1. Special Property Transactions
Chapter 12
Special Property Transactions
“A fool and his money are soon parted.
It takes creative tax laws for the rest.”
---Bob Thaves (“Frank & Ernest”)
Chapter 12 – Special Property Transactions

2. LO #1 Like-Kind Exchange Rules
3 criteria for a like-kind exchange
There must be an exchange;
The property transferred and the property received must be held for productive use in a trade or business or for investment;
The property must be like-kind.
Exchange rules are not elective
The like-kind exchange rules are not elective. If the three criteria are met, the exchange rules must be used.

3. LO #1 Like-Kind Exchange
Not eligible for like-kind treatment
Inventory
Stocks, bonds, etc.
Debt instruments
Interest in a partnership
Certificates of trust
Dealer does not qualify for a like-kind exchange treatment
Dealers in a product (e.g., a car dealer) can never exclude gains by using the like-kind rules. Like-kind exchanges are disallowed for stocks, bonds, and partnership interests as well.

4. LO #1 Like-Kind Exchange
What is a like-kind asset?
Same nature or character
Grade or quality does not matter
Same depreciation class
Boot Property – any extra consideration given or received other than the like-kind property
A like-kind asset does not have to be an exact duplicate to qualify as a like-kind exchange. “Boot” property is any property given or received in addition to the like-kind asset – usually cash.

5. LO #1 Like-Kind Exchange
Recognized gain is the lesser of:
The FMV of the boot received; or
The realized gain on the exchange.
Receipt of boot causes recognition of gain
Giving boot does not cause gain recognition
With like-kind exchanges, gain is recognized to the lesser of the realized gain or the boot received. Giving of boot does not trigger gain recognition.

6. LO #1 Like-Kind Exchange
Basis calculation of property received
Basis of property given
Plus basis of boot given
Plus gain recognized
Less boot received
Or, FMV of property received less deferred gain.
The easiest method to calculate basis of the property received is to take the FMV of the property received and subtract any deferred gain. It is a nice check to calculate basis both ways.

7. LO #1 Like-Kind Exchange
Time period
45 days to locate replacement property;
180 days to receive replacement property.
Liabilities assumed
Release of a liability is considered boot received
Presence of a liability can trigger gain
Like-kind exchanges have limited time periods to first locate the replacement property and then to actually receive the property. The assumption of liability adds complexity to the transaction and could possibly cause the recognition of gain. Liability assumption is treated as boot received.

8. LO #1 Like-Kind Exchange Concept Check 12-1
1. With a correctly executed like-kind exchange, gain is never recognized unless the taxpayer receives boot.
True
2. In order for a transaction to qualify for a like-kind exchange, an exchange of assets must occur, the assets must be held for trade or business use, and be like-kind assets.

9. LO #1 – Concept Check 12-1
3. A taxpayer has 180 after relinquishing his or her property to identify a replacement property.
False
4. The basis is in the replacement property is typically the FMV of the property received less the gain postponed.
True

10. LO #2 – Involuntary Conversions
Property is destroyed, stolen, condemned and the taxpayer receives similar property or proceeds.
Defer entire gain – replacement property must be purchased for an equal or greater amount of the proceeds.
A taxpayer can defer a gain caused by an involuntary conversion. The most common involuntary conversion happens when insurance proceeds for a casualty (fire, storm, etc.) exceed the basis of the property.

11. LO #2 – Involuntary Conversions
Replacement Property
Similar or related in service or use
More restrictive than the “like-kind” test
Real property can only be “like-kind”
Replacement Period
Two years after the close of tax year
Three years for real business property
Just like like-kind exchanges, there is a limited amount of time to replace property that has been involuntarily converted.

12. LO #2 – Involuntary Conversions
Basis of replacement property
Basis of converted property
Less money not used to replace
Plus gain recognized
Less boot received
Holding Period – holding period of replacement property includes holding period of property converted
Typically, the basis of the replacement property is the basis of the old property less any money not used to replace the property plus any gain that was recognized.

13. LO #2 – Concept Check 12-2
1. A fire destroyed Andrew’s building used in his wood working business. Andrew purchased the building several years ago for $75,000 and it now has a $50,000 adjusted basis. Andrew received $105,000 in insurance proceeds for the replacement cost. If Andrew does not replace the building, what is his taxable gain?
$55,000
2. Assuming the same facts as above, how many years does Andrew have to replace the building in order to deferred any recognized gain?
3 years – it is business real property

14. LO #2 – Concept Check 12-2
3. Assuming the same facts as above, how much gain would Andrew be required to recognize if he replaced the building (within the replacement period) with another building costing $95,000?
$10,000
4. Assuming the same facts as above, how much gain would Andrew be required to recognize if he replaced the building with another building costing $115,000? $0
5. Assuming the same facts as number 4 above, how much would Andrew’s basis be in the new building?
$60,000

15. LO #3 – Installment Sales
A disposition of property where at least one payment is to be received after the year of sale.
Installment payments consist of three components:
Interest income
Return of basis
Gain on the sale
Gross Profit Percentage = gross profit divided by contract price
The installment sale method allows the taxpayer to spread the gain of a property sale over several years if the receipt of the sales price is collected over several years.

