchanges between related persons. These rules affect both direct and indirect exchanges.
Under these rules, if
either person disposes of the property within 2 years after the exchange, the exchange is disqualified from nonrecognition
treatment. The gain or loss
on the original exchange must be recognized as of the date of the later disposition.
Related persons.
Under these rules, related persons include, for example, you and a member of your family (spouse, brother, sister,
parent, child, etc.), you and a
corporation in which you have more than 50% ownership, you and a partnership in which you directly or indirectly own more
than a 50% interest of the
capital or profits, and two partnerships in which you directly or indirectly own more than 50% of the capital interests or
profits.
An exchange structured to avoid the related party rules is not a like-kind exchange. See Like-Kind Exchanges Using Qualified
Intermediaries,
earlier.
For more information on related persons, see Nondeductible Loss under Sales and Exchanges Between Related Persons in chapter
2.
Example.
You used a panel truck in your house painting business. Your sister used a pickup truck in her landscaping business. In December
2006, you
exchanged your panel truck plus $200 for your sister's pickup truck. At that time, the fair market value (FMV) of your panel
truck was $7,000 and its
adjusted basis was $6,000. The fair market value of your sister's pickup truck was $7,200 and its adjusted basis was $1,000.
You realized a gain of
$1,000 (the $7,200 fair market value of the pickup truck minus the $200 you paid minus the $6,000 adjusted basis of the panel
truck). Your sister
realized a gain of $6,200 (the $7,000 fair market value of your panel truck plus the $200 you paid minus the $1,000 adjusted
basis of the pickup
truck).
However, because this was a like-kind exchange, you recognized no gain. Your basis in the pickup truck was $6,200 (the $6,000
adjusted basis of the
panel truck plus the $200 you paid). Your sister recognized gain only to the extent of the money she received, $200. Her basis
in the panel truck was
$1,000 (the $1,000 adjusted basis of the pickup truck minus the $200 received, plus the $200 gain recognized).
In 2007, you sold the pickup truck to a third party for $7,000. You sold it within 2 years after the exchange, so the exchange
is disqualified from
nonrecognition treatment. On your 2007 tax return, you must report your $1,000 gain on the 2006 exchange. You also report
a loss on the sale of $200
(the adjusted basis of the pickup truck, $7,200 (its $6,200 basis plus the $1,000 gain recognized), minus the $7,000 realized
from the sale).
In addition, your sister must report on her 2007 tax return the $6,000 balance of her gain on the 2006 exchange. Her adjusted
basis in the panel
truck is increased to $7,000 (its $1,000 basis plus the $6,000 gain recognized).
Two-year holding period.
The 2-year holding period begins on the date of the last transfer of property that was part of the like-kind exchange.
If the holder's risk of loss
on the property is substantially diminished during any period, however, that period is not counted toward the 2-year holding
period. The holder's risk
of loss on the property is substantially diminished by any of the following events.
-
The holding of a put on the property.
-
The holding by another person of a right to acquire the property.
-
A short sale or other transaction.
A put is an option that entitles the holder to sell property at a specified price at any time before a specified future
date.
A short sale involves property you generally do not own. You borrow the property to deliver to a buyer and, at a later
date, buy substantially
identical property and deliver it to the lender.
Exceptions to the rules for related persons.
The following kinds of property dispositions are excluded from these rules.
-
Dispositions due to the death of either related person.
-
Involuntary conversions.
-
Dispositions if it is established to the satisfaction of the IRS that neither the exchange nor the disposition had as a main
purpose the
avoidance of federal income tax.
Other Nontaxable Exchanges
The following discussions describe other exchanges that may not be taxable.
Exchanges of partnership interests do not qualify as nontaxable exchanges of like-kind property. This applies regardless of
whether they are
general or limited partnership interests or are interests in the same partnership or different partnerships. However, under
certain circumstances the
exchange may be treated as a tax-free contribution of property to a partnership. See Publication 541, Partnerships.
An interest in a partnership that has a valid election to be excluded from being treated as a partnership for federal tax
purposes is treated as an
interest in each of the partnership assets and not as a partnership interest. See Publication 541.
U.S. Treasury Notes or Bonds
Certain issues of U.S. Treasury obligations may be exchanged for certain other issues designated by the Secretary of the Treasury
with no gain or
loss recognized on the exchange. See U.S. Treasury Bills, Notes, and Bonds under Interest Income in Publication 550 for more
information on the tax treatment of income from these investments.
