CCH Federal Taxation
Basic Principles
Chapter 11
Property Transactions:
Nonrecognition of Gains and
Losses
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Chapter 11 Exhibits
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
Sale of a Principal Residence—General Rules
Sale of Home by Married Taxpayers—General Rules
Sale of Home by Married Taxpayers—Examples
Sale of Home by Divorced or Separated Taxpayers—Ownership
Requirement
Sale of Home by Divorced or Separated Taxpayers—Occupancy
Requirement
Sale of Home by Widowed Taxpayers
Sale of Home Due to Unforeseen Circumstances
Sale of Home by Incapacitated Taxpayers
Sale of Home by U.S. Citizens Temporarily Working Abroad
Like-Kind Exchanges—Tangible Property
Like-Kind Exchanges—Intangible Property
Like-Kind Exchanges—Tax Treatment for Gain or Loss
Like-Kind Exchanges—Time Limitations
Like-Kind Exchanges—Holding Period Rules
Chapter 11, Exhibit Contents A
CCH Federal Taxation Basic Principles
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Chapter 11 Exhibits
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
Involuntary Conversions—What Qualifies
Involuntary Conversions—Time Limitations
Involuntary Conversions—Holding Period Rules
Involuntary Conversions—Template for Problem Solving
Installment Method—Eligible Property
Installment Method—Four-Step Computation
Installment Method— Example
Installment Method— Solution Step One
Installment Method— Solution Step Two
Installment Method— Solution Step Three
Installment Method— Solution Step Four
Chapter 11, Exhibit Contents B
CCH Federal Taxation Basic Principles
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Sale of a Principal Residence—General Rules
Amount and tax effect of the exclusion
 $250,000 (Married individuals filing jointly may exclude
up to $500,000.)
 This is a permanent exclusion, not just a deferral or
rollover of gain until a later time. Moreover, there is no
reinvestment requirement.
Chapter 11, Exhibit 1a
CCH Federal Taxation Basic Principles
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Sale of a Principal Residence—General Rules
Qualifying for the exclusion
To qualify for the exclusion, a taxpayer must:
 Own and use the property as a principal residence for an
aggregate of at least two of the five years preceding the sale or
exchange; and,
 Not claim the exclusion during the two years immediately
preceding the sale.
Chapter 11, Exhibit 1b
CCH Federal Taxation Basic Principles
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Sale of a Principal Residence—General Rules
Example.
Fred, a single individual, owns and occupies his home
during all of 20x1 and 20x2. He rents it to a tenant
during all of 20x3, 20x4 and 20x5. He sells it on
December 31, 20x5, realizing a $200,000 gain. If Fred
had not taken exclusion on the sale of any other
principal residence during 20x4 and 20x5, he may be
entitled to exclude all of the $200,000 gain in 20x5.
Chapter 11, Exhibit 1c
CCH Federal Taxation Basic Principles
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Sale of a Principal Residence—General Rules
Short-term absences
Absences due to short-term illness, business travel and
vacation generally count as occupancy. Under certain
situations, taxpayers may be able to claim the exclusion even
though they fail to meet either the one-sale-every-two-years
limitation or the two-out-of-five-year holding period
requirement.
Chapter 11, Exhibit 1d
CCH Federal Taxation Basic Principles
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Sale of Home by Married Taxpayers—
General Rules
Rules of eligibility to claim an exclusion on a joint return
The maximum exclusion that can be claimed on a joint return
is either $250,000 or $500,000. Three requirements for these
maximum exclusion amounts are summarized in the
following charts.
Chapter 11, Exhibit 2a
CCH Federal Taxation Basic Principles
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Sale of Home by Married Taxpayers—
General Rules
Three
Requirements:
Minimum Two-Year
Ownership:
Chapter 11, Exhibit 2b
Maximum $500,000
Exclusion
Either spouse owns the
principal residence for an
aggregate of at least two of the
five years immediately
preceding the sale or exchange.
CCH Federal Taxation Basic Principles
Maximum $250,000
Exclusion
Either spouse owns the
principal residence for an
aggregate of at least two of
the five years immediately
preceding the sale or
exchange.
