Unit 8 - Nonrecognition Property Transactions Flashcards
The 3 most common examples of non-recognition transactions are
- Selling a primary residence – excluded gain under section 121
- Like kind exchanges – non-taxable/deferred exchange under section 1031
- Involuntary conversions – exchange under section 1033
Section 121 exclusion
Only pertains to a taxpayers primary residence does not apply to rental properties, vacation, homes, or secondary residences
Taxpayers can often exclude the gain from selling their primary residence
Unmarried and MFS – up to $250,000 of gain can be excluded
MFJ – up to $500,000 of gain can be excluded
Requirements for reporting profit on the sale of a home
And where reported?
If the entire profit is excluded, it is not necessary to report the sale unless…
A form 1099 – S is received for the proceeds
If a portion of the gain is taxable – the sale must be reported on schedule D and form 8949
Any profit earned from selling a home that is not considered the primary residence – must be reported as taxable income
Keycriteria for a property to be classified as a home?
Includes having sleeping quarters, a kitchen, and bathroom facilities
Eligibility requirements for section 121
To be eligible for the section 121 exclusion, taxpayer must
- Have sold their main home.
- Meet “ownership and use” tests
- Not have excluded gain in the two years prior to the current sale of a home.
But some exceptions when the primary reason for selling the home residence was a change of employment, health, or unforeseen circumstances
Ownership test
During the five-year period ending on the date of the sale – the taxpayer must have owned the home for at least two years
Does not have to be continuous
Figured separately from the test
24 months or 730 days
Use test
During the five-year period ending on the date of the sale – the taxpayer must have lived in the home as their main home for at least two years
Does not have to be continuous
Separately from the ownership test
24 full months or 730 days
Taxpayer must physically occupy the home, except for temporary brief absences, such as short vacations and seasonal trips
Eligibility requirements for section 121 – married homeowners
Married homeowners must meet all the following conditions to meet the ownership and use test
They file a joint return
Either spouse meets the ownership test – only one is required to own the home
Both spouses meet the use test
Neither spouse has excluded gain in the two years before the current sale of the home
If only one spouse qualifies – that spouse may still be eligible for a separate exclusion of up to $250,000 – instead of claiming the full $500,000 exclusion (regardless if filing MFJ or MFS)
Home sale - special rule for the holding. For a divorce.
Ownership transfers from one spouse to the other during a divorce
But the individual must still have used, lived in, the house for the two years
Section 121 exclusion – unrelated individuals
Unmarried and unrelated individuals that cohabitate together
Both parties meet the use and ownership test
Both individuals can exclude up to $250,000 of gain on their separate returns
Section 121 exclusion – deceased spouses
Surviving spouse is treated as if they owned and lived in the home during any period that the deceased spouse did
May exclude up to $500,000 of gain from the sale if it occurs within two years after the death of the deceased spouse
As long as the surviving spouse did not remarry before the sale
Section 121 exclusion – military personnel exception
The five year period can be suspended for up to 10 years for US military, as well as for foreign service personnel, US peace corpse, workers, and intelligence officers that are on official extended duty
Offers taxpayers a greater chance to fulfill the two-year residency requirement
Section 121 exclusion – disability exception
Exception to the use test, if during the five year period before the sale of the home a taxpayer becomes physically or mentally disabled
Must have owned and lived in the home for at least one year
Considered to have lived in the home during any time that they are forced to live in a licensed facility, including a nursing home
Must still meet the two-year ownership test
Home sale section 121– rules for reduced exclusions
If taxpayer owned and used a home for less than two years or who has used the homes sale exclusion within the prior to your period…
May still be eligible for a reduced exclusion if they meet one of the following three exceptions
- Work related move.
- Health related move.
- Unforeseeable events.
Rules for reduced exclusions – work related move
Safe Harbor applies if the new job is at least 50 miles farther from the old home then was the former place of employment
If no former employment – the distance between the new place of employment and the old home must be at least 50 miles
Rules of reduced exclusions – health related move
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
Rules of reduced exclusions – unforeseeable events
Safe harbors include the following
Death, divorce, or legal separation
Unemployment
Multiple births, resulting from the same pregnancy
Damage to the residence, resulting from a disaster, an active war, or terrorism
Involuntary conversion of the property or condemnation
Calculating the section 121 – reduced exclusion amount
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.
- The period between the last sale for which the taxpayer claimed the exclusion and the sale date for the home currently being sold.
The denominator is two years or the equivalent in months or days (730 days or 24 months)
It’s possible for the reduced exclusion amount to be more than the gain on the sale – resulting in a non-taxable gain on the full amount
Land sales
The sale of a vacant plot of land with no house on it does not qualify for the section 121 exclusion
If land is sold on which the main home is located, but not the house itself – the gain is not excludable
Land sale exclusion
Taxpayer may be able to exclude the gain from selling a vacant lot that is connected to their primary residence
Can only be applied if the vacant land was used in connection with the main home and the sale occurs within two years before or after selling the home
Must be directly adjacent to the home and must have been owned and used as part of the home – not for any business purposes
Section 121 exclusion – homes used partially for business
If a taxpayers home was used partially for business purposes or as a rental property
The gain is reported on form 4797 – sales of business property
If a taxpayer claimed depreciation deductions – they cannot exclude the portion of the gain equivalent to the amount of depreciation deducted
Section 121 only applies to the portion of a home
Homes used partially for business – calculating the exclusion amount
Rules apply for properties that are converted from a non-qualifying use such as a rental to a qualifying use such as a personal residence
Equals a fraction
Numerator is the amount of time used for business use
Denominator is the total amount of time owed
Multiplied by the total gain equals the amount, not excluded
I need depreciation would be subtracted from the excludable portion of the gain
Uncaptured section 1250 gain
The amount of depreciation claimed in prior years up to the amount of recognized gain
Technically, long-term gain with a special maximum rate of 25%
Only applies to the sale of depreciable real estate and not other types of business assets, like machinery or equipment
What is a “like-kind exchange” - section 1031 exchange
An exchange that takes place when a taxpayer trades, one qualifying real property for another
Any gain is considered postponed
Two types
- Simultaneous swap – a swap of two properties
- Deferred exchange – allows a taxpayer to sell their property and then acquire one or more replacement properties at a later date.