Sales & Exchanges

If you sell, exchange, or otherwise dispose of your property, you usually have a gain or a loss. This section explains certain rules for determining whether any gain you have is taxable, and whether any loss you have is deductible.

A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. An exchange is a transfer of property for other property or services.

Determining Gain or Loss

You usually realize a gain or loss when you sell or exchange property. A gain results if the amount you realize from a sale or exchange of property is more than its adjusted basis. A loss results if the adjusted basis of the property is more than the amount you realize.

See chapter 7 for the definition of basis, adjusted basis, and fair market value.

Amount realized. The amount you realize from a sale or exchange is the total of all money you receive plus the fair market value of all property or services you receive. The amount you realize also includes any of your liabilities assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage.

If the liabilities relate to an exchange of multiple properties, see Treatment of liabilities under Multiple Property Exchanges in chapter 1 of Publication 544.

Amount recognized. Your gain or loss realized from a sale or exchange of property is usually a recognized gain or loss for tax purposes. A recognized gain is a gain you must include in gross income and report on your income tax return. A recognized loss is a loss you deduct from gross income. For example, if your recognized gain from the sale of your tractor is $5,300, you include that amount in gross income on Form 1040. However, your gain or loss realized from certain exchanges of property is not recognized for tax purposes. See Like-Kind Exchanges, next. Also, a loss from the disposition of property held for personal use is not deductible.

Like-Kind Exchanges

Certain exchanges of property are not taxable. This means any gain from the exchange is not recognized, and any loss cannot be deducted. Your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive.

The exchange of property for the same kind of property is the most common type of nontaxable exchange. To be a like-kind exchange, the property traded and the property received must be both the following.

• Qualifying property.
• Like property.

These two requirements are discussed later.

Additional requirements apply to exchanges in which the property received is not received immediately upon the transfer of the property given up. See Deferred exchange, later.

If the like-kind exchange involves the receipt of money or unlike property or the assumption of your liabilities, you may have a recognized gain. See Partially nontaxable exchange, later.

Multiple-party transactions. The like-kind exchange rules also apply to property exchanges that involve three- and four-party transactions. Any part of these multiple-party transactions can qualify as a like-kind exchange if it meets all the requirements described in this section.

Receipt of title from third party. If you receive property in a like-kind exchange and the other party who transfers the property to you does not give you the title, but a third party does, you can still treat this transaction as a like-kind exchange if it meets all the requirements.

Basis of property received. If you acquire property in a like-kind exchange, the basis of the property is the same as the basis of the property given up. See chapter 7 for more information about basis.

Money paid. If, in addition to giving up like property, you pay money in a like-kind exchange, you still have no recognized gain or loss. The basis of the property received is the basis of the property given up, increased by the money paid.

Example. Bill Smith trades an old tractor for a new one. The new tractor costs $10,800. He is allowed $2,000 for the old tractor and pays $8,800 cash. He has no recognized gain or loss on the transaction regardless of the adjusted basis of his old tractor. If Bill sold the old tractor to a third party for $2,000 and bought a new one, he would have a recognized gain or loss on the sale of his old tractor equal to the difference between the amount realized and the adjusted basis of the old tractor.

Reporting the exchange. Report the exchange of like-kind property on Form 8824, Like-Kind Exchanges. The instructions for the form explain how to report the details of the exchange. Report the exchange even though no gain or loss is recognized.

If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040) or Form 4797, whichever applies. You may also have to report the recognized gain as ordinary income because of depreciation recapture on Form 4797. See chapter 11 for more information.

Qualifying property. In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. Machinery, buildings, land, trucks, and rental houses are examples of property that may qualify.

The rules for like-kind exchanges do not apply to exchanges of the following property.

• Property you use for personal purposes, such as your home and your family car.
• Stock in trade or other property held primarily for sale, such as crops and produce.
• Stocks, bonds, notes, or other securities or evidences of indebtedness, such as accounts receivable.
• Partnership interests.