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Sale of Home by Married Taxpayers—
General Rules
Three
Requirements:
Minimum Two-Year
Occupancy:
Chapter 11, Exhibit 2c
Maximum $500,000
Exclusion
Maximum $250,000
Exclusion
Both spouses, while married,
occupy the dwelling as their
principal residence for an
aggregate of at least two of the
five years immediately preceding
the sale or exchange.
The owner-spouse occupies
the dwelling as a principal
residence for an aggregate of
at least two of the five years
immediately preceding the sale
or exchange. This two-year
occupancy requirement can be
met either before or during
marriage.
CCH Federal Taxation Basic Principles
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Sale of Home by Married Taxpayers—
General Rules
Three
Requirements:
Maximum Two-Year
Frequency:
Maximum $500,000
Exclusion
Neither spouse claimed the
exclusion within two years
preceding the sale.
Maximum $250,000
Exclusion
The owner-spouse has not
claimed the exclusion within
two years preceding the sale.
(Note that a non-ownerspouse’s ineligibility does not
bar the owner-spouse from
claiming a $250,000
exclusion on a joint return.)
Chapter 11, Exhibit 2d
CCH Federal Taxation Basic Principles
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Sale of Home by Married Taxpayers
Example 1.
While single, Greg and Lynne live in separate principal
residences for over two years. On January 1, 20x1, they marry
and move into a new house. Later that year they convert their
former principal residences into rental properties. On June 31,
20x3, Lynne sells her former principal residence at a $600,000
gain. How much of Lynne’s gain may be excluded on a joint
return?
Chapter 11, Exhibit 3a
CCH Federal Taxation Basic Principles
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Sale of Home by Married Taxpayers
Answer: $250,000.
Only Lynne occupied the home as her principal residence
during two of the five years preceding the sale.
(Note: Had Greg and Lynne decided to use Lynne’s home as their
principal residence during any two of the five years preceding sale, they
could have claimed a $500,000 exclusion even though Greg was not an
owner.)
Chapter 11, Exhibit 3b
CCH Federal Taxation Basic Principles
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Sale of Home by Married Taxpayers
Example 2.
Continuing from example 1 above, on December 31, 20x3,
the couple sells the new principal residence at a $700,000
gain. How much of the gain may be excluded on their joint
return?
Chapter 11, Exhibit 3c
CCH Federal Taxation Basic Principles
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Sale of Home by Married Taxpayers
Answer: None.
Lynne had used her exclusion on June 30, 20x3, within two
years preceding the December 31, 20x3 sale.
(Note: If they had sold Greg’s rental home instead of their jointly-owned
principal residence, a $250,000 exclusion would have been available on
their joint return. Greg would still be considered to have owned and
occupied the rental house as his principal residence during two of the
five years preceding sale, i.e. the two years preceding marriage. He
would not have had to wait two years from June 30, 200x3, (the effective
date of Lynne’s exclusion) to become eligible because a non-ownerspouse’s ineligibility does not bar the owner-spouse from claiming a
$250,000 exclusion on a joint return.)
Chapter 11, Exhibit 3d
CCH Federal Taxation Basic Principles
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Sale of Home by Divorced or Separated Taxpayers—
Ownership Requirement
If a residence is transferred to a taxpayer under a divorce or
separation instrument, the time during which the taxpayer’s
spouse or former spouse owned the residence is added to the
taxpayer’s period of ownership.
Chapter 11, Exhibit 4a
CCH Federal Taxation Basic Principles
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Sale of Home by Divorced or Separated Taxpayers—
Ownership Requirement
Example.
John has owned his principal residence for several years. On
January 1, 20x1, he marries Tina. After one year of sharing a
principal residence, the marriage turns sour, John moves into
an apartment and they divorce. Pursuant to a divorce decree,
John transfers ownership in the house to Tina on December
31, 20x1 and she immediately sells it at a $300,000 gain.
Although she did not own the residence for two years, Tina
can claim a $250,000 exclusion. She is deemed to have
owned the house as her ex-spouse owned it, thus satisfying
the two-out-of-five-year ownership requirement.
