Like-Kind Exchanges and Involuntary Conversions Flashcards
Section 1036 and Section 1031 difference
1036 is for exchanges of securities, whereas 1031 is for property (must be same class)
non-simultaneous exchange
like-kind exchange if completed within specified time period:
-identified within 45 days after date of transfer, received/closed within earlier of 180 days (after transfer or due date for filing return); may not control proceeds of first exchange during the time in between
In order to benefit from deferral of gain, then need to bring in qualified intermediary (QI), to meet deadlines noted above, realty for realty that is used for business/income production purposes, must fulfill:
napkin rule, sum value of replacement property needs to be equal or greater of the one given up, all proceeds rule- all proceeds from sale given up needs to be used for replacement
how to avoid constructive receipt
substantial restrictions on taxpayer’s control of the receipt of funds/property
qualified escrow account
Established to pull proceeds from property given up and meet requirement of like-kind exchange rules to ensure avoidance of constructive receipt:
- Must be qualified, which means that escrow holder is not related/agent of taxpayer
- escrow agreement limits taxpayer’ right /restricts taxpayer from accessing/benefitting from escrow held in account
Basis of property received (in a nontaxable exchange)
Basis of property exchanged-boot received+gain recognized-loss recognized(when taxpayer transfers boot with basis greater than FMV)
How long must related parties hold on to like-kind property after an exchange in order for it to be considered a like-kind exchange?
Two years
Holding period for boot property received begins
day after exchange
Realized gain
Excess of amount received due to involuntary conversion including expenses and accounting for adjusted basis. Interest due to delayed proceed payments is taxed as odinary income
Recognized gain
Portion of realized gain that is over the replacement property, if replacement property is less than amount realized
Basis of replacement property
Cost minus deferred gain, holding period includes converted property if electing to defer gain
Severance damage affect on basis
Amounts received as severance damages reduce the basis of the retained property and any amount received in excess of the property’s basis is treated as gain.
Qualified replacement property
similar or related in service or use to the property so converted, must pass functional-use test. Qualifies for non-recognition of gain due to involuntary conversion
T/F: Ted owns a farm that has livestock. His livestock was destroyed due to a soil contamination caused by a chemical spill. Ted used the replacement money for other needs on the farm instead of purchasing more livestock. This is an allowable replacement of property.
True. The replacement property is modified when the proceeds from the involuntary conversion of livestock may not be reinvested in property similar or related in use to the converted livestock because of soil contamination or other environment contamination.
functional-use test
replacement property must be functionally the same as the converted property, otherwise not able to defer gain under section 1033
Replacement with like kind property
Only if real property was held for productive use in a trade/business/investment (not inventory) and is condemned or involuntarily converted as a result of a presidentially declared disaster after 1984
Taxpayer-use test
Involuntary conversion of rental property owned by an investor (greater flexibility than functional-use test)
Replacement property difference between involuntary conversions and condemnations
Can be indirect (>=80% of stock) in case of involuntary conversions, but must be like-kind property in the case of condemned real property used in trade/business/investment
Time requirements for replacement
starts after tax year of conversion: personal/business use due to converted property use: 2 years after the close of the first taxable year in which any gain is realized, 3 years if condemnation of real property used in trade/business/investment, 4 yrs if personal, federally declared disaster. Can request extension with IRS
In what cases would a taxpayer prefer taxable exchange over non-taxable like kind exchange?
-If gain is taxed as a capital gain and taxpayer has capital losses, also if gain on the exchange is recognized instead of deferred, the basis of the property received in the exchange is higher.
Blanche owns an acre of land in the Naples, Florida suburbs that she has held for investment purposes. She originally purchased the land in 1978 for $60,000 and it is now worth $250,000. Bill owns an investment in five acres of land in rural Pennsylvania. He paid $225,000 for the land that now is worth $180,000. Both parties come to terms and agree to exchange their holdings.
Bill will receive the Naples, Florida property with a basis of ______________.
