Module 21 Tax Deferred Exchanges

Menu n n Tax deferred exchanges and the concept of substituted basis n n §1031 like-kind exchanges n n §1033 involuntary conversions n n Exchanges in qualifying corporate reorganizations n n Miscellaneous tax deferred exchanges

Tax Deferred Exchanges and the Concept of Substituted Basis Key Learning Objectives (1) n n Realized gain or loss n n Recognized gain or loss n n Postponed gain or loss

Realized Gain or Loss n The difference between Fair market value (FMV) and Adjusted basis (A/B) n Of property sold or disposed of.

Recognized Gain or Loss n n Amount of realized gain or loss Taxable or deductible for income tax purposes.

Postponed Gain or Loss n Difference between realized gain or loss and recognized gain or loss

Tax Deferred Exchanges and the Concept of Substituted Basis Key Learning Objectives (2) n n Purchase price basis n n Carryover basis n n Substituted basis

Purchase Price Basis n Fully taxable transaction n Purchase price becomes the adjusted basis n Holding period begins on the date of purchase

Carryover Basis n The basis of the transferee Basis of the transferor + Any gain recognized n Holding period of the transferee Includes the transferor’s

Substituted Basis n Property received basis is n Its fair market value u Purchase price basis F Reduced by postponed gain F Increased by postponed loss

§1031 Like-Kind Exchanges Key Learning Objectives (1) n n Introduction to like-kind exchanges n n Qualifying properties under §1031 n n The like-kind requirement: realty n n The like-kind requirement: personality

§1031 Like-Kind Exchanges n In all cases need to determine n Gain/loss realized n Gain recognized u Losses are never recognized n Basis adjustment required to reflect gain/loss not recognized

Introduction to Like-Kind Exchanges n Not elective n No gain/loss recognition if property is exchanged for “like-kind” property u Used in T/B or held for investment u And no “boot” is received for gain F Loss is never recognized

Non-Qualifying Properties Under §1031 n §1031 excludes Inventory Partnership interest Stock/bonds/securities Evidence of indebtedness Certain non-qualified preferred stock

The Like-Kind Requirement Real Estate n Like-kind broadly construed n Real estate for any real estate

The Like-Kind Requirement Personality n Like-kind broadly construed n Personality IF substantially the same use as original property

Boot n Any property received or given up in an exchange that does not qualify for tax deferral treatment Property not like-kind Non-qualifying property Net debt relief

Research Query: Gold for Silver? n The taxpayer has gold bullion that she would like to exchange for silver bullion n Does this qualify as a like kind exchange under §1031?

Solution--Research Query: Gold for Silver? Not Like-Kind Rev Rul , CB 190 n n The values of silver and gold bullion are determined solely on the basis of metal content n n They are "intrinsically” different n n Used in different ways u Silver--essentially an industrial commodity u Gold--primarily utilized as investment in itself

§1031 Like-Kind Exchanges Key Learning Objectives (2) n n Computation of gain or loss under §1031 n n The effects of liabilities on recognized gain or loss n n Special §1031 problems: deferred exchanges n n Special §1031 problems: related party exchanges

Computation of Gain or Loss Under §1031 n Gain realized is recognized to extent of FMV of boot n Losses never recognized even with boot

In Class Exercise: Recognition Under §1031 Case A B C D E A/R Like-Kind Boot Total A/R A/B Like-Kind Boot Total A/R Realized (25) (4)

Solution--In Class Exercise: Recognition Under §1031 n Losses not recognized if §1031 applies u No loss recognition Cases A & B n Gains not recognized if no boot u No gain recognition Case C n No recognition in excess of realization u 10 recognized; but 15 boot Case D n Gain recognized to extent of boot u 15 of 25 realized gain is recognized Case E

Computation of Substitute Basis Under §1031 n Basis in new property = FMV of like-kind property received - Gain not recognized + Loss not recognized

In Class Exercise: Basis Calculation Under §1031 Case A B C D E A/R Like-Kind Boot Total A/R A/B Like-Kind Boot Total A/R Realized(25) (4)

