Nontaxable Exchanges

1
Chapter 15

• Nontaxable Exchanges
• Note Read all relevant examples

2
Nontaxable Exchanges Summary
Section
Action
Elective or Mandatory
121
Exclusion of gain from sale
Mandatory
of personal residence
1031
Deferral of gain or loss on
Mandatory
like-kind exchange
1033
Defers gain on involuntary
a) Mandatory for direct
conversions
conversions
b) Elective for indirect
conversions
3
Section 121 Exclusion of 250,000 (500,000
MFJ) of Gain on Sale of Personal Residence

• Purpose of Sec. 121
• To exclude 250,000 (500,000 MFJ) of gains on
  sale of a personal residence
• Eligibility
• TP must own and occupy home as principal
  residence for at least 2 of 5 prior years.
• The full exclusion is available only if TP has
  not utilized exclusion in previous two years.

A partial exclusion is allowed if TP moves for
employment, health, or other unexpected
circumstances.
of months req. are met 24 months
Partial exc. Full exc. x
4
Section 121 Example

• S (Single TP) sells her home and realizes a
  125,000 gain. S, who is moving to a new state
  to take a new job, has owned the home for only 9
  months.

S may exclude 93,750 of her realized gain.
250,000 x 9 months 24 months
93,750
5
Section 121Special Rule for Depreciation

• If depreciation was recognized on home (home
  office or rental for example) gains must be
  recaptured up to amount of depreciation taken
  before the Sec. 121 exclusions, as per Sec. 1245
  depreciation recapture rules.

6
Section 1031Like-Kind Exchanges - Boot

• Mandatory deferred gain or loss on exchange of
  business/investment property
• To qualify, property must be like-kind
• Real estate can be exchanged for real estate
• For personalty, property exchanged must be in
  same General Asset Class or Product Class for
  safe-harbor
• Traditionally, personalty-for-personalty
  qualifies
• Section 1031 excludes inventories, stocks,
  bonds, notes, interest in P/Ss

7
Section 1031Like-Kind Exchanges with Boot

• When boot is received in a like-kind exchange
• Recognize as income lesser of boot received or
  gain realized
• No loss is recognized when boot is received
• Paying boot causes recognition of G or L if the
  boot is not qualifying property
• Boot - cash, nonqualifying property, not like
  kind property

8
Like-Kind Exchange of Mortgaged Property

• X-chg. of mortgaged property
• treat as x-chg involving boot -- TP who is
  relieved of mortgage treated as having received
  cash in amount of mortgage
• if both properties x-chgd are mortgaged, treat
  difference in mortgages as boot
• Realized losses on Sec. 1031 exchanges are not
  recognized
• Basis of property received is adjusted by
• subtracting deferred gains
• adding deferred losses
• Exhibit 15-4

9
Like-Kind Exchanges - Timing

• Timing
• simultaneous exchange required
• simultaneous IF
• Prop. to be recd in the exchange is identified
  w/in 45 days after TP gives up his/her property
  and
• Incoming property is actually recd w/in 180 days
  after TP transfers property out, or by the date
  of the tax return (including extensions), which
  ever is earlier

10
Like-Kind Exchange Between Related Parties

• Deferral of G not allowed if a related person
  (Sec. 267) contributes exchange property, when G
  10,000
• Any gain that is deferred on exchange between
  related persons is recognized if exchanged
  property is sold within two years of the exchange

11
Basis of Property Recd inSec. 1031 Exchange
Method 1 Adj. Basis of Property Given Up

• Less
• Boot recd
• Liabilities assumed by transferee (notes
  receivable to transferor)
• Liabilities encumbering property transferred out

• Plus
• Gain recognized
• Boot paid (cash or property)
• Liabilities assumed by TP
• Liabilities encumbering property recd

Equals Basis of property received
12
Basis of Property Recd inSec. 1031 Exchange
Method 2 FMV of Like-kind Property Received

• Less Gain deferred
• Plus Realized loss deferred
• Equals Basis of property received

13
Section 1033Involuntary Conversions

• General Rule If property (as a result of its
  destruction in whole or in part, theft, seizure,
  or requisition or condemnation or threat or
  imminence thereof) is compulsorily or
  involuntarily converted into property similar or
  related in service or use to the property so
  converted, no gain shall be recognized.

• Note
• Sec. 1033 defers gains only losses must be
  recognized
• No suddenness test required
• Generally, casualty losses are deductible under
  Sec. 165.
• Some casualty gains may be deferred under Sec.
  1033.
• Elective deferral of gain if indirect replacement
  occurs

14
Replacement Property forInvoluntary Conversions
Must be similar or related in service or use
Test
Applies to
Rules
1. Like-kind test
Real prop. used in T/B or held for investment
which is condemned or seized
Realty for realty (same test as for Sec. 1031)
2. Taxpayer use test
Replacement prop. must be used by TP as rental
prop. regardless of lessees use
Rental properties(TP is owner-investor)
1. Character of service or use must be the
same and 2. physically the prop. must be similar
3. Functional use test
All other real and personal property
15
Timely Replacement Involuntary Conversions

• General Rule Replacement must be made by the
  last day of the second year after the year in
  which the gain is realized.

EXAMPLE Machinery destroyed by flood on 1/10/00.
Calendar year TP has until 12/31/02 to replace.

• Exception For real property used in a trade or
  business that is condemned, TP gets one
  additional year to replace.

EXAMPLE Office building seized 1/10/00.
Calendar year TP has until 12/31/03 to replace.

• Beginning Dates for Replacement Period Date of
  disposition of property, or Date of beginning of
  threat, or imminence of threat of requisition or
  condemnation.

16
Involuntary Conversions Amount of Gain Deferred
Basis Adjustments

• Recognize only the excess of the gain realized
  over the amount reinvested
• Basis Adjustments
• Direct Conversion basis carries over (no gain
  recognized)
• Indirect Conversion New Basis Cost of
  Replacement Property - Any Deferred Gain
• If loss is recognized
• New Basis Cost of Replacement