Chapter 11, Exhibit 4b
CCH Federal Taxation Basic Principles
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Sale of Home by Divorced or Separated Taxpayers—
Ownership Requirement
Recap of John and Tina Analysis:
20x0:
Actual
Deemed
Ownership Ownership:
John
Tina
Actual
Occupancy:
John
Deemed
Occupancy:
Tina
20x1:
John
Tina
John and Tina
Tina
Observation: Tina owned the house for only one day and
occupied it for one year. Nevertheless, she is deemed to have
owned, the residence for two years.
Chapter 11, Exhibit 4c
CCH Federal Taxation Basic Principles
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Sale of Home by Divorced or Separated Taxpayers—
Occupancy Requirement
A taxpayer who owns a residence is deemed to have
occupied it as a principal residence while the
taxpayer’s spouse or former spouse is given use of
the residence under the terms of a divorce separation.
Chapter 11, Exhibit 5a
CCH Federal Taxation Basic Principles
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Sale of Home by Divorced or Separated Taxpayers—
Occupancy Requirement
Example.
Colleen purchases her principal residence on January 1, 20x1,
and marries Stan that same day. After one year of living
together in Colleen’s home, the marriage turns sour and they
divorce. On January 1, 20x2, Colleen moves into an
apartment, and under the terms of a divorce decree, Stan is
allowed to live in the house for an additional year before
Colleen can sell it. On January 1, 20x3, Colleen sells the
house realizing a $500,000 gain. Despite not occupying the
house for a full two years, Colleen can claim a $250,000
exclusion. She is deemed to have occupied the house during
the one year her ex-spouse occupied it, thus satisfying the twoout-of-five-year occupancy period requirement.
Chapter 11, Exhibit 5b
CCH Federal Taxation Basic Principles
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Sale of Home by Divorced or Separated Taxpayers—
Occupancy Requirement
Recap of Colleen and Stan Analysis:
Actual Ownership
Actual Usage:
Deemed Usage:
20x1:
Colleen
Colleen and Stan
Colleen
20x2:
Colleen
Stan
Colleen
Observation: Colleen actually occupied the house for only one
year, 20x1. However, she is deemed to have occupied it for two
years, including 20x2, the year her ex-spouse occupied it.
Chapter 11, Exhibit 5c
CCH Federal Taxation Basic Principles
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Sale of Home by Widowed Taxpayers
A surviving spouse’s period of ownership and
occupancy includes the period during which a
deceased spouse owned and occupied the
residence.
Chapter 11, Exhibit 6a
CCH Federal Taxation Basic Principles
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Sale of Home by Widowed Taxpayers
Example.
Joe, a single individual, has owned and occupied his principal
residence for over two years. On January 1, 20x2, he marries
Sue and they begin living together in Joe’s house. Three weeks
later, Joe dies and ownership of the house is transferred to Sue.
Sue immediately sells the house. Despite not owning and
occupying the residence for two years, Sue can claim a $500,000
exclusion on their joint return (Joe’s final return). She is
deemed to have owned and occupied the house during the period
in which her deceased spouse owned and occupied it, thus
satisfying the two-out-of-five-year holding period requirement.
If she delays the sale until a later year, then as a single taxpayer,
her maximum exclusion would drop to $250,000.
Chapter 11, Exhibit 6b
CCH Federal Taxation Basic Principles
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Sale of Home by Widowed Taxpayers
Recap of Joe and Sue Analysis
Less than 1 month
Actual Ownership
and Occupancy:
Joe and Sue
Deemed Ownership
and Occupancy:
Sue
Balance of 2 years
Joe
Sue
Observation: Although actually owning and occupying the
principal residence for less than one month, Sue is deemed to
have owned and occupied it during the period in which her
deceased spouse owned and occupied it.
Chapter 11, Exhibit 6c
CCH Federal Taxation Basic Principles
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Sale of Home Due to Unforeseen Circumstances
If a change in place of employment, health or other
unforeseen circumstances precipitate a sale or exchange
before any of the three requirements (i.e., the two-year
ownership, occupancy or frequency requirements) are
satisfied, the exclusion may be prorated. The extent to
which “unforeseen circumstances” qualify is to be
determined by IRS regulations.
Chapter 11, Exhibit 7a
CCH Federal Taxation Basic Principles
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Sale of Home Due to Unforeseen Circumstances
Formula forProrating the Exclusion Where Unforeseen Circumstances Apply
(a)
Available exclusion (i.e., $250,000 or $500,000).