Solution--In Class Exercise: Basis Calculation Under §1031 Start with FMV of like-kind received Case A B C D E FMV Gain deferred Loss deferred New Basis

Special §1031 Problems: Deferred Exchanges n Three corner exchanges may be OK A wants C’s property & tax deferral B wants A’s property B purchases C’s property B exchanges with A n A should get tax deferral

Special §1031 Problems: Non-Simultaneous Exchange n A wants tax deferral but has not picked replacement property n B wants A’s property and is willing to acquire any property A wants n B gets A’s property right now n A’s property chosen within 45 days n A’s property delivered within 180 days

§1033 Involuntary Conversions Key Learning Objectives (1) n n Tax deferral n n Losses on involuntary conversions n n Recognized gain n n Basis of replacement property n n Destruction and theft conversions

Defer Recognition by n Reinvesting in qualified property u Within specific time limits u Realization year + 2 tax years n Losses recognized u Unless personal use property

In Class Exercise: Involuntary Conversion--Gain Recognition Case A B C D E A/R A/B Realized(25) ReinvestN/A n n In each case determine the gain recognized

Solution--In Class Exercise: Recognition Under §1033 n Case A Losses always recognized u Unless personal use property; then deductible only if casualty loss n Case B Full recognition of gain if no reinvestment n Case C Full deferral if A/R (or greater) reinvested

Solution--In Class Exercise: Recognition Under §1033 n Case D Recognize gain to extent A/R not reinvested. u Recognize 8 u Defer12 n Case E Recognize 20 u Full recognition of gain since amount reinvested is 25 short of A/R and realized gain was 20

Involuntary Conversion Substituted Basis n Basis = cost of new - gain deferred n Generally an elective provision u So could choose to recognize gain

In Class Exercise: Involuntary Conversion--New Basis Case A B C D E A/R A/B Realized(25) ReinvestN/A n n In each case determine the basis in the new property

Solution--In Class Exercise: Basis in New Under §1033 Start with purchase price of new Case A B C D E Purchase priceN/A N/A Gain deferred New BasisN/A N/A

Involuntary Conversion Theft or Destruction n Generally deals with gains only n As per casualty/theft n But suddenness not required n Occurs if insured for replacement cost and property is appreciated

§1033 Involuntary Conversions Key Learning Objectives (2) n n Condemnations n n Qualified replacement property: owner-user properties n n Qualified replacement property: owner-lessor properties n n Qualified replacement period

Involuntary Conversion Condemnation n Forced transfer to governmental authority w/ power to enforce sale u Taken for public use u Seizure u Requisition u Condemnation n Sold under threat of condemnation

Replacement Property--Similar or Related in Use or Service n Owner who is user must meet u Functional use test u Replacement serves same function in taxpayer's business

Replacement Property--Similar or Related in Use or Service n Owner who is lessor must meet u Taxpayer use test u Rental property replaced with any rental property

Special Rules for §162 or §212 Property n Get an extra year to reinvest n Replacement can be “like-kind” u See §1031 definition

Exchanges in Qualifying Corporate Reorganizations Key Learning Objectives n n Character of gain to shareholders and security holders n n Basis of the shareholder's replacement stock and/or securities

Character of Gain to Shareholders and Security Holders n Ordinary income if the receipt of the boot has the same effect as the distribution of a dividend

Basis of Shareholder’s Replacement Stock/Securities n Basis of stock/securities received is Adjusted basis of stock or securities surrendered + Gain recognized on the exchange - Boot received in the exchange

Seven Organizational Patterns Qualifying for Non-Recognition n Described in §368(a)(1)(A) through Sec. 368(a)(1(G). n Stock and securities received in a corporate reorganization is treated in much the same way as a like-kind exchange

Miscellaneous Tax Deferred Exchanges Key Learning Objectives (1) n n An overview n n Transfers between spouses u §1041 n n Exchanges of life insurance, endowment, and annuity contracts u §1035

Miscellaneous Tax Deferred Exchanges Key Learning Objectives (2) n n Divestitures under conflict-of-interest rules u §1043 n n Investments in specialized small business investment companies u §1044 n n Reinvestments of proceeds of an ESOP sale u §1042