Dr. Bob’s 460 Notes, 7-1
CHAPTER 7
PROPERTY TRANSACTIONS –
GAIN/LOSS, BASIS, NONTAXABLE EXCHANGES
I.
Dispositions - Determining Gain or Loss
Amount Realized
Minus Adjusted Basis
Equals Realized Gain or Loss
Realized vs. Recognized Gain or Loss
 Not recognized
 Postponed
II.
Basis and Holding Period. Why important?
A. Basis
A.
Holding Period
 Rule of thumb
Dr. Bob’s 460 Notes, 7-2
III. Determining Basis – Different Methods of Acquisition
A. Purchases
1.
Cost basis includes cash, FMV of other property given, debt, and transactions
costs incurred in the acquisitsion.
2.
Allocation of basis for multiple assets acquired in a single purchase based on
relative FMVs (property tax values also acceptable).
Example: Purchase a building (and the land upon which it sits) for $250,000.
Property tax assessment values the land at $20,000 and the building at $180,000.
B.
Self-Constructed Assets
1.
Uniform capitalization rules are mandated for inventory and certain other
property.
2.
Construction period interest must be capitalized for certain “long useful life”
property.
C.
Taxable Exchanges
1.
Basis determined by:
2.
D.
Holding period starts:
Nontaxable Exchanges
 Rules to remember:
 Basis
 Holding Period
Dr. Bob’s 460 Notes, 7-3
Examples of Nontaxable Exchanges
1.
Stock Dividends - Allocate basis of original holding to all shares now held.
2.
Stock Rights - Allocation of a nontaxable stock right received is mandatory only
if the right has a FMV  15% of the FMV of the underlying stock. Allocation of basis
to other nontaxable stock rights is elective.
Example: You own 1,000 shares of ABC common stock with a basis of $10,000 and
a FMV of $20,000. 1,000 rights, worth $5 each ($5,000 total) allow you to purchase
1,000 shares of stock at $15 per share.
3.
Like-Kind Exchanges
Example: Old truck (adjusted basis = $15,000, FMV = $17,000) traded and $10,000
cash given for new truck. Basis of new =
4.
a.
Transfers to Business Entities
Proprietorships & Partnerships, LLCs
c.
Corporations (C & S)
Dr. Bob’s 460 Notes, 7-4
E.
Disallowed Losses
1.
Related Party Sales
2.
Wash Sales
F.
Converting Personal Use Property to Business Use
1.
Lower of adjusted basis or FMV at date of conversion.
Example: Convert personal residence (basis = $80,000, FMV = $70,000) to rental.
G.
Gifts
1.
FMV > Donor Basis
a.
Donee’s basis = Donor basis + the portion of any gift tax paid (by donor)
that is the property’s appreciation relative to the taxable gift.
Example: Donor basis = $30,000, FMV = $50,000. Donor pays $10,000 gift
tax. Donee basis =
2.
FMV < Donor Basis
a.
Dual Basis results:
Gain basis = donor (transferred) basis
Loss basis = FMV at gift date
Example: Donor basis = $50,000, FMV = $30,000. Donor pays $6,000 gift tax.
Donee basis =
H.
Inheritances
1.
Basis is FMV at date of death or alternate valuation date (6 months after date of
death).
2. Holding period is always deemed to be long-term.
Dr. Bob’s 460 Notes, 7-5
IV. Like-Kind Exchanges (§1031)
A. General Rule.
1. NO GAIN OR LOSS recognized on an exchange of like-kind property
 EXCEPTION –GAIN recognized if boot is received.
2. Property must be held for investment or for use in a trade or business. Treatment is
mandatory.
B. Like-Kind Property Defined
1. Exchanged property must be of the same class (i.e. personal property for personal and
real property for real). Personal property must be within the same General Business
Asset Class or within the same Product Class.
2. Inventory and securities do not qualify for like-kind exchange treatment.
C. Direct Exchange Must Occur
 EXCEPTION for qualified real estate transactions (45 days after sale to identify
replacement property, 180 days to close).
D. Receipt of Boot
1. Gain is recognized to the extent of boot received, limited by the realized gain.
2. No loss is ever recognized on a like-kind exchange.
3. What is Boot?
4. If both properties are encumbered with debt, the mortgages are offset to determine if
there is net boot.
E. Basis of Property Received
1. Basis =
basis of property given up (including boot)
less boot received
plus gain recognized.
2. This may also be computed as:
FMV of new property
less any gain NOT recognized or
plus any loss NOT recognized
3. The basis of non-qualifying property (boot) is always the property's fair market value.
Dr. Bob’s 460 Notes, 7-6
F. Holding Period for Property Received
1. The holding period of like-kind property received includes the holding period of the
like-kind property given up, WHY???