(b)
Aggregate # months of ownership during the five year period
ending on the date of sale.
(c)
Aggregate # months of occupancy during the five year period
ending on the date of sale.
(d)
# months since the previous sale to which the exclusion applied.
(Use “24 months” if no previous sale.)
(e)
24 months
(f) = [lesser of (b) (c) or
(d)]  (e)
Pro rata fraction
(g) = (a) x (f)
Available exclusion
Chapter 11, Exhibit 7b
CCH Federal Taxation Basic Principles
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Sale of Home Due to Unforeseen Circumstances
Example.
On January 1, 20x1, Burke purchases a townhouse in
Boston for $450,000. Later in the year, he accepts an offer
of employment in Atlanta. On November 1, 20x1, he sells
his townhouse at a $30,000 gain. His change in place of
employment enables him to claim a portion of the $250,000
exclusion. Because he owned and occupied the townhouse
for 10 months, his available exclusion is $104,167
($250,000 x 10  24) and he recognizes no gain.
Chapter 11, Exhibit 7c
CCH Federal Taxation Basic Principles
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Sale of Home by Incapacitated Taxpayers
If an individual becomes physically or mentally incapable of
self-care, the individual is deemed to use a residence as a
principal residence during the time in which the individual
owns the residence and resides in a licensed care facility (e.g.,
a nursing home). In order for this rule to apply, the taxpayer
must have owned and used the residence as a principal
residence for an aggregate period of at least one year during
the five years preceding the sale or exchange.
Chapter 11, Exhibit 8a
CCH Federal Taxation Basic Principles
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Sale of Home by Incapacitated Taxpayers
Example.
On January 1, 20x1, Patrick purchases a house that he occupies
as his principal residence. On January 1, 20x2, he moves into a
nursing home due to a sudden decline in health. On January 1,
20x3, he sells his house, realizing a $100,000 gain. Patrick’s
one-year ownership of the house while under the care of a
licensed medical facility is now deemed to be one-year usage
since he had previously used the house for at least one year
during the five years preceding the sale of the house. His oneyear occupancy of the house plus the additional one year of
ownership while incapacitated, satisfies the two-out-of-fiveyear occupancy requirement, and he can claim the exclusion.
Chapter 11, Exhibit 8b
CCH Federal Taxation Basic Principles
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Sale of Home by Incapacitated Taxpayers
Note: If Patrick had moved into the nursing home before
January 1, 20x2, he would not have been able to claim the
exclusion. since he had not previously used the house for at
least one year.
Chapter 11, Exhibit 8c
CCH Federal Taxation Basic Principles
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Sale of Home by U.S. Citizens Temporarily
Working Abroad
Code section 121(a) states that the two-out-of-five-year
holding period requirement is satisfied if “property has been
owned and used by the taxpayer as the taxpayer’s principal
residence for periods aggregating 2 years or more.”
Congress intended the word “used” to encompass something
more than absentee-ownership. Until Congress provides
specific relief to U.S. citizens working abroad, the term
“used” should be construed to mean something akin to
physical occupancy, not an extended absence while working
abroad.
Chapter 11, Exhibit 9a
CCH Federal Taxation Basic Principles
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Sale of Home by U.S. Citizens Temporarily
Working Abroad
Example.
Kevin purchases a house on January 1, 20x1, which he uses as
a principal residence. On January 1, 20x2, he accepts a
temporary assignment overseas, leaving his house unoccupied.
After one year overseas, Kevin decides to sell his house. On
January 1, 20x3, he realizes a $200,000 gain on the sale.
Although he owned the house for two years preceding the sale,
he did not physically occupy it for two years, thus he cannot
claim the exclusion.
Chapter 11, Exhibit 9b
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Tangible Property
General Rule for Qualifying Property
Tangible personal and real property held for business or
investment may qualify. The rules are rigid for all
tangible personal property and flexible for all real
property. Inventory and personal-use property do NOT
qualify. Certain intangible property may qualify.
Chapter 11, Exhibit 10a
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Tangible Property
Examples:
Real for real is OK (e.g., timberland for a bowling alley).
 Tangible personal for tangible personal may be OK (e.g., printer for
a computer is OK since both properties fall within the same General
Asset Class described below; a computer for a delivery truck is NOT
OK since they fall within different General Asset Classes.)
