10 Property Transactions: Special Topics

Question 1

What is an installment sale?

Answer 1

A disposition of property in which at least one payment is to be received after the close of the tax year of the disposition.

Question 2

What method must be used to report installment sales?

Answer 2

The installment method, unless election is made not to apply the method

Question 3

What dispositions are excluded from installment sales?

Answer 3

• inventory personal property sales
• revolving credit personal property sales
• dealer dispositions, including dispositions of personal property of a type regularly sold by the person on the installment plan and real property held for sale to customers in the ordinary course of trade or business
• securities, generally, if public traded
• sales on agreement to establish an irrevocable escrow account

Question 4

What specific dispositions are not excluded from installment sale deferral?

Answer 4

Not excluded from installment sale deferral are certain sales of residential lots or timeshares subject to interest on the deferred tax and property used or produced in a farming business.

Question 5

How do you calculate the amount of gain to recognize?

Answer 5

The amount of realized gain to be recognized in a tax year is equal to the gross profit multiplied by the ratio of payments received in the current year divided by the total contract price.

Recognize as income payments received multiplied by the gross profit percentage

recognized gain = gross profit percentage x payments received

Question 6

How is gross profit calculated to determine recognized gain?

Answer 6

sales price - selling expenses (including debt forgiveness) - adjusted basis

The sales price is the sum of any cash received, liability relief, and installment notes from the buyer, it does not include imputed interest

Question 7

How do sellers recognize gains or losses from repossession of installment sale property?

Answer 7

The seller recognizes as gain or loss any difference between the FMV of repossessed personal property and the adjusted basis of an installment sale obligation satisfied by the repossession. If real property recognize the lesser of:

• cash and other property (FMV) received in excess of gain already recognized
• gross profit in remaining installments less repossession costs

Question 8

How is interest imposed on installment sales?

Answer 8

Interest is imposed on deferred tax on obligations from nondealer installment sales (of more than $150,000) outstanding at the close of the tax year. This interest is applied if the taxpayer has nondealer installment receivables of over $5 million at the close of the tax year from installment sales of over $150,000 that occurred during the year.

Question 9

What installment sales do not have interest applied?

Answer 9

• personal-use property
• residential lots and time shares
• property produced or used in the farming business

Question 10

How is disposition of installment obligations recognized?

Answer 10

The excess of FMV over the AB of an installment obligation is generally recognized if it is transferred. FMV is generally the amount realized. If a gift, use the face amount of the obligation. The date the installment payment is received determines the capital gains rate to be applied rather than the date the asset was sold under an installment sales contract.

Question 11

What are exceptions to recognizing excess FMV in the disposition of installment obligations?

Answer 11

Disposition of obligations by the following events can result in the transferee treating payments as the transferor would have:

• transfers to a controlled corporation
• corporate reorganizations and liquidations
• contributions to capital of, or distributions from, partnerships
• transfer between spouses incident to divorce
• transfer upon death of the obligee

Question 12

What is an anti-avoidance rule?

Answer 12

Applies to an installment sale of property to a related party. On a second disposition (by the related party transferee in the first sale), payments received must be treated as payment received by the person who made the first (installment) sale to a related party. A second disposition by gift is included, the FMV is treated as the payment. Death of the first disposition seller or buyer does not accelerate recognition.

Question 13

What is the general rule regarding realized gains?

Answer 13

The general rule is to recognize all gain realized during the tax year.

Question 14

What section of IRC determines recognizing gain or loss for like-kind exchanges (LKE)?

Answer 14

Section 1031 - defers recognizing gain or loss to the extent that real property productively used in a trade or business or held for the production of income (investment) is exchanged for property of like kind.

Question 15

What type of properties are considered like kind?

Answer 15

Properties are of like kind without regard to differences in use (business or investment), improvements (bare land or house), location (city or rural), or proximity. Examples of like-kind exchanges are an unimproved farm property for an office building, a store building for a parking lot, and investment real property for business real property.

Question 16

Can real property located within the United States be like-kind with foreign real estate?

Answer 16

No, real property located within the United States is like-kind with all other real property in the US. Foreign real estate is like-kind with other foreign real estate. But U.S. real estate and foreign real estate are not like-kind.

Question 17

What is the foreign real property exchange rule?

Answer 17

The foreign real property exchange rule does not apply to the replacement of condemned real property (Sec. 1033 involuntary conversions). 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

Question 18

What is boot?

Answer 18

Boot is all nonqualified property transferred in an exchange transaction. Boot received includes cash, net liability relief, and other nonqualified property (its FMV).

Question 19

How is gain on a like-kind exchange with boot recognized?

Answer 19

Gain is recognized equal to the lesser of gain realized or boot received.

Question 20

How is basis determined for property in like-kind exchanges?

