Chapter 12: Nontaxable Exchanges Of Property

Question 1

Most common transactions that result in nonrecognition of a realized gain or loss

Answer 1

• like-kind exchanges (section 1031)
• involuntary conversions (section 1033)
• sale of personal residence (section 121)

Question 2

Section 1031(a)

Answer 2

“No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged soly for real property of like-kind which is to be held either for productive use in a trade or business or for investment”

Question 3

Is nonrecognition of gain or loss on like-kind property elective?

Answer 3

No. If exchange is like-kind then nonrecognition of gain or loss is mandatory.

Question 4

What determines if property is “like-kind”?

Answer 4

About the character or nature (not grade or quality)

Real vs personal
And
Business/trade/investment vs personal-use

(Real property in us and outside us are not like kind exchange)

Question 5

TCJA limitation of like-kind exchange qualifications

Answer 5

After 2017 exchange of like-kind PERSONAL (not real) property no longer qualifies for nonrecognition of gain or loss

Question 6

Exchange of like-kind securities

Answer 6

Like-kind exchange rules do not apply

BUT no gain or loss is recognized if exchanging the same class of security (common stock or preferred stock) of the same corporation even if those stocks have slightly different benefits

Must be SAME class of stock and SAME corporation

Applies between two stockholders or the stockholder and the corporation

Section 1036

Question 7

Type of exchange required for like-kind exchange rules to applt

Answer 7

Must be a direct exchange. Not sale of one property and immediate purchase of another (unless transactions interdependent: such as when taxpayer sells one property to a dealer and purchases like-kind property from the same dealer)

Question 8

Three party exchanges

Answer 8

Wherein one taxpayer trades in like kind exchange with another taxpayer who sells it to a prospective buyer

If single integrated plan still considered a like-kind exchange for the first part of the exchange. Sale is still sale with gain or loss

Exchange may be nonsimultaneous

Question 9

When is a nonsimultaneous exchange treated as a like-kind exchange

Answer 9

Property to be received in exchange must be identified within 45 days after the transfer of the property relinquished in the exchange

Replacement property must be received within the earlier of 180 days after date original property relinquished or the due date for filing the return (including extensions) in the year the transfer occurs

Question 10

Boot

Answer 10

Cash and non-like-kind property given to complete a like-kind property exchange where the property values aren’t equal

Question 11

How receipt of boot changes tax treatment of like-kind exchange

Answer 11

Gain is recognized:
- to the extent of the boot received (cash or FMV of non-like-kind property)
- but limited to amount of realized gain
(So gain is lesser of boot received or realized gain)
Boot does not allow a realized loss on a nontaxable exchange to be recognized

Question 12

When a property transfer involves the transfer of a liability

Answer 12

Amount of liability assumed is considered money received/paid by taxpayer on exchange

If occurs in a like-kind exchange assumption of liability is treated as boot

Question 13

Property taken subject to liability

Answer 13

Taxpayer receiving said property is responsible for the debt only to the extent that the property could be used to pay the debt

Question 14

Basis of like-kind property received in nontaxable exchange

Answer 14

Adjusted basis of property exchanged increase by any gain recognized and reduced by any boot received or loss recognized

(Alternately: FMV - unrecognized gain or + unrecognized loss)

Question 15

What happens to realized but unrecognized gains and losses from nontaxable exchanfe

Answer 15

They are deferred because they are reflected in the basis of the property now held and will be recognized when property is actually disposed of in a taxable transaction

Question 16

Allocating basis in Like-kind exchange with multiple properties

Answer 16

Allocated in proportion to relative FMV on date of exchange

Question 17

Basis of non-like-kind property received in exchange

Answer 17

(boot)

FMV on date of exhange

Question 18

Exchanges of property between related parties

Answer 18

NOT like-kind exchanges of either party disposes of the property within two years of the exchange.