However, you might have a nontaxable exchange under other rules. See Other Nontaxable Exchanges in chapter 1 of Publication 544.

Like property. To qualify as a nontaxable exchange, the properties exchanged must be of "like kind" as defined in the income tax regulations. Generally, real property exchanged for real property qualifies as an exchange of like-kind property.

Personal property. Depreciable tangible personal property can be either "like kind" or "like class" to qualify for nontaxable exchange treatment. Like-class properties are depreciable tangible personal properties within the same General Asset Class or Product Class.

General Asset Classes. General Asset Classes describe the types of property frequently used in many businesses. They include the following property.

1. Office furniture, fixtures, and equipment (asset class 00.11).
2. Information systems, such as computers and peripheral equipment (asset class 00.12).
3. Data handling equipment except computers (asset class 00.13).
4. Airplanes (airframes and engines), except planes used in commercial or contract carrying of passengers or freight, and all helicopters (airframes and engines) (asset class 00.21).
5. Automobiles and taxis (asset class 00.22).
6. Buses (asset class 00.23).
7. Light general purpose trucks (asset class 00.241).
8. Heavy general purpose trucks (asset class 00.242).
9. Railroad cars and locomotives except those owned by railroad transportation companies (asset class 00.25).
10. Tractor units for use over the road (asset class 00.26).
11. Trailers and trailer-mounted containers (asset class 00.27).
12. Vessels, barges, tugs, and similar water-transportation equipment, except those used in marine construction (asset class 00.28).
13. Industrial steam and electric generation or distribution systems (asset class 00.4).

Product Classes. Product Classes include property listed in a 4-digit product class (except any ending in "9," a miscellaneous category) in Division D of the Standard Industrial Classification codes of the Executive Office of the President, Office of Management and Budget, Industrial Classification Manual. Copies of the manual may be obtained from the National Technical Information Service, an agency of the U.S. Department of Commerce. To order the manual, call 1-800- 553-NTIS (1-800-553-6847). The cost of the manual is $30 and the order number is PB87-100012INQ.

Examples. An exchange of a truck for a tractor is an exchange of like-kind property, and so is an exchange of timber land for crop acreage. An exchange of a tractor for acreage, however, is not an exchange of like-kind property. Neither is the exchange of livestock of one sex for livestock of the other sex. An exchange of the assets of a business for the assets of a similar business cannot be treated as an exchange of one property for another property. Whether you engaged in a like-kind exchange depends on an analysis of each asset involved in the exchange.

Partially nontaxable exchange. If you exchange your property for like-kind property and also receive money or unlike property, or both, in an exchange on which you realize gain, you have a partially nontaxable exchange. You are taxed on the gain realized to the extent of the money and the fair market value of the unlike property you receive. A loss is not deductible.

Example 1. You trade farm land that cost $30,000 for $10,000 cash and other land to be used in farming with a fair market value of $50,000. You have a gain of $30,000, but only $10,000, the cash received, is recognized.

Example 2. Assume the same facts as in Example 1, except that, instead of money, you received a tractor with a fair market value of $10,000. Your recognized gain is still limited to $10,000, the value of the tractor (the unlike property).

Example 3. Assume in Example 1 that the fair market value of the land you received was only $15,000. Your $5,000 loss is not deductible.

Unlike property given up. If you trade property for like-kind property and also give up unlike property in the exchange, you have a recognized gain or loss on the unlike property you give up. This gain or loss is the difference between the fair market value of the unlike property and the adjusted basis of the unlike property.

Like-kind exchanges between related persons. Special rules apply to like-kind exchanges between related persons. These rules affect both direct and indirect exchanges. Under these rules, if either person disposes of the property within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. The gain or loss on the original exchange must be recognized as of the date of the later disposition. The 2-year holding period begins on the date of the last transfer of property that was part of the like-kind exchange.