 Personal for real, or vice versa, is NOT OK (e.g., delivery truck for
a warehouse).
 Inventory for anything is NOT OK (e.g., computer held for resale in
exchange for a computer used in an accounting department).
 Personal-use property for anything is NOT OK (e.g., a principal
residence for a rental home).
Chapter 11, Exhibit 10b
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Tangible Property
General Asset Classes for Tangible Personal Property
Rev. Proc. 87-56, [1987-2 C.B. 674] describes types of
depreciable tangible personal property that frequently are
used in businesses.
Chapter 11, Exhibit 10c
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Tangible Property
Asset Class #:
Description
00.11
Office furniture, fixtures, and equipment
00.12
Information systems (computers and peripheral equipment)
00.13
Data handling equipment, except computers
00.21
Airplanes (airframes & engines), except those used in commercial or contract
carrying of passengers or freight, and all helicopters (airframes & engines)
00.22
Automobiles and taxis
00.23
Buses
00.241
Light general purpose trucks
00.242
Heavy general purpose trucks
00.25
Railroad cars and locomotives, except those owned by RR transportation cos.
00.26
Tractor units for use on public roads
00.27
Trailers and trailer-mounted containers
00.28
Vessels, barges, tugs and similar water-transportation equip., except those used in
marine construction
00.4
Industrial steam and electric generation and/or distribution systems
Personal property within the same Asset Class qualifies for Code Sec. 1031 treatment, if used for business or investment purposes.
Chapter 11, Exhibit 10d
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Intangible Property
Code Sec. 1.1031(a)(2) allows Code Sec. 1031
application to exchanges of intangible personal
property that occur after 4/10/91.
Types of Code Sec. 197 intangible personal property
Intangible personal property includes: copyrights,
covenants not to compete, formulas, franchises,
goodwill, patents, processes, trademarks or trade
names.
Chapter 11, Exhibit 11a
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Intangible Property
Code Sec. 197 Property that Qualifies for Code Sec. 1031
Treatment
No General Asset Classes are provided for Code Sec. 197
property. To qualify, the Code Sec. 197 property must be of
the same nature or character (e.g., a copyright for a patent is
NOT OK; it must be a patent for a patent, or a copyright for
a copyright). In addition, the nature or character of the
underlying property to which the Code Sec. 197 relates
must be like-kind (e.g., a patent on a factory machine for a
patent on an airplane engine is NOT OK; however, a patent
on an airplane engine for a patent on a helicopter engine IS
OK).
Chapter 11, Exhibit 11b
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—
Tax Treatment for Gain or Loss
Mandatory Rule
A portion of realized gain or loss may be recognizable.
Deferral of any remaining gain or loss is mandatory, not
elective. Here are the rules for recognizing gain or loss:
Code Sec. 1031 recognized gain = The lesser of:
1. Realized gain (i.e., FMV of all consideration received –
basis of all consideration given – depreciation recapture,
if any)
2. Net boot received (i.e., FMV of boot received - basis of
boot given)
Chapter 11, Exhibit 12a
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—
Tax Treatment for Gain or Loss
Code Sec. 1031 losses are only recognized when boot is
given with a FMV below basis. Depreciation recapture is
always taxable immediately as ordinary income in a gain
recognized situation.
Chapter 11, Exhibit 12b
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—
Tax Treatment for Gain or Loss
Boot defined
Boot is cash or other property received or given in a Code Sec.
1031 exchange that is not “like-kind.” For example, if land is
exchanged for land, and a truck is included in the exchange,
the truck is boot. Conversely, if a truck is exchanged for a
truck, and land is included in the exchange, the land is boot.
Cash is always boot.
Chapter 11, Exhibit 12c
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—
Tax Treatment for Gain or Loss
Net boot received (NBR)
“Net boot received” however is a tricky concept. Generally, 3
rules apply to NBR:
1. Mortgage relief may be offset by any boot given, except
boot in rule 3 below.
2. Mortgage assumptions may offset only mortgage relief.
3. The basis of inventory, stock and other intangible
property given may not offset the FMV of any boot
received.
Chapter 11, Exhibit 12d
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—
Tax Treatment for Gain or Loss
Review the following examples below to grasp these rules.
