Chapter 13 - Nontaxable Exchanges Flashcards
A like-kind exchange resulting in tax deferral provides a benefit to investors by allowing the taxpayer to keep all of the cash proceeds of the sale and thus reinvest the full cash proceeds in a new property.
By not paying the tax currently, the taxpayer is indirectly borrowing at a zero percent rate from the U.S government, and hopefully generating greater returns on their investments.
The use of like-kind provisions is mandatory if applicable.
Like-Kind Exchange Section 1031
When a realization event occurs outside of the control of the taxpayer, the event is referred to as an involuntary conversion.
An involuntary conversion is the result of the destruction (complete or partial), theft, seizure, requisition or condemnation, or the sale or exchange under threat or imminence of requisition or condemnation of the taxpayer’s property. The form of the involuntary conversion may be either direct or indirect. In the direct form, the involuntarily converted property is converted directly into the replacement property (i.e., property into property). For the indirect form, the taxpayer receives money or other property (i.e., not qualifying property) which is then used to purchase the replacement property (i.e., property into money into property).
To avoid recognition of the gain on an involuntary conversion, the taxpayer must invest the proceeds in a replacement property that has a similar use to the property that was involuntarily converted.
Involuntary Conversions Section 1033
Life for:
Life
MEC
Annuity
MEC for:
MEC
Annuity
Annuity for:
Annuity
Exchanging Insurance and Annuity Products Section 1035
Under IRC Section 1041, ALL transactions between spouses or incident to a divorce result in a carry-over basis and carry-over of holding periods.
Transactions Between Spouses Incident to Divorce Section 1041
Perhaps the most widely used type of nontaxable exchange occurs when an individual sells his or her principal residence.
IRC Section 121 excludes up to $500,000 (MFJ) of the gain from the sale of a principal residence from income tax if certain requirements are met. ($250,000 single filer)
Sale of Personal Residence Section 121
Two requirements must be met.
First, the taxpayer must have owned and used the home as his principal residence for two out of the last five years (the ownership and use test).
If married filing joint, only one spouse need meet the ownership test, but both must meet the use test.
Second, to claim the exemption, the taxpayer must not have excluded gain on the sale of a principal residence within the last two years.
Section 121 Qualifications
