1. Module 21 Tax Deferred Exchanges

2. 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

3. 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

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

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

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

7. 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

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

9. 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

10. 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

11. §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

12. §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

13. 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

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

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

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

17. 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

18. 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?

19. Solution--Research Query: Gold for Silver? Not Like-Kind Rev Rul 82-166, 1982-2 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

20. §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

21. 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

22. In Class Exercise: Recognition Under §1031 Case A B C D E A/R Like-Kind 100100100100100 Boot - 6 - 15 15 Total A/R100106100115115 A/B Like-Kind 110110 80105 90 Boot 15 0 8 0 0 Total A/R125110 88105 90 Realized (25) (4) 12 10 25

23. 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

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

25. In Class Exercise: Basis Calculation Under §1031 Case A B C D E A/R Like-Kind 100100100100100 Boot - 6 - 15 15 Total A/R100106100115115 A/B Like-Kind 110110 80105 90 Boot 15 0 8 0 0 Total A/R125110 88105 90 Realized(25) (4) 12 10 25

26. Solution--In Class Exercise: Basis Calculation Under §1031 Start with FMV of like-kind received Case A B C D E FMV100100100 100 100 - Gain deferred 0 0 12 0 10 +Loss deferred 25 4 0 0 0 New Basis125104 88 100 90

27. 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

28. 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

29. §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

30. 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

31. In Class Exercise: Involuntary Conversion--Gain Recognition Case A B C D E A/R 200200 200 200 200 A/B 225180 180 180 180 Realized(25) 20 20 20 20 ReinvestN/A -0- 205 192 175 n n In each case determine the gain recognized

32. 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

33. 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

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

35. In Class Exercise: Involuntary Conversion--New Basis Case A B C D E A/R 200200 200 200 200 A/B 225180 180 180 180 Realized(25) 20 20 20 20 ReinvestN/A -0- 205 192 175 n n In each case determine the basis in the new property

36. 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 205 192 175 - Gain deferred 20 12 0 New BasisN/A N/A 185 180 175

37. 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

38. §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

39. 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

40. 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

41. 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

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

43. 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

44. 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

45. 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

46. 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

47. 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

48. 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