For other information on these notes and bonds, call the Bureau of the Public Debt at 1-800-722-2678 (Legacy Treasury Direct).
Or, visit
www.publicdebt.treas.gov on the Internet.
Insurance Policies and Annuities
No gain or loss is recognized if you make any of the following exchanges.
-
A life insurance contract for another or for an endowment or annuity contract.
-
An endowment contract for an annuity contract or for another endowment contract providing for regular payments beginning at
a date not later
than the beginning date under the old contract.
-
One annuity contract for another if the insured or annuitant remains the same.
-
A portion of an annuity contract for a new annuity contract if the insured or annuitant remains the same.
If you realize a gain on the exchange of an endowment contract or annuity contract for a life insurance contract or an exchange
of an annuity
contract for an endowment contract, you must recognize the gain.
For information on transfers and rollovers of employer-provided annuities, see Publication 575, Pension and Annuity Income,
or Publication 571,
Tax-Sheltered Annuity Plans (403(b) Plans).
Cash received.
The nonrecognition and nontaxable transfer rules do not apply to a rollover in which you receive cash proceeds from
the surrender of one policy and
invest the cash in another policy. However, you can treat a cash distribution and reinvestment as meeting the nonrecognition
or nontaxable transfer
rules if all the following requirements are met.
-
When you receive the distribution, the insurance company that issued the policy or contract is subject to a rehabilitation,
conservatorship,
insolvency, or similar state proceeding.
-
You withdraw all amounts to which you are entitled or, if less, the maximum permitted under the state proceeding.
-
You reinvest the distribution within 60 days after receipt in a single policy or contract issued by another insurance company
or in a single
custodial account.
-
You assign all rights to future distributions to the new issuer for investment in the new policy or contract if the distribution
was
restricted by the state proceeding.
-
You would have qualified under the nonrecognition or nontaxable transfer rules if you had exchanged the affected policy or
contract for the
new one.
If you do not reinvest all of the cash distribution, the rules for partially nontaxable exchanges, discussed earlier, apply.
In addition to meeting these five requirements, you must do both the following.
-
Give to the issuer of the new policy or contract a statement that includes all the following information.
-
The gross amount of cash distributed.
-
The amount reinvested.
-
Your investment in the affected policy or contract on the date of the initial cash distribution.
-
Attach the following items to your timely filed tax return for the year of the initial distribution.
-
A statement titled “Election under Rev. Proc. 92-44” that includes the name of the issuer and the policy number (or similar identifying
number) of the new policy or contract.
-
A copy of the statement given to the issuer of the new policy or contract.
Property Exchanged for Stock
If you transfer property to a corporation in exchange for stock in that corporation (other than nonqualified preferred stock,
described later), and
immediately afterward you are in control of the corporation, the exchange is usually not taxable. This rule applies both to
individuals and to groups
who transfer property to a corporation. It does not apply in the following situations.
-
The corporation is an investment company.
-
You transfer the property in a bankruptcy or similar proceeding in exchange for stock used to pay creditors.
-
The stock is received in exchange for the corporation's debt (other than a security) or for interest on the corporation's
debt (including a
security) that accrued while you held the debt.
Control of a corporation.
To be in control of a corporation, you or your group of transferors must own, immediately after the exchange, at least
80% of the total combined
voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes
of stock of the corporation.
The control requirement can be met even though there are successive transfers of property and stock. For more information,
see Revenue Ruling
2003-51 in Internal Revenue Bulletin 2003-21.
Example 1.
You and Bill Jones buy property for $100,000. You both organize a corporation when the property has a fair market value of
$300,000. You transfer
the property to the corporation for all its authorized capital stock, which has a par value of $300,000. No gain is recognized
by you, Bill, or the
corporation.
Example 2.
You and Bill transfer the property with a basis of $100,000 to a corporation in exchange for stock with a fair market value
of $300,000. This
represents only 75% of each class of stock of the corporation. The other 25% was already issued to someone else. You and Bill
recognize a taxable gain
of $200,000 on the transaction.
Services rendered.
The term property does not include services rendered or to be rendered to the issuing corporation. The value of stock
received for services is
income to the recipient.
Example.
You transfer property worth $35,000 and render services valued at $3,000 to a corporation in exchange for stock valued at
$38,000. Right after the
exchange, you own 85% of the outstanding stock. No gain is recognized on the exchange of property. However, you recognize
ordinary income of $3,000 as
payment for services you rendered to the corporation.
Property of relatively small value.