Related persons. Under these rules, related persons generally include members of your family (spouse, brother, sister, parent, child, etc.), a corporation in which you have more than 50% ownership, a partnership in which you directly or indirectly own more than a 50% interest of the capital or profits, and two partnerships in which you directly or indirectly own more than 50% of the capital or profits interest.

For the list of related persons, see Nondeductible Loss under Sales and Exchanges Between Related Persons in chapter 2 of Publication 544.

Example. You used a truck in your farming business. Your sister used a station wagon in her landscaping business. In December 1999, you exchanged your truck, plus $200, for your sister's station wagon. At that time, the fair market value (FMV) of your truck was $7,000 and its adjusted basis was $6,000. The FMV of your sister's station wagon was $7,200 and its adjusted basis was $1,000. You realized a gain of $1,000 (the $7,200 FMV of the station wagon minus the $200 you paid, minus the $6,000 adjusted basis of the truck). Your sister realized a gain of $6,200 (the $7,000 FMV of your truck plus the $200 you paid, minus the $1,000 adjusted basis of the station wagon).

However, because this was a like-kind exchange, you recognized no gain. Your basis in the station wagon was $6,200 (the $6,000 adjusted basis of the truck plus the $200 you paid). Your sister recognized gain only to the extent of the money she received, $200. Her basis in the truck was $1,000 (the $1,000 adjusted basis of the station wagon minus the $200 received, plus the $200 gain recognized).

In 2000, you sold the station wagon to a third party for $7,000. Because you sold it within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. On your tax return for 2000, you must report your $1,000 gain on the exchange in 1999. You also report a loss on the sale of $200 (the adjusted basis of the station wagon, $7,200 (its $6,200 basis plus the $1,000 gain recognized), minus the $7,000 realized from the sale).

In addition, your sister must report on her tax return for 2000 the $6,000 balance of her gain on the 1999 exchange. Her adjusted basis in the truck is increased to $7,000 (its $1,000 basis plus the $6,000 gain recognized).

Exceptions to the rules for related persons. The following property dispositions are excluded from these rules.

• Dispositions due to the death of either related person.
• Involuntary conversions.
• Dispositions where it is established to the satisfaction of the IRS that neither the exchange nor the disposition has as a main purpose the avoidance of federal income tax.

Exchanges of multiple properties. Under the like-kind exchange rules, you must generally make a property-by-property comparison to figure your recognized gain and the basis of the property you receive in the exchange. However, for exchanges of multiple properties, you do not make a property-by-property comparison if you do either of the following.

• Transfer and receive properties in two or more exchange groups.
• Transfer or receive more than one property within a single exchange group.

For more information, see Multiple Property Exchanges in chapter 1 of Publication 544.

Deferred exchange. A deferred exchange is one in which you transfer property you use in business or hold for investment and later receive like-kind property you will use in business or hold for investment. The property you receive is replacement property. The transaction must be an exchange (that is, property for property) rather than a transfer of property for money used to buy replacement property.

A deferred exchange for like-kind property may qualify for nonrecognition of gain or loss if the like-kind property is identified and transferred within the following time limits.

1. You must identify the property to be received within 45 days after the date you transfer the property given up in the exchange.
2. The property must be received by the earlier of the following dates.
   1. The 180th day after the date on which you transfer the property given up in the exchange.
   2. The due date, including extensions, for your tax return for the tax year in which the transfer of the property given up occurs.

For more information, see Deferred Exchange in chapter 1 of Publication 544.

Transfer to Spouse

No gain or loss is recognized (included in gross income) on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or a former spouse if incident to divorce. This rule does not apply if the recipient is a nonresident alien. Nor does this rule apply to a transfer in trust to the extent the liabilities assumed and the liabilities on the property are more than the property's adjusted basis.

Any transfer of property to a spouse or former spouse on which gain or loss is not recognized is not considered a sale or exchange. The recipient's basis in the property will be the same as the adjusted basis of the giver immediately before the transfer. This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than either its fair market value at the time of transfer or any consideration paid by the recipient. This rule applies for determining loss as well as gain. Any gain recognized on a transfer in trust increases the basis.