Answer 20

AB of property given + gain recognized + boot given (cash, liability incurred, other property) - boot received (cash, liability relief, other property) + exchange fees incurred - loss recognized (boot given) = basis in acquired property

basis in property acquired is increased for gain recognized

Question 21

What does Section 1031 state about like-kind exchanges and realized gain?

Answer 21

Realized gain is usually recognized only to the extent of boot received (cash +FMV of other property + net liability relief)

Question 22

What does Section 1245 state about like-kind exchanges and realized gain?

Answer 22

Ordinary income is limited to the sum of the following:

• gain recognized
• FMV of property acquired that is not Sec 1245 property and is not included in computing the recognized gain.

Question 23

What does Section 1250 state about like-kind exchanges and realized gain?

Answer 23

Ordinary income is limited to the greater of the following:

• recognized gain
• excess of the potential Sec. 1250 ordinary income over the FMV of Sec. 1250 property received

Question 24

How is loss recognized in like-kind exchanges?

Answer 24

If some qualified property is exchanged, loss realized with respect to qualified property is not recognized, but loss on boot given may be recognized.

Question 25

What is a qualified exchange accommodation arrangement or agreement?

Answer 25

With a qualified exchange accommodation agreement, the property given up or the replacement property is transferred to a qualified intermediary (Qi), also referred to as exchange accommodation titleholder (EAT) or facilitator. The Qi is considered the beneficial owner of the property. This arrangement allows a transfer in which a taxpayer acquires replacement property before transferring relinquished property to qualify as a tax-free exchange.

Question 26

What are the requirements that must be met in a qualified exchange accommodation arrangement agreement?`

Answer 26

• time limits for identifying and transferring the property are satisfied
• a written agreement exists
• the exchange accommodation titleholder has the qualified indications of ownership of the property

Question 27

What is an involuntary conversion of property?

Answer 27

An involuntary conversion of property results from destruction, theft seizure, requisition, condemnation, or the threat of imminent requisition or condemnation. Involuntary conversions are not limited to real property.

Question 28

Under Sec. 1033 how may a taxpayer recognize gains for property that is involuntarily converted?

Answer 28

A taxpayer may elect to defer recognition of gain if property is involuntarily converted into qualified replacement property similar or related in service or use under Sec. 1033 within the replacement period. If converted to money or property that is not similar or related in service or use to the involuntarily converted property, similar or related in service or use property must be purchased within the required replacement period.

Question 29

Does Section 1033 apply to realized losses?

Answer 29

No, a loss from condemnation or requisition of a personal-use asset is not deductible. But certain casualty losses are deductible. When loss is realized, basis is determined independently of Sec. 1033.

Question 30

Under Sec 1033 rules for replacing condemned property to postpone reporting gain on the condemnation are foreign and U.S. real property considered like-kind property?

Answer 30

Yes, but under the Sec 1031 rules foreign and U.S. real property are not like-kind property.

Question 31

What does similar or related in service or use mean?

Answer 31

That the property has the qualities:

1. for an owner-user, functional similarity, meets a functional use test that requires that the property
   - have similar physical characteristics
   - be used for the same purpose
2. for an owner-investor, a close relationship to the service or use the previous property had to the investor, such that the owner-investor’s risks, management activities, services performed, etc. continue without substantial change.

Question 32

How is property held for investment or for productive use in a trade or business involuntarily converted due to a federally declared disaster treated?

Answer 32

The tangible replacement property will be deemed similar or related in service or use.

Question 33

What does section 121 provide regarding the sale of principal residence?

Answer 33

Section 121 provides an exclusion upon the sale of a principal residence. No loss may be recognized on the sale of a personal residence. A taxpayer may exclude up to $250,000 ($500,000 MFJ) of realized gain on the sale of a principal residence. The exclusion may be used only once every two years. The exclusion amount may be prorated if the use and ownership tests are not met. The exclusion is based on the ratio of months used to 24 months and is a proportion of the total exclusion.

Question 34

What are the requirements for excluding gain on the sale of principal residence under Sec 121?

Answer 34

The individual must have owned and used the residence for an aggregate of 2 of the 5 prior years.

For married taxpayers, the $500,000 exclusion is available if:
- either spouse meets the ownership requirement
- both spouses meet the use requirement
- neither spouse is ineligible for the exclusion by virtue of a sale or an exchange of a residence within the last 2 years

However, if one spouse fails to meet these requirements, the other qualifying spouse is not prevented from claiming a $250,000 exclusion

The taxpayer’s home is not eligible for the exclusion if:
- the taxpayer acquired the property through a Sec. 1031 like-kind exchange during the past 5 years
- the taxpayer is subject to expatriate tax. - the expatriation tax provision applies to U.S. citizens who have renounced their citizenship and long-term residents who have ended their U.S. resident status for federal tax purposes.