Gain resulting from original exchange recognized in year of disposition (unless from death, involuntary conversion, or non-tax avoidance purposes)

Question 19

Gain or loss on transfer of non-like-kind property

Answer 19

= difference between FMV and the adjusted basis of the non-like-kind property surrendered

(No loss recognized if it is a personal-use asset)

May recognize a loss if the FMV < basis of the non-like-kind asset even if overall transaction is an unrecognized gain

Question 20

Holding period for like-kind property received in non-taxable exchange

Answer 20

Includes holding period of the property exchanged IF the like-kind property surrendered is a capital asset or a section 1231 asset

Question 21

Holding period for any boot received in an exchange

Answer 21

Begins the day after the date of the exchange

Question 22

Gain due to involuntary conversion of property

Answer 22

Taxpayer may elect to defer recognition of the gain if qualifying replacement property is acquired within a specified time period at a cost equal or greater to the amount realized in the conversion

Question 23

When is no gain recognized on involuntary conversion

Answer 23

If property is converted into property similar or related in service or use to the property converted

Question 24

Basis for replacement property from involuntary conversion

Answer 24

Property’s cost reduced by degrees gain on conversion

Question 25

Is deferral of gain on involuntary conversion elective or mandatory

Answer 25

Elective unless property is converted directly into similar property

Question 26

Loss on involuntary conversion

Answer 26

Cannot be deferred

Question 27

Involuntary conversion of property

Answer 27

Property compulsorily or involuntarily converted into money or other property May be due to theft, seizure, requisition, condemnation, or destruction (complete or partial) of property. (inc government acquisition under eminent domain)

Question 28

Transfer of property under threat or imminence of requisition or condemnation

Answer 28

May permit a taxpayer to defer why gain from sale or exchange. but requires documentation of reasoning for sale and existence of the threat

Question 29

Sale of property under threat or reasonable belief of imminent condemnation

Answer 29

Sale counts as involuntary conversion even if not sold to governmental unit that would be condemning the property

Question 30

Destruction or sale of livestock because of disease

Answer 30

Considered involuntary conversions

Question 31

When may gain be deferred on involuntarily converted property

Answer 31

If the taxpayer makes proper replacement of the converted property within a specified period and elects to defer the gain Property acquired must have a cost equal than or greater to the amount realized from the conversion

Question 32

Realized gain on involuntary conversion

Answer 32

Any excess of the amount received on conversion (reduced by any expenses incurred to determine amount received) over the adjusted basis of the property Interest received for a delayed payment are ordinary income and not included in calculation of gain or loss

Question 33

If replacement property from involuntary conversion costs less than amount realized from conversion

Answer 33

Portion of the realized gain that is excess of the amount realized (full amount, not just gain) over cost of replacement property must be recognized

Question 34

Basis of replacement property purchased from involuntary conversion

Answer 34

= cost of replacement - any deferred gain

Question 35

Holding period of replacement property from involuntary conversion

Answer 35

ONLY IF GAIN IS DEFERRED: holding period of replacement includes holding period of converted property

Question 36

Severance damages

Answer 36

Payment to a taxpayer for the decline in value of property retained if only part of their property is condemned Considered analogous to insurance proceeds

Question 37

Tax treatment of severance damages

Answer 37

- amounts received as damages reduce the basis of the retained property - any amount received in excess of the property's basis is a gain - if severance damages used to restore retained property or replace involuntarily converted property only part not used is immediately taxed

Question 38

Qualified replacement property for property involuntarily converted

Answer 38

Must be similar or related in service or use to property converted Use functional-use test to determine Sometimes may be with like-kind property If property owned and leased may use taxpayer-use test

Question 39

Functional-use test

Answer 39

Replacement property must be functionally the same as converted property (same *use* not just same type of property)

Question 40

When may involuntarily converted property be replaced with like kind property

Answer 40

If real property held for productive use in a trade or business or for investment is condemned (Only applies for condemnations. If destroyed the must use functional use test)

