Nontaxable Exchanges
An exchange of property involves the
disposition of an asset and acquisition of
another (non-cash) asset
 An exchange of property is nontaxable
only if a specific statutory provision
requires deferral of gain or loss.
Otherwise, the disposition is taxable, and
the acquisition is capitalized with tax
basis equal to purchase price

8-1
Characteristics of a
Generic Nontaxable Exchange

Taxpayers exchange ‘qualifying property’
Value-for-value presumption
 Gain/loss realized is not recognized currently, but is
deferred until taxable disposition of property received


Substituted basis rule leads to deferral of gain/loss

8-2
Tax basis of the qualifying property received
= Tax basis of qualifying property surrendered
- FMV of boot received + FMV of boot paid
+ gain recognized
= FMV of qualifying property - deferred gain
+ deferred loss
Generic Exchange continued

Treatment of ‘Boot’
 Definition:
any cash or non-qualifying property
included in a nontaxable exchange
 Effect of boot:
 Taxpayer
receiving boot recognizes gain (not loss)
equal to the lesser of:
– realized gain on the exchange
– FMV of the boot received
 Basis
of boot received equals its FMV
 Taxpayer giving boot recognizes gain or loss only if
the FMV of the boot differs from its adjusted basis
8-3
Specific Nontaxable
Exchange Provisions
Sec. 1031 - Like-kind exchanges
 Sec. 1033 - Involuntary conversions
 Sec. 351 - Corporate formations
 Sec. 721 - Partnership formations
 Sec. 1091 - wash sales

8-4
Like-kind Exchanges
No gain or loss recognized by a taxpayer
who exchanges business or investment
property for other business or investment
property of a like-kind
 Does not apply to:

 Exchanges
of inventory
 Exchanges of corporate stock or partnership
interests
 Personal use assets
8-5
Like-kind Exchanges
continued

Determination of like-kind status:
 Real
property - virtually all types of business
and investment real property are considered
like-kind
 Examples:
land for office building, apartment
building for shopping center
 Personal
property - exchangeability depends
on IRS classification system
 Examples:
office furniture and copier are likekind, copier and personal computer are not
8-6
In-Class Problem:
Like-kind Exchange
Matt owns an office building with $70,000
adjusted basis and $200,000 FMV.
 Phil owns land held for investment with
$180,000 adjusted basis and $170,000
FMV.
 If Matt and Phil wish to exchange assets,
how much boot must be given, and by
whom, in order for this exchange to be
economically rational?

8-7
In-Class Problem continued
Assuming that boot is given as
determined above, how much gain or loss
is realized by Matt and Phil on the
exchange? How much gain or loss is
recognized?
 Determine the adjusted basis of the
assets received by Matt and Phil.

8-8
Debt and Like-kind Exchanges
When property is transferred subject to a
mortgage, such debt relief is included in
the amount realized on disposition and is
considered boot received by the party
relieved of debt and boot given by the
party assuming the debt
 When both parties assume debt, only the
net amount is considered boot given and
received

8-9
In-Class Problem:
Like-kind Exchange with Debt
Thomas owns an apartment complex with
$300,000 adjusted basis, $450,000 FMV,
subject to a mortgage of $200,000.
 Angela owns an office building with
$480,000 adjusted basis, $500,000 FMV,
subject to a mortgage of $250,000.
 Thomas and Angela agree to exchange
these assets, subject to the related debt.

8-10
In-Class Problem continued
Are Thomas and Angela each receiving
equal value in the exchange?
 How much gain or loss is realized by
Thomas and Angela on the exchange?
How much gain or loss is recognized?
 Determine the adjusted basis of the
assets received by Thomas and Angela.

8-11
Involuntary Conversions
Include loss of property due to theft,
natural disaster, or condemnation
 A gain will result from involuntary
conversion when insurance or
condemnation proceeds exceed the
adjusted basis of the property
 A taxpayer may elect to defer gain on
involuntary conversion if the amount
realized is reinvested in property that is
similar or related in service or use within 2
years

8-12
Corporate Formations

Sec. 351 defers recognition of gain or loss if:
 property
is transferred to a corporation solely in
exchange for that corporation’s stock and
 the transferors are in control of the corporation
immediately after the transfer
Property includes tangible and intangible
assets and cash, but not services
 Control requires ownership of at least 80%
of the corporation’s outstanding stock

8-13
Corporate Formations
continued
Any money or property received by the
transferors other than stock of the
controlled corporation is considered boot
 Transferee corporation recognizes no
gain or loss when exchanging its stock for
property or services

 Tax
basis of property received equals
transferors’ adjusted tax basis plus any gain
recognized by the transferors
8-14
In-Class Problem:
Corporate Formation
Ira has been operating a business as a sole
proprietorship. He wishes to expand, and has
approached Rochelle, owner of a building in a good
location, regarding a joint venture. For legal reasons,
they have decided to incorporate the new business.
Ira transfers assets worth $100,000 ($40,000 tax
basis) to a newly formed corporation, IRA Inc., in
exchange for 500 shares of common stock. Rochelle
transfers the building, worth $300,000 ($100,000 tax
basis) in exchange for 1,500 shares. Rochelle also
receives 100 shares in exchange for her services in
coordinating the corporate formation.
8-15
In-Class Problem continued
How much gain or loss have Ira and
Rochelle each realized in this exchange?
Does the exchange qualify for
nonrecognition treatment under Sec.
351?
 What are Ira and Rochelle’s tax bases in
the stock of IRA Inc.? What is the
corporation’s tax basis in the assets
received?

8-16
Partnership Formations
Sec. 721 - No gain or loss is generally
recognized by a partnership or any
partner when property is contributed in
exchange for a partnership interest
 Sec. 721 has no ‘control’ requirement
similar to that of Sec. 351

8-17
Wash Sales
Sec. 1091 disallows recognition of losses
realized on wash sales of marketable
securities
 A wash sale occurs when an investor
realizes a loss on sale of a security and
reacquires substantially the same
investment within 30 days before or after
the date of sale

8-18
Update to Book/Tax
Difference List
Temporary Differences
• Deferral of gain/loss on
nontaxable exchanges
8-19
Permanent Differences