Section 2: Income & Assets Unit 8: Nonrecognition Property Transactions Flashcards
Section 1031 Exchange
- Only for real property, no personal property
- ‘like-kind’ & ‘tax-deferred’ exchanges
- 180 to exchange property
Section 121 Use & Ownership Tests
The IRS figures the ownership and use tests separately, and the time periods do not have to be
continuous. During the five-year period ending on the date of the sale, the taxpayer must have:
* Owned the home for at least two years (the ownership test), (either spouse if MFJ) and
* Lived in the home as their main home for at least two years (the use test). (Both spouses if MFJ)
A taxpayer meets both tests if the taxpayer owned and lived in the property as their main home for
either 24 full months or 730 days (365 × 2) during the five-year period. The required two years of
ownership and use do not have to be continuous. Further, ownership and use tests can be met during different two-year periods.
Exceptions for Section 121
Work-Related Move: This safe harbor applies if a new job is at least 50 miles farther from the
old home than was the former place of employment. If there was no former place of
employment, the distance between the new place of employment and the old home must be at
least 50 miles. Other circumstances may qualify as related to a job change even if the safe
harbor is not met based on the facts and circumstances.
* Health-Related Move: The health safe harbor applies if a doctor recommends a change of
residence for reasons of health of the taxpayer, a spouse, a child, or certain other related
persons. The related person does not have to be a dependent for the reduced exclusion to apply.
Other circumstances may qualify as related to health even if the safe harbor is not met based
on the facts and circumstances.
* Unforeseeable Events: the “unforeseen circumstances” safe harbors include the following:
o Death, divorce, or legal separation,
o Unemployment,
o Multiple births resulting from the same pregnancy,
o Damage to the residence resulting from a disaster, an act of war, or terrorism; and
o Involuntary conversion of the property or condemnation.
o Other situations may qualify as unforeseen circumstances.
The reduced exclusion amount equals the full $250,000 (or $500,000) multiplied by a fraction. The numerator is the shorter of:
* The period the taxpayer owned and used the home as a principal residence during the five-year
period ending on the sale date, or
* The period between the last sale for which the taxpayer claimed the exclusion and the sale date
for the home currently being sold.
Katherine is unmarried. She bought her principal residence for $340,000 in San Diego, CA
on January 1, 2023. Nine months later, she loses her high-paying job and could no longer afford the
mortgage payments. She sells the house for $600,000 on December 31, 2023. She has a $260,000 gain
($600,000 sale price - $340,000 basis). She owned and lived in the house exactly one year (365 days)
before selling it. Even though she only occupied the house for a year, she qualifies for the reduced
exclusion because she became unemployed. How much gain can she exclude from the sale?
Katherine can exclude $125,000 of the gain ($250,000 ×
[365 ÷ 730]). The remainder of the gain would be taxable and cannot be excluded.
Question ID: 94849538 (Topic: Like-Kind Exchange)
Penny wishes to exchange her rental duplex in Miami, Florida with a triplex in Las Vegas, Nevada. Penny’s duplex has an existing mortgage of $500,000 and a basis of $500,000. The triplex in Las Vegas has an existing mortgage of $900,000 which Penny assumes. Penny also adds $100,000 of her own cash to the deal in order to close the sale. The buyer assumes the $500,000 existing mortgage on Penny’s Miami Duplex. The Section1031 exchange is completed within 60 days, and Penny takes possession of the triplex in Las Vegas. What is Penny’s basis in the new rental property (the Nevada triplex)?
A. $500,000
B. $600,000
C. $1,000,000
D. $900,000
Correct Answer Explanation for C:
The answer is $1,000,000. Her basis in the Las Vegas triplex is calculated as follows:
Basis of Relinquished Property (Miami duplex) $500,000
ADD: Mortgage liability assumed by Penny +$900,000
Plus: Amount of cash boot paid by Penny +$100,000
Less: Liabilities assumed by other party ($500,000)
Equals: Penny’s basis in the Las Vegas property = $1,000,000
Involuntary Conversions
An involuntary conversion refers to a situation where a taxpayer’s property is lost, damaged, or
destroyed, and the taxpayer receives a payment as a result. This can occur due to a casualty, disaster,
theft, or condemnation.
The taxpayer reports the gain or deducts the loss in the year it is REALIZED. Under section 1033, taxpayer can elect to defer reporting the gain if they reinvest the proceeds in similar property.
They have generally 2 years after the end of the first tax year in which any part of the gain is realized.
Question ID: 94849585 (Topic: Involuntary Conversions)
Melody’s main home, located in Florida, was completely destroyed by a hurricane. She had no homeowner’s insurance at the time, because she had let it lapse. The area was later designated a Presidentially Declared Disaster. On which of the following forms would she report her casualty loss?
A. Form 4684
B. Form 1045
C. Form 4797
D. Schedule B
Correct Answer Explanation for A: Form 4684
Taxpayers can report casualty and theft losses on Form 4684, Casualties and Thefts. Section A of the form is for personal-use property (like a main home) and Section B for business or income-producing property. To see more information about casualty losses, see Topic No. 515 Casualty, Disaster, and Theft Losses.