Question 41

Replacement of business or investment property involuntarily converted as a result of a presidentially declared disaster

Answer 41

May replace property with any tangible property held for productive use in trade or business

Question 42

Taxpayer use test

Answer 42

Used in cases of involuntary conversion of rental property owned by an investor Owner-investor must still lease out replacement property but lessee need not use it for the same functional use

Question 43

How may taxpayers obtain replacement property

Answer 43

Generally by purchasing directly Potentially indirectly by purchasing control of a corporation (80%+ of stock) that owns the replacement property (not valid for purchase of like-kind property to replace condemned real property used in a trade or business or held for investment

Question 44

Time requirement for obtaining replacement for converted property

Answer 44

Generally within two years after the close of the taxable year in which any part of the gain is recognized (aka the year in which any proceeds from conversion are received) May be extended by obtaining permission from IRS Three years for involuntary conversion of real property held for trade or business via condemnation

Question 45

Tax treatment of gain on the sale of a principal residence after 5/6/97

Answer 45

$250,000 of gain ($500,000) MFJ is excludable. Must elect OUT of exclusion it not desired As long as residence was owned and occupied as a principal residence for at least two years of the five year period preceding three the sale or exchange

Question 46

Restrictions on excluding the gain on sale of principal residence for MFJ

Answer 46

- both meet use test - at least one meets ownership test - neither spouse is ineligible for exclusions due to the sale or exchange of a residence within the last two years

Question 47

Gain on sale of principal residence in excess of exclusion

Answer 47

A capital gain (long term or short term depending on length of ownership) BUT considered to be investment income so maybe subject to 3.8% tax on her investment income

Question 48

Loss on sale or exchange of a personal residence

Answer 48

Not deductible

Question 49

Realized gain on sale of personal residence

Answer 49

Amount realized - adjusted basis (Amount realized is reduced by selling expenses)

Question 50

Adjusted basis of personal residence

Answer 50

Original basis (depends on if purchase, gifted, or inherited) including all acquisition costs + Capital improvements + Any expenses incurred to protect the taxpayer's title

Question 51

Personal residence purchased before 1997

Answer 51

Basis of replacement residence reduced by any deferred gain from previous residence

Question 52

Restrictions on use of exclusion

Answer 52

Can only use once every two years Determined on an individual basis so may claim an exclusion even if spouse used the exclusion within past two years If spouses maintain separate principal residences exclusion available for each residence

Question 53

What determines principal residence

Answer 53

What property the taxpayer resides in a majority of the time May also consider factors like place of employment, mailing address for bills, voter registration, location of religious/club affiliations As long as property was principal residence for at least two of the last five years it qualifies. Does not have to be the most recent two years

Question 54

Circumstances when a gain on the sale of a personal residence may be excluded even if within two years of taking the eccludion

Answer 54

Part of the gain may be excluded if the sale or exchange is due to a change in employment, health, or unforseen circumstances

Question 55

Determining portion of gain excluded for sale of more than one principal residence in a two year period

Answer 55

Exclusion is the ratio of; - the shorter of: - the period during which the ownership and use tests were met during the five year period ending with the date of sale, or - the period of time after the date of the most recent prior sale or exchange for which the exclusion applied until the date of the current sale or exchange Divided by - 730 days or 24 months (depending how above is expressed) * 250,000 or 500,000 = Exclusion

Question 56

If principal residence is sold before ownership and use tests fully satisfied

Answer 56

Partial gain may be excluded if sale due to change in employment, health, or unforseen circumstances Exclusion = (days use & ownership tests met/ 730 days or 24 months) * full exclusion

Question 57

Residence owned by a deceased spouse

Answer 57

Taxpayers ownership period includes period of ownership by deceased spouse

Question 58

If taxpayer or spouse is on extended duty as member of uniformed armed services

Answer 58

Any period up to ten years during which taxpayer or spouse is on qualified official extended duty does not count towards the five year period for the ownership/use test