Net Boot Received Computations:
Example 1
Example 2
Example 3
Example 4
Rec’d
Mtg. Relief
100
Mtg. Relief
100
Cash
100
Cash
100
- Given
Mtg. Ass.
(60)
Cash
(60)
Mtg. Ass.
(60)
Stock
(60)
= NBR
NBR
40
NBR
40
NBR
100
NBR
100
Rule #
Chapter 11, Exhibit 12e
1&2
1
CCH Federal Taxation Basic Principles
2
3
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Like-Kind Exchanges—
Tax Treatment for Gain or Loss
Recognized gain or loss from boot given = [FMV – Basis],
regardless of realized gain or loss on the Code Sec. 1031
exchange. [Reg. 1.1031(d)-1(e)].
Chapter 11, Exhibit 12f
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Time Limitations
Time Limitation
Two time limitations govern like-kind exchanges under the
Starker rule (named after a landmark court case):
1. Identification requirement. Like-kind property to be
received must be identified within 45 days of the date that
the like-kind property is given.
2. Receipt requirement. Like-kind property must be
received within 180 days of the date that the like-kind
property is given.
Chapter 11, Exhibit 13a
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Starker Transactions
Starker transactions: “Giving Before Receiving” May Be OK
Giving like-kind property and subsequently receiving likekind property would qualify for Code Sec. 1031 if the 45-day
and 180-day time constraints were met. This is known as a
“Starker transaction.”
Chapter 11, Exhibit 13b
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Reverse Starker Transactions
Reverse-Starker transactions: “Receiving Before Giving” NOT
OK
Receiving like-kind property before giving like-kind property
is known as a “reverse-Starker” transaction. IRS TAKES THE
POSITION THAT Code Sec. 1031 DOES NOT APPLY TO
REVERSE-STARKER TRANSACTIONS! [Preamble to final
regulations, 56 Fed. Reg. 19933 (5/1/91)]
Thus, in a two-party exchange where like-kind property is
exchanged at different times, one party may qualify for Code
Sec. 1031 while the other party may not!
Chapter 11, Exhibit 13c
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Avoiding Reverse Starkers
Techniques involving leasehold interests, options to purchase, or
qualified intermediaries may be used to avoid the reverseStarker problem.
Rev. Proc. 2000-37 creates a safe harbor for certain postSeptember 14, 2000 reverse Starker transactions. This
involves “parking” the properties to be exchanged with an
“exchange accommodation titleholder’ until a qualified
exchange can occur.
Chapter 11, Exhibit 13d
CCH Federal Taxation Basic Principles
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Like-Kind Exchanges—Holding Period Rules
The holding period of like-kind property and boot are:
1. Like-kind property received. Same as the holding period of
the like-kind property given.
2. Boot received. Begins on the day AFTER receipt.
Chapter 11, Exhibit 14
CCH Federal Taxation Basic Principles
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Involuntary Conversions—What Qualifies
Qualified Events
Code Sec. 1033 applies to involuntary conversions occurring
through casualty, theft or condemnation. A casualty qualifies
for special tax treatment if it is caused by some sudden event
such as fire, storm or shipwreck. Termite damage would not
qualify. A condemnation qualifies if there is confirmation
that property is going to be taken for public purposes. News
reports are not deemed to be confirmations.
Chapter 11, Exhibit 15a
CCH Federal Taxation Basic Principles
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Involuntary Conversions—What Qualifies
Mandatory/Elective Rules
The nature of the replacement property dictates whether Code
Sec. 1033 is mandatory or elective:
1. Like-kind replacement. If the award is like-kind
replacement, gains but NOT losses must be postponed.
2. Dissimilar replacement. If the award is cash or other
NON-like kind replacement, Code Sec. 1033 may be
elected for gains but NOT losses.
Chapter 11, Exhibit 15b
CCH Federal Taxation Basic Principles
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Involuntary Conversions—What Qualifies
Qualifying Like-Kind Property
Code Sec. 1033 is more restrictive than Code Sec. 1031, except for the
replacement of condemned real property. Generally, Code Sec. 1033
replacement property must be used in substantially the same way as the
involuntary conversion property.