The term property does not include property of a relatively small value when it is compared to the value of stock
and securities already owned or
to be received for services by the transferor if the main purpose of the transfer is to qualify for the nonrecognition of
gain or loss by other
transferors.
Property transferred will not be considered to be of relatively small value if its fair market value is at least 10%
of the fair market value of
the stock and securities already owned or to be received for services by the transferor.
Stock received in disproportion to property transferred.
If a group of transferors exchange property for corporate stock, each transferor does not have to receive stock in
proportion to his or her
interest in the property transferred. If a disproportionate transfer takes place, it will be treated for tax purposes in accordance
with its true
nature. It may be treated as if the stock were first received in proportion and then some of it used to make gifts, pay compensation
for services, or
satisfy the transferor's obligations.
Money or other property received.
If, in an otherwise nontaxable exchange of property for corporate stock, you also receive money or property other
than stock, you may have to
recognize gain. You must recognize gain only up to the amount of money plus the fair market value of the other property you
receive. The rules for
figuring the recognized gain in this situation generally follow those for a partially nontaxable exchange discussed earlier
under Like-Kind
Exchanges. If the property you give up includes depreciable property, the recognized gain may have to be reported as ordinary income
from
depreciation. See chapter 3. No loss is recognized.
Nonqualified preferred stock.
Nonqualified preferred stock is treated as property other than stock. Generally, it is preferred stock with any of
the following features.
-
The holder has the right to require the issuer or a related person to redeem or buy the stock.
-
The issuer or a related person is required to redeem or buy the stock.
-
The issuer or a related person has the right to redeem or buy the stock and, on the issue date, it is more likely than not
that the right
will be exercised.
-
The dividend rate on the stock varies with reference to interest rates, commodity prices, or similar indices.
For a detailed definition of nonqualified preferred stock, see section 351(g)(2) of the Internal Revenue Code.
Liabilities.
If the corporation assumes your liabilities, the exchange generally is not treated as if you received money or other
property. There are two
exceptions to this treatment.
-
If the liabilities the corporation assumes are more than your adjusted basis in the property you transfer, gain is recognized
up to the
difference. However, if the liabilities assumed give rise to a deduction when paid, such as a trade account payable or interest,
no gain is
recognized.
-
If there is no good business reason for the corporation to assume your liabilities, or if your main purpose in the exchange
is to avoid
federal income tax, the assumption is treated as if you received money in the amount of the liabilities.
For more information on the assumption of liabilities, see section 357(d) of the Internal Revenue Code.
Example.
You transfer property to a corporation for stock. Immediately after the transfer, you control the corporation. You also receive
$10,000 in the
exchange. Your adjusted basis in the transferred property is $20,000. The stock you receive has a fair market value (FMV)
of $16,000. The corporation
also assumes a $5,000 mortgage on the property for which you are personally liable. Gain is realized as follows.
The liability assumed is not treated as money or other property. The recognized gain is limited to $10,000, the cash
received.
No gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or
a former spouse if
incident to divorce. This rule does not apply to the following.
-
The recipient of the transfer is a nonresident alien.
-
A transfer in trust to the extent the liabilities assumed and the liabilities on the property are more than the property's
adjusted
basis.
-
A transfer of certain stock redemptions, as discussed in section 1.1041-2 of the regulations.
Any transfer of property to a spouse or former spouse on which gain or loss is not recognized is treated by the recipient
as a gift and is not
considered a sale or exchange. The recipient's basis in the property will be the same as the adjusted basis of the property
to the giver immediately
before the transfer. This carryover basis rule applies whether the adjusted basis of the transferred property is less than,
equal to, or greater than
either its fair market value at the time of transfer or any consideration paid by the recipient. This rule applies for determining
loss as well as
gain. Any gain recognized on a transfer in trust increases the basis.
For more information on transfers to a spouse, see Property Settlements in Publication 504, Divorced or Separated Individuals.
Rollover of Gain From Publicly Traded Securities
You can elect to roll over a capital gain from the sale of publicly traded securities (securities traded on an established
securities market) into
a specialized small business investment company (SSBIC). If you make this election, the gain from the sale is recognized only
to the extent the amount
realized is more than the cost of the SSBIC common stock or partnership interest bought during the 60-day period beginning
on the date of the sale
(and did not previously take into account on an earlier sale of publicly traded securities). You must reduce your basis in
the SSBIC stock or
partnership interest by the gain not recognized.
The gain that can be rolled over during any tax year is limited. For individuals, the limit is the lesser of the following
amounts.
-
$50,000 ($25,000 for married individuals filing separately).