16. LO #3 – Installment Sales
Dealers can not use the installment method.
The installment method can not be used on the sale of publicly traded stock.
Any depreciation recapture is recognized in the year the asset is disposed.
One important aspect of installment sales is that these rules do not apply to dealers. Also, the installment sales can not be used on sales of publicly traded stock.

17. LO #3 – Concept Check 12-3
Tamaria sold a tract of land for $30,000 in The land has a basis of $18,000 and she incurred $2,000 of selling expenses. Tamaria received $5,000 down (received in 2007) and will receive five additional annual payments of $5,000 each. What is Tamaria’s gross profit percentage on the sale.
a %
b %
c %
d %
Answer: C

18. LO #3 – Concept Check 12-3
Assume the same facts as above, how much income will Tamaria recognize in 2007 when she receives the first additional payment of $5,000?
a. $
b. $1,667.
c. $3,335.
d. $5,000.
Answer: C

19. LO #4 – Sale of Residence
Married taxpayer can exclude up to $500,000 ($250,000 single) of the gain on the sale of their personal residence
This provision is an exclusion not a deferral of gain.
Most gains on the sale of personnel residences are now completely excluded from tax. For married taxpayers, the maximum gain that can be excluded is $500,000.

20. LO #4 – Sale of Residence
During a five year period before the sale, the taxpayer must have:
Ownership Test – owned the home for at least two years.
Use Test – lived in the home as the main home for at least two years.
The tests do not have to be continuous.
Typically, a taxpayer can exclude the gain from a sale of a personal residence every two years. The taxpayer must pass the ownership and use tests.

21. LO #4 – Sale of Residence
Exclusion applies to only one sale every two years.
If for health or employment reasons, a reduced exclusion is available for a second sale based on the ratio of days owned divided by 730.
In special situations, a reduced exclusion is available for a second sale within two years if the sale is caused by health or employment reasons.

22. LO #4 – Concept Check
1. If married taxpayers live in their personal residence for more than two years, the couple can exclude the gain on the sale of their residence up to $500,000. True or False?
True
2. A taxpayer can not exclude any gain on the sale of a residence if he or she has lived there less than two years. True or False?
False

23. LO #4 – Concept Check
3. Sharon and Johnny were recently married and Sharon moved into Johnny’s house. Sharon then sold her home and took the exclusion. Since Sharon took the exclusion, Johnny must forfeit his exclusion if he were to sell his home within the next two years.
False

24. LO #5 – Related Party Losses & Wash Sales
Losses on sales between related parties are disallowed
Related parties include family members and more than 50% owned entities
Constructive ownership rules apply
The loss disallowance does not affect the basis of the property to the buyer.

25. LO #5 – Related Party Losses & Wash Sales
Wash sale rules disallow a tax loss where the ownership of a company is not reduced.
A wash sale occurs if essentially the same stock is purchased 30 days before or 30 days after the sale.
Wash sale rules disallow a tax loss where the ownership of a company via stock did not actually change. If a taxpayer sells a stock for a loss on December 31 and then repurchases the same stock within 30 days, the loss is not allowed in the December tax year.

26. LO #5 – Concept Check
1. Leslie sold 500 shares of Bluff, Co. stock to her brother for $5,000. Leslie purchased the stock three years ago for $7,000. How much of the loss can Leslie deduct on her tax return in the current year?
Answer: $0
2. Would the answer to question #1 change if Leslie sold the stock to Leslie Co. instead of her brother? Explain assuming the following facts.
a. Assume Leslie owns 25% of the outstanding stock in Leslie Co.
b. Assume Leslie owns 75% of the outstanding stock in Leslie Co.
Answer: a. Leslie could deduct $2,000 in capital losses.
Answer: b. $0

27. LO #5 – Concept Check 3. What is the purpose of the wash sale rules?
Answer: The purpose of the wash sale rules is to disallow a tax loss where the ownership of a company is not reduced. Thus, if a taxpayer buys similar stock within 30 days (before or after) of a stock sale, any loss on the sale is disallowed.