Real for real is not always OK; (e.g., timberland - a bowling alley,
unless one of the real properties had been condemned. Only condemned
real property gets the same like-kind flexibility afforded Code Sec. 1031
property)
Personal for personal is not always OK; (e.g., delivery truck business car; however a delivery truck for a delivery truck, or a business car for a
business car, is OK.)
Chapter 11, Exhibit 15c
CCH Federal Taxation Basic Principles
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Involuntary Conversions—Time Limitations
Two time limitations govern like-kind replacement of
involuntary conversions property:
1. Earliest date to replace involuntary conversion. The
earlier of:
(a) Date of disposition of the involuntary conversion
property; or
(b) Earliest date of threat of disposition. (Note that
casualties and thefts occur "suddenly," therefore (b)
would apply only to condemnations.)
Chapter 11, Exhibit 16a
CCH Federal Taxation Basic Principles
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Involuntary Conversions—Time Limitations
2. Latest date to replace involuntary conversion. Like-kind
property must be received or purchased:
(a) Condemned real property. Within 3 years after the end
of the taxable year in which gain is first realized.
(b) All other qualified property. Within 2 years after the end
of the taxable year in which gain is realized for:
(i) Real casualty or theft property;
(ii) Personal property.
Chapter 11, Exhibit 16b
CCH Federal Taxation Basic Principles
54 of 66
Involuntary Conversions—Holding Period Rules
The holding period of like-kind property and boot are the
same as under Code Sec. 1031:
1. Like-kind property received. Same as holding period
of the involuntarily-converted property.
2. Non like-kind property received. Begins on the day
AFTER receipt.
Chapter 11, Exhibit 17
CCH Federal Taxation Basic Principles
55 of 66
Involuntary Conversions—
Template for Problem Solving
(a)
Ins. Proceeds
100
100
100
(b)
FMV replacement prop.
75
75
175
(c)
AB old prop.
85
55
55
(d) = (a) – (c)
Realized gain
15
45
45
(e) = (a) –(b)
Limit on recognized gain
25
25
0 (cannot be
negative)
(f) = < of (d) or Recognized gain
(e)
15
25
0
(g) = (d) – (f)
Postponed gain
0
20
0
(h) = (b) – (g)
AB new property
75
55
175
Chapter 11, Exhibit 18
CCH Federal Taxation Basic Principles
56 of 66
Installment Method—Eligible Property
The installment method applies to gains (but not losses) from
the sale of certain property where the seller will receive at
least one payment after the year of sale. However, the
installment method is not available for the following property:
 Inventory.
 Stock or securities traded on an established market.
 Depreciation recapture from Code Sec. 1245 or Code
Sec. 1250 property.
Chapter 11, Exhibit 19
CCH Federal Taxation Basic Principles
57 of 66
Installment Method—Four-Step Computation
Installment method computations require four steps:
1. Allocate installment payments between principal and interest.
2. Compute ordinary income (“OI”) and Code Sec. 1231 gain. (If the
property had been held long-term for investment purposes, rather than
business purposes, then the gain would be classified as a long-term
capital gain (LTCG), rather than a Code Sec. 1231 gain.)
3. Compute the gross profit %.
4. Compute recognized gain on the down payment and deferred gain on
the installment payments.
Chapter 11, Exhibit 20
CCH Federal Taxation Basic Principles
58 of 66
Installment Method—Example
FACTS:
A tract of land is sold under the following terms:
1. Date of contract: .........................................................……11/11/x1
2. Sales price of land: ..…………………………….....……....$50,000
3. Seller’s original purchase price: ..........................................$38,000
4. Terms: $8,000 cash down; 8% compounded semiannually (meets AFR
requirements), resulting in 6 payments of $8,012 due on 5/11 and 11/1.
QUESTION: What are the tax consequences to seller in 20x1 – 20x4?
Chapter 11, Exhibit 21
CCH Federal Taxation Basic Principles
59 of 66
Installment Method—Solution Step One
SOLUTION:
STEP 1: Allocate $8,012 installment payments between principal and interest.
($42,000 installment loan = $50,000 sales price - 8,000 down payment)
(a)
(b)
(c) =
(a) x (8% 2)*
(d) =
(b) - (c)
(e) =
(a) - (d)
Payment
Due Date
Loan Beg.