-
$500,000 ($250,000 for married individuals filing separately) minus the gain rolled over in all earlier tax years.
For more information, see chapter 4 of Publication 550.
For C corporations, the limit is the lesser of the following amounts.
Sales of Small Business Stock
If you sell qualified small business stock, you may be able to roll over your gain tax free or exclude part of the gain from
your income. Qualified
small business stock is stock originally issued by a qualified small business after August 10, 1993, that meets all 7 tests
listed in chapter 4 of
Publication 550.
Rollover of gain.
You can elect to roll over a capital gain from the sale of qualified small business stock held longer than 6 months
into other qualified small
business stock. This election is not allowed to C corporations. If you make this election, the gain from the sale generally
is recognized only to the
extent the amount realized is more than the cost of the replacement qualified small business stock bought within 60 days of
the date of sale. You must
reduce your basis in the replacement qualified small business stock by the gain not recognized.
Exclusion of gain.
You may be able to exclude from your gross income 50% of your gain from the sale or exchange of qualified small business
stock you held more than 5
years. This exclusion is not allowed to C corporations. Different rules apply when the stock is held by a partnership, S corporation,
regulated
investment company, or common trust fund.
Your gain from the stock of any one issuer that is eligible for the exclusion is limited to the greater of the following
amounts.
-
Ten times your basis in all qualified stock of the issuer you sold or exchanged during the year.
-
$10 million ($5 million for married individuals filing separately) minus the gain from the stock of the same issuer you used
to figure your
exclusion in earlier years.
More information.
For more information on sales of small business stock, see chapter 4 of Publication 550.
Rollover of Gain From Sale of Empowerment Zone Assets
You may qualify for a tax-free rollover of certain gains from the sale of qualified empowerment zone assets. This means that
if you buy certain
replacement property and make the election described in this section, you postpone part or all of the recognition of your
gain.
You can make this election if you meet all the following tests.
-
You hold a qualified empowerment zone asset for more than 1 year and sell it at a gain.
-
Your gain from the sale is a capital gain.
-
During the 60-day period beginning on the date of the sale, you buy a replacement qualified empowerment zone asset in the
same zone as the
asset sold.
Any part of the gain that is ordinary income cannot be postponed and must be recognized.
Qualified empowerment zone asset.
This means certain stock or partnership interests in an enterprise zone business. It also includes certain tangible
property used in an enterprise
zone business. You must have acquired the asset after December 21, 2000.
Amount of gain recognized.
If you make the election described in this section, the gain on the sale is generally recognized only to the extent,
if any, that the amount
realized on the sale exceeds the cost of the qualified empowerment zone asset that you bought during the 60-day period beginning
on the date of sale
(and did not previously take into account in rolling over gain on an earlier sale of qualified empowerment zone assets).
If this amount is equal to or more than the amount of your gain, you must recognize the full amount of your gain.
If this amount is less than the
amount of your gain, you can postpone the rest of your gain by adjusting the basis of your replacement property as described
next.
Basis of replacement property.
You must subtract the amount of postponed gain from the basis of the qualified empowerment zone assets you bought
as replacement property.
More information.
For more information about empowerment zones, see Publication 954, Tax Incentives for Distressed Communities. For
more information about this
rollover of gain, see the Instructions for Form 4797 and Schedule D (Form 1040). Also, see section 1397B of the Internal Revenue
Code.
Exclusion of Gain From Sale of DC Zone Assets
If you sold or exchanged a District of Columbia Enterprise Zone (DC Zone) asset that you held for more than 5 years, you may
be able to exclude the
“qualified capital gain.” The qualified gain is, generally, any gain recognized in a trade or business that you would otherwise include on Form
4797, Part I. This exclusion also applies to an interest in, or property of, certain businesses operating in the District
of Columbia.
DC Zone asset.
A DC Zone asset is any of the following.
Qualified capital gain.
The qualified capital gain is any gain recognized on the sale or exchange of a DC Zone asset that is a capital asset
or property used in a trade or
business. It does not include any of the following gains.
-
Gain treated as ordinary income under section 1245;
-
Gain treated as unrecaptured section 1250 gain. The section 1250 gain must be figured as if it applied to all depreciation
rather than the
additional depreciation;
-
Gain attributable to real property, or an intangible asset, which is not an integral part of a DC Zone business; and
-
Gain from a related-party transaction. See Sales and Exchanges Between Related Persons in chapter 2.
See Publication 954 and section 1400B for more details on DC Zone assets and special rules.
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