2. The holding period for non-qualifying property (boot) begins with the date of the
exchange.
G. EXAMPLES
1. X and Y exchange like-kind property. FMV of each is $20,000. X's basis is $25,000;
Y's basis is $15,000.
X
Y
Received:
Gave:
Gain(Loss) Realized:
Gain(Loss) Recognized:
Basis of new asset:
2. X and Y exchange like-kind property. X's has a FMV of $18,000 and a basis of
$25,000; Y's has a FMV of $20,000 and a basis of $15,000. X pays Y $2,000 in cash to
even the deal.
X
Y
Received:
Gave:
Gain(Loss) Realized:
Gain(Loss) Recognized:
Basis of new asset:
Dr. Bob’s 460 Notes, 7-7
3. X and Y exchange like-kind property. X's has a FMV of $12,000 and a basis of
$25,000; Y's has a FMV of $22,000, a basis of $15,000, and is subject to a debt of
$10,000, which X assumes.
X
Y
Received:
Gave:
Gain(Loss) Realized:
Gain(Loss) Recognized:
Basis of new asset:
4. X and Y exchange real property. X gives up a building with a FMV of $90,000 and a
basis of $27,000. Y gives up a building with a FMV of $82,000 and a basis of $64,000. Y also
gives up stock with a FMV of $8,000 and a basis of $10,000.
X
Y
Received:
Gave:
Gain(Loss) Realized:
Gain(Loss) Recognized:
Basis of new asset:
Dr. Bob’s 460 Notes, 7-8
V. Involuntary Conversions (§1033)
A. General Rule.
1. Gains are deferred if the full amount of the proceeds is invested in qualifying
replacement property within a certain period.
2. Losses are recognized.
B. Involuntary Conversion Defined
1. Includes theft, seizure, requisition, condemnation, or destruction of property.
C. Determination of Gain and Basis
1. Gain is recognized to the extent proceeds (e.g., insurance recovery) > cost of qualifying
replacement property, limited to realized gain.
2. Adjusted basis of replacement property is cost less unrecognized gain.
3. EXAMPLE: A taxpayer receives $160,000 of insurance proceeds from an involuntary
conversion; basis in the property was $110,000. Replacement property was purchased
for $140,000.
D. Replacement Property
1. Generally, replacement property is required to be similar or related in service or use to
the converted property.
EXAMPLE: A stolen delivery truck used in the taxpayer's trade or business would need
to be replaced with some type of delivery vehicle to qualify for gain deferral.
2. If real property used in a trade or business or held for investment is condemned, it may
be replaced under the less restrictive like-kind standard.
E. Time Requirements for Replacement
1. The normal replacement period is two years after the end of the tax year in which the
involuntary conversion gain is realized.
2. Condemned real property can be replaced within three years after the end of the tax year
in which the involuntary conversion gain is realized.
Dr. Bob’s 460 Notes, 7-9
VI.
Sale of Principal Residence by Individuals - Exclusion of Gain
A. Exclusion of gain up to $250,000 ($500,000 for married, joint returns).
B. Requirements:
1. Must have owned and used the property as a principal residence for at least 2 years
during the 5-year period ending on the date of sale.
2. Exclusion allowed on each sale, but no more than once every 2 years.
3. Exception to the use and limit of once every 2 years: Prorated exclusion allowed if
either of the 2-year requirements not met if caused by reason of a change in place of
employment, health, or other unforeseen circumstances.
Exclusion Ratio =
Shorter of: (1) Actual ownership & use; or (2) time since most recent excluded sale
2 years
Example: Mr. and Ms. Jones purchased and occupied a principal residence in 2009.
Exactly one year later, Ms. Jones is transferred by her employer to another city and the
Jones move. They sell their home at a $200,000 gain. What is their exclusion?
4. Exception for “nonqualified use,” defined as any period of time after 2008 that the
house is not used as the principal residence.
Example: Bob buys a second home January 1, 2005, then moves into it as his principal
residence on January 1, 2011, and sells it on January 1, 2013. He meets the 2-out-of-5 year requirement, but 2 years of ownership (2009 and 2010) is not qualified use, so twoeighths of any gain is not eligible for the exclusion.
5. Rules for married individuals:
a. MFJ taxpayers can exclude up to $500,000 if (1) either meets the ownership test; (2)
both meet the use test; and (3) neither is ineligible because of a prior sale within 2 years.
b. On the other hand, each spouse can exclude $250,000. Thus, if H marries W, who
sold her home in the prior year, H could still get a $250,000 exclusion.
6. Depreciation recapture occurs for any business use of the home for periods after 5/6/97.
a. Business use includes home office & rental.