Balance
Installment
Received
Interest
Income
Principal
Payment
Loan End.
Balance
5/11/x2
42,000
8,012
1,680
6,332
35,668
11/11/x2
35,668
8,012
1,427
6,585
29,083
5/11/x3
29,083
8,012
1,163
6,849
22,234
11/11/x3
22,234
8,012
889
7,123
15,111
5/11/x4
15,111
8,012
604
7,408
7,703
11/11/x4
7,703
8,012
308
7,703
0
* (8% is  by 2 because interest is compounded semi-annually.)
Chapter 11, Exhibit 22a
CCH Federal Taxation Basic Principles
60 of 66
Installment Method—Solution Step One
STEP ONE: CONTRACT INTEREST RATE
The contract interest rate would be divided by two if payments were
received by the seller semi-annually. If installments were monthly,
divide the rate by 12 and show 12 rows of computations; if quarterly
installments, divide by 4, and so on.
Chapter 11, Exhibit 22b
CCH Federal Taxation Basic Principles
61 of 66
Installment Method—Solution Step One
Imputed interest rate
Imputed interest computations would have been required if:
1. The installment contract price exceeded $3,000; AND
2. The interest rate charged was less than the applicable federal rate.
[Sects. 483 and 1274.]
This would require a slight modification to the illustration above -- i.e.,
column (c) would be based on the AFR rate, not the 8% contract rate.
The rest of the schedule would flow as shown above.
Note that the interest portion of annual installment payments must be
computed using semi-annual compounding. [Secs. 1274(a), 1273(a)
and 1272(a)]
Chapter 11, Exhibit 22c
CCH Federal Taxation Basic Principles
62 of 66
Installment Method—Solution Step Two
STEP 2: COMPUTE DEFERRED GAIN
(a)
Cash down payment
8,000
(b)
+ Installment note payable to seller
42,000
(c)=(a)+(b)
= Amount realized
50,000
(d)
Seller’s original cost
(e)
- Accumulated depreciation
(f)=(d) - (e)
= Seller’s adjusted basis
(g)=(c) - (f)
Realized gain = Amount realized -seller’s basis
(h)
Ord. income from Code Sec. 1245 depr’n. recapture
(i)=(g) - (h)
Deferred gain
Chapter 11, Exhibit 23
CCH Federal Taxation Basic Principles
38,000
N/A
38,000
12,000
N/A
12,000
63 of 66
Installment Method—Solution Step Three
STEP 3: COMPUTE GROSS PROFIT %
(j) = (a) + (b)
Contract Price =
Cash Down Payment + Installment N/P
50,000
(k) = (i)  (k)
GP % = Deferred gain  Contract Price
24%
Chapter 11, Exhibit 24
CCH Federal Taxation Basic Principles
64 of 66
Installment Method—Solution Step Four
STEP 4: COMPUTE RECOGNIZED GAIN
Year
Principal Received
Gross Profit % Recognized Gain
‘x1
$8,000 (down payment)
24%
1,920
‘x2
$12,917 (6,332 + 6,585)
24%
3,100
‘x3
$13,972 (6,849 + 7,123)
24%
3,353
‘x4
$15,111(7,408 + 7,703)
24%
3,627
Note: “Principal received” was computed on the previous page.
Chapter 11, Exhibit 25a
CCH Federal Taxation Basic Principles
65 of 66
Installment Method—Solution Step Four



Code Sec. 1245 and 1250 Depreciation Recapture. The full amount of
any depreciation recapture must be recognized in the year of sale, even if
no payments are received in that year. [Code Sec. 453(i)] The remaining
gain is Code Sec. 1231 gain or long-term capital gain.
Contract Price. The contract price should NOT include seller’s debt
relief (i.e., seller debt assumed by buyer).
Post-May 6, 1997 Installments on Pre-May 7, 1997 Contract. If Code
Sec. 1231 property (or capital gain property) is sold under an installment
sales contract entered into prior to May 7, 1997 installments received
after May 6, 1997 are the lower rate (i.e., 10%, 15%, 20%, or 25%
rates) under the new law. Of course, if the property consists of
“collectibles, then the maximum capital gain rate is 28% under current
law.
Chapter 11, Exhibit 25b
CCH Federal Taxation Basic Principles
66 of 66