Question 59

Distance test for move due to change in place of employment

Answer 59

New place of employment must be at least 50 miles farther from the residence sold or exchanged than was the former place of employment If no former place of employment: distance between new place of employment and residence sold or exchanged just be at least 50 miles

Question 60

Move due to change in health

Answer 60

Need not be taxpayers health, but health of a qualified individual: must be a relative (per dependency standards) but need not be a dependent A move where the primary reason is to "obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of a disease, illness, or injury or a qualified individual"

Question 61

Unforseen circumstances

Answer 61

An event the taxpayer could not reasonably have anticipated prior to purchasing and occupying the residence Marriage or adoption not considered unforseen (may be able to argue facts and circumstances)

Question 62

Period of Nonqualified use

Answer 62

Any period that the property is not used as a principal residence after 2008 But NOT including any portion of the five year period ending on the date of sale that is after the property ceases to be used as a principal residence (so vacating before selling), nor are absences due to change in employment, health conditions, or unforseen circumstances or any period where taxpayer or taxpayer's spouse is on qualified extended duty

Question 63

Gain from the sale of a principal residence with periods of nonqualified use

Answer 63

Gains must be allocated to periods of nonqualified use based on the ration of nonqualified use to total ownership Gains allocated to the periods of nonqualified use are not excluded from income

Question 64

Gain on the sale of a personal residence that used to be business property

Answer 64

Any gain due to depreciation must be recognized, additionally must allocate gain to any period of Nonqualified use after 2008

Question 65

Gain on involuntary conversion of a personal residence

Answer 65

- may be deferred until section 1033 requirements are satisfied (use functional use test) - destruction, theft, seizure, requisition, or condemnation all treated as sale so $250,000/500,000 may be excluded from income

Question 66

Gain on involuntary conversion of personal residence if proper and timely replacement is made

Answer 66

Can exclude gains of up to $250,000/500,000 and defer the rest (Amount realized due to induced conversion is reduced by any excluded gain) Amount deferred increases basis of new residence and the holding period of the old residence is added to that or the replacement

Question 67

Loss due to condemnation of a personal residence

Answer 67

Not recognized

Question 68

Loss of personal residence due to casualty

Answer 68

Deductible amount based on casualty loss rules for non-business property

Question 69

When might a taxpayer prefer a taxable exchange to a nontaxable

Answer 69

If taxpayer has capital losses that would offset the capital gain. Basis in new property would be higher (less likely to have significant gains later) Also if taxpayer would prefer to recognize a loss may be advantageous to sell property at a loss and purchase new property as a separate transaction

Question 70

If sale and purchase transactions for like kind property done with same party

Answer 70

IRS maintains like kind exchange rules apply

Question 71

Tax treatment of sale of house used for both residence and business

Answer 71

If business conducted in separate structure: treat of sale of two structures, and may only exclude gain on residential portion If not separate: gains attributable to depreciation after May 6 1997 are not eligible for exclusion but the rest is

Question 72

How does a taxpayer elect to defer recognition of gain on involuntary conversion

Answer 72

Simply does not report the gain as income for the first year in which the gain is recognized

Question 73

If taxpayer defers gain on involuntary conversion but does not make property replacement

Answer 73

Must file amended return for the year(s) the election to defer the gain was made (Including if cost of replacement property was less then cost anticipated at time of election)

Question 74

If taxpayer does not elect to defer gain on involuntary conversion but purchases replacement property within time requred

Answer 74

Taxpayer should file a refund claim for the tax year in which the gain was recognized

Question 75

Can an election to defer gain on involuntary conversion be revoked?

Answer 75

No. Can only be amended if proper replacement isn't made or if replacement costs less than expected

Question 76

Can you change which property is designated as replacement property?

Answer 76

No

Question 77

How to report the sale of your principal residence

Answer 77

Only need to report if have gain that is not excluded. Then use schedule D (show total gain and then show amount excluded as a loss)