Bill’s adjusted basis in the Pennsylvania property (i.e., the property exchanged) was $225,000 and there are no additional adjustments to the basis. Thus, Bill will have a $225,000 basis in the Naples, Florida property.
Property received will NOT be treated as property of a like-kind if:
the replacement property is not received on or before the day that is 180 days after the date on which the taxpayer transfers the property relinquished in the trade.
Relinquish Property Close
The exchanger has 45 days from the closing date of the relinquished property to identify the replacement property.
Company A transfers property subject to a $400,000 mortgage in a qualifying like-kind exchange for property subject to a $300,000 mortgage and $25,000 in cash.
What is the result of this transaction?
When liability is assumed (or property is taken subject to liability) in an exchange, the liability is treated as boot received by the original debtor.
In this case, the net boot received by Company A is $75,000 [$400,000 (liability assumed by B) – [$300,000 (liability assumed by A) + $25,000 (boot given)].
In an involuntary conversion, the principal requirement of the ____________ test is that the owner-investor must lease out the replacement property that is acquired.
The taxpayer-use test applies to the involuntary conversion of rental property owned by an investor. The principal requirement is that the owner-investor must lease out the replacement property that is acquired.
To qualify for non-recognition of gain treatment in an involuntary conversion, the converted property generally must be replaced within _______________ after the close of the first taxable year in which any part of the gain upon the conversion is realized.
The general rule is that the period begins with the date of disposition of the converted property and ends “two years after the close of the first taxable year in which any part of the gain upon the conversion is realized.”
The property to be received in the exchange must be identified within ____ days after the date of the transfer of the property relinquished in the exchange.
The property to be received in the exchange must be identified within 45 days after the date of the transfer of the property relinquished in the exchange.
The replacement property must be received within the earlier of 180 days, after the date the taxpayer transfers the property relinquished in the exchange or the due date for filing a return (including extensions) for the year in which the transfer of the relinquished property occurs.
The original gain or loss deferred on a qualifying like-kind exchange between related parties must be recognized if the taxpayer or the related party dispose of the property acquired in the exchange within:
Exchanges of property between related parties are not like-kind exchanges under the current law if either party disposes of the property within two years of the exchange. Any gain resulting from the original exchange is recognized in the year of the subsequent disposition.
Identify the qualifying like-kind exchange.
Real property in the U.S. for real property in Canada.
Real property in the U.S. for personal-use property in the U.S.
Real property in the U.S. for real property in the U.S.
Personal-use property in the U.S. for personal-use property in the U.S.
Under the Tax Cuts and Jobs Act (TCJA), Section 1031 now applies only to exchanges of real property and not to exchanges of personal or intangible property.
In general, IRC Section 1031 does not allow exchanges between a U.S. property and a foreign-based property. The IRC specifically states that property held in the U.S. is not of a like-kind with foreign-held property.
Donald owns a warehouse that is used in business while Gayle owns land. Donald exchanges the warehouse for the land, which will be used for business purposes. The FMV of the warehouse is $240,000 (basis $100,000) and the warehouse is subject to a mortgage of $50,000, which is assumed by Gayle. Donald receives $40,000 cash and Gayle’s land, which has a FMV of $150,000 & basis of $130,000.
What is Gayle’s recognized gain on the transaction?
Gayle has no gain to recognize. She did not receive any boot and like-kind property was exchanged.
The amount realized for Gayle is the FMV of the property received of $240,000 plus (or minus) net boot. In this transaction, Gayle has ($90,000) in net boot (i.e., ($40,000) cash to Donald and ($50,000) for the assumption of mortgage debt). $240,000 - $90,000 = $150,000 amount realized.
The realized gain is the amount realized minus the basis of the property transferred. The amount realized is $150,000, and the basis of the transferred property is $130,000. $150,000 - $130,000 = $20,000 of realized gain.
The recognized gain in a Section 1031 Like-Kind Exchange is the lesser of:
Realized gain
Boot received
Realized gain on this transaction for Gayle is $20,000 and the boot received is $0, therefore, the recognized gain is $0 (the lesser of the two).