For more information on transfers of property incident to divorce, see Property Settlements in Publication 504.

Foreclosure or Repossession

If you do not make payments you owe on a loan secured by property, the lender may foreclose on the loan or repossess the property. The foreclosure or repossession is treated as a sale or exchange from which you may realize gain or loss. This is true even if you voluntarily return the property to the lender. You may also realize ordinary income from cancellation of debt if the loan balance is more than the fair market value of the property.

Buyer's (borrower's) gain or loss. You figure and report gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. The gain or loss is the difference between your adjusted basis in the transferred property and the amount realized. See Determining Gain or Loss, earlier.

You can use Table 10-1 to figure your gain or loss from a foreclosure or repossession.

Table 10-1

Amount realized on a nonrecourse debt. If you are not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the amount you realize includes the full amount of the debt canceled by the transfer. The total canceled debt is included even if the fair market value of the property is less than the canceled debt.

Example 1. Ann paid $200,000 for land used in her farming business. She paid $15,000 down and borrowed the remaining $185,000 from a bank. Ann is not personally liable for the loan (nonrecourse debt), but pledges the land as security. The bank foreclosed on the loan 2 years after Ann stopped making payments. When the bank foreclosed, the balance due on the loan was $180,000 and the fair market value of the land was $170,000. The amount Ann realized on the foreclosure was $180,000, the debt canceled by the foreclosure. She figures her gain or loss in Part I, Form 4797, by comparing the amount realized ($180,000) with her adjusted basis ($200,000). She has a $20,000 deductible loss.

Example 2. Assume the same facts as in Example 1 except the fair market value of the land was $210,000. The result is the same. The amount Ann realized on the foreclosure is $180,000, the debt canceled by the foreclosure. Because her adjusted basis is $200,000, she has a deductible loss of $20,000, which she reports in Part I, Form 4797.

Amount realized on a recourse debt. If you are personally liable for repaying the debt (recourse debt), the amount realized on the foreclosure or repossession does not include the canceled debt that is income from cancellation of debt. However, if the fair market value of the transferred property is less than the canceled debt, the amount realized includes the canceled debt up to the fair market value of the property. You are treated as receiving ordinary income from the canceled debt for the part of the debt that is more than the fair market value. See Cancellation of debt, later.

Example 3. Assume the same facts as in Example 1 earlier except Ann is personally liable for the loan (recourse debt). In this case, the amount she realizes is $170,000. This is the canceled debt ($180,000) up to the fair market value of the land ($170,000). Ann figures her gain or loss on the foreclosure by comparing the amount realized ($170,000) with her adjusted basis ($200,000). She has a $30,000 deductible loss, which she figures in Part I, Form 4797. She is also treated as receiving ordinary income from cancellation of debt. That income is $10,000 ($180,000 - $170,000). This is the part of the canceled debt not included in the amount realized. She reports this income on line 10 of Schedule F.

Seller's (lender's) gain or loss on repossession. If you finance a buyer's purchase of property and later acquire an interest in it through foreclosure or repossession, you may have a gain or loss on the acquisition. For more information, see Repossession in Publication 537.

Cancellation of debt. If property that is repossessed or foreclosed upon secures a debt for which you are personally liable (recourse debt), you generally must report as ordinary income the amount by which the canceled debt is more than the fair market value of the property. This income is separate from any gain or loss realized from the foreclosure or repossession. Report the income from cancellation of a business debt on Schedule F, line 10. Report the income from cancellation of a nonbusiness debt as miscellaneous income on line 21, Form 1040.

You can use Table 10-1 to figure your income from cancellation of debt.

However, income from cancellation of debt is not taxed if any of the following apply.

• The cancellation is intended as a gift.
• The debt is qualified farm debt (see chapter 4).
• The debt is qualified real property business debt (see chapter 5 of Publication 334).
• You are insolvent or bankrupt (see Publication 908).

Forms 1099-A and 1099-C. A lender who acquires an interest in your property in a foