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LIKE KIND EXCHANGES 1 Chapter 39. Nonrecognition Transactions §1031 2 No gain or loss recognized when property is exchanged solely for property of like-kind.

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Presentation on theme: "LIKE KIND EXCHANGES 1 Chapter 39. Nonrecognition Transactions §1031 2 No gain or loss recognized when property is exchanged solely for property of like-kind."— Presentation transcript:

1 LIKE KIND EXCHANGES 1 Chapter 39

2 Nonrecognition Transactions § No gain or loss recognized when property is exchanged solely for property of like-kind Defer recognition of gain or loss until property is disposed of in a taxable transaction Replacement property receives substituted basis

3 Exceptions to § Stock in trade or other property held primarily for sale Stocks, bonds or notes Other securities or evidence of indebtedness or interest Interests in a partnership Certificates of trust or beneficial interests Choses in action

4 Continuity of Interest 4 §1031 assumes property received in an exchange is simply a continuation of that investment in a modified form Inappropriate time to levy a tax or permit a deduction– there is no wherewithal to pay Administrative difficulty in valuing like-kind exchange property

5 Like Kind Property 5 Transferred property must be exchanged solely for property of a like kind to be held either for productive use in a trade or business or for investment §1031(a)(1) Remember, inventory, stocks, bonds, notes, securities, partnership interests, and similar intangibles are EXCLUDED §1061(a)(2)

6 Like Kind Property (continued) 6 like kind refers to nature or character of the property and not its grade or quality Property exchanged must be exchanged for property in the same class Real estate – building for land; improved real estate for unimproved real estate Personalty property – same general business asset class; auto for auto, equipment for equipment

7 Like Kind Property (continued) 7 Additional considerations Personal property treated with narrower approach Transfer of multiple assets No business for business exchange, need to look at underlying assets

8 Holding Requirements 8 Property given up in the exchange must be held for productive use in a trade or business or for investment Property received in the exchange is to be held for productive use in a trade or business or for investment No personal-use property allowed Property use of one party does not necessarily disqualify the other party 2 year holding period on exchanges between related parties

9 Example 9 In-class exercise

10 Receipt of Nonqualified Property (Boot) 10 Does not disqualify nonrecognition treatment Boot = receipt of money or nonqualified property Requires recognition of gain to the extent of boot received (money or FMV of nonqualified property) Does NOT permit recognition of loss

11 Example 1 11 Taxpayer exchanged Blackacre (Adjusted Basis=$50,000) for Whiteacre (FMV=75,000) and cash ($10,000) Amount Realized$85,000 (75 for Whiteacre +10 for cash/ boot) Less: Adjusted Basis 50,000 (Blackacre) Gain$35,000 Gain recognized$10,000 (boot received) Gain deferred$25,000 (35-10)

12 Example 2 12 Taxpayer exchanged Blackacre (Adjusted Basis =$100,000) for Whiteacre (FMV=75,000) and cash ($10,000) Amount Realized$85,000 (75 for Whiteacre +10 for cash/ boot) Less: Adjusted Basis100,000 (Blackacre) Loss $(15,000) Loss recognized -0- Loss deferred$15,000

13 Liabilities Transferred 13 If mortgaged property is exchanged for unencumbered property, then debt (relief) is boot If mortgaged property is exchanged for mortgaged property, then liabilities are netted Debt received by transferee is boot to transferor to extent debt assumed by transferee is greater than debt assumed by transferor If transferor transfers debt and other boot, can use other boot to reduce amount of debt transferred

14 Example 1 14 Taxpayer exchanged Blackacre (Adjusted Basis=$50,000) subject to a mortgage of $10,000 for Whiteacre (FMV=75,000) Amount Realized$85,000 (75 for Whiteacre +10 for mortgage) Less: Adjusted Basis 50,000 (Blackacre) Gain$35,000 Gain recognized$10,000 (boot received-debt relief) Gain deferred$25,000 (35-10)

15 Example 2 15 Taxpayer exchanged Blackacre (Adjusted Basis=$50,000) subject to a mortgage of $10,000 for Whiteacre (FMV=75,000) subject to a mortgage of $8,000 Amount Realized$77,000 (75 for Whiteacre +10 Blackacre mortgage -8 Whiteacre mortgage) Less: Adjusted Basis 50,000 Gain$27,000 Gain recognized$2,000 (boot - net debt relief) B>W Gain deferred$25,000 (27-2)

16 Example 3 16 Taxpayer exchanged Blackacre (Adjusted Basis=$50,000) subject to a mortgage of $15,000 AND cash of $5,000 for Whiteacre (FMV=75,000) Amount Realized $85,000 (75 for Whiteacre +15 Blackacre mtg. -5 cash) Less: Adjusted Basis 50,000 Gain$35,000 Gain recognized$10,000 (boot received) *Cash reduces mtg. Gain deferred$25,000 (35-10)

17 Basis of Property Received 17 Basis of like-kind property surrendered + Basis of Boot surrendered + Gain recognized on Boot – Basis of Boot received (FMV) – Loss recognized on Boot Basis of like-kind property received Or FMV of like-kind property received + Unrecognized loss – Unrecognized gain Basis of like-kind property received

18 Example 1 18 Taxpayer exchanges Blackacre with adjusted basis of $500,000 and FMV of $800,000 subject to a mortgage of $150,000 for Whiteacre with a FMV $600,000 and $30,000 cash and oil painting with FMV $20,000 {gain realized=[( )-500]=300,000} Basis of like-kind property surrendered$500,000 (Blackacre) + Basis of Boot surrendered + Gain recognized on Boot 200,000 (Mtg.+cash+painting) – Basis of Boot received (FMV)-200,000 – Loss recognized on Boot Basis of like-kind property received$500,000 Or, (600,000 – 100,000 = 500,000)

19 Depreciation and Amortization 19 Like-kind property received in like-kind exchange is recovered over the remaining recovery period of the surrendered property

20 Related Parties §1031(f) 20 Nonrecognition is denied to both parties to a like- kind exchange between related persons if either of them disposes of the property received within 2 years

21 Example 21 In-class exercise

22 Qualifying Exchanges Reciprocal transfer of properties (most common) Multiparty Exchanges (Round- robin exchange) A transfers Blackacre to B, B transfers Whiteacre to C, C transfers Greenacre to A D purchases Whiteacre from T, D transfers Whiteacre to F in exchange for Blackacre (only F qualifies for nonrecognition) 22

23 Qualifying Exchanges (continued) 23 Deferred Exchanges §1031(a)(3) Property must be identified within 45 days after the taxpayers transfer Property must be received within the earlier of 180 days after the taxpayers transfer or the due date (including extensions) of the taxpayers tax return Safe harbor for qualified intermediary Reverse Exchanges Rev. Proc Receipt of replacement property before transferring relinquished property

24 Involuntary Conversions § Gain on involuntary conversion (destruction in whole or in part, casualty, theft, condemnation) of property is not recognized if property is replaced with property similar or related in service or use Mandatory if property is converted directly into qualified replacement property (direct conversion) Elective if taxpayer receives cash or other dissimilar property and then acquires qualified replacement property (indirect conversion)

25 involuntary conversion 25 Process by which the taxpayer loses or relinquishes property in exchange for money or other property Destruction in whole or in part – encompasses casualties, however, does not need to be sudden Theft Seizure – confiscation of property by a public agency without compensation Requisition or Condemnation – confiscation of property for public use with just compensation Threat or Imminence of Requisition or Condemnation Miscellaneous Events

26 similar or related in service or use 26 Substantially similar business property Reasonably similar business continuation More stringent than like-kind property rules Exception: §1033(h)(2) – tangible property held in trade or business or for investment converted in a presidentially declared disaster replaced with ANY tangible trade or business property (but not for investment) qualifies Exception: §1033(g) – real property converted by seizure, requisition, or condemnation or threat of imminence need only meet like-kind requirement similar to §1031 Remodeling or improving property satisfies requirement that replacement property to be purchased

27 Elective nonrecognition of gain 27 Replacement property cost amount realized on conversion Purchase of property occurs within 2 years after close of tax year in which gain on conversion was realized Cost of replacement property includes cash paid and liabilities assumed Amount realized includes cash received and liabilities discharged less expenses incurred Gain recognized to the extent amount realized on conversion cost of replacement property Amounts received for compensation for lost profits are included in income

28 Example 28 Taxpayer received $10,000 condemnation award for Blackacre (adjusted basis=$10,000). Condemning authority paid $15,000 to discharge mortgage. Taxpayer paid $2,000-legal fees in proceedings. Taxpayer paid $5,000 cash, $15,000 mortgage, and $1,000 commissions for replacement property. Amount realized $23,000 (10 award +15 mtg discharge -2 legal fees) Less: Adjusted basis(10,000) Gain realized$13,000 Gain recognized Amount realized$23,000 Less: repl. property(21,000) (5 cash+15 mtg + 1 comm.) Gain recognized$ 2,000

29 Basis of Replacement Property 29 Cost of Replacement Property Less: Unrecognized Gain Basis of Replacement Property

30 Depreciation 30 Basis of replacement property is recovered over the remaining recovery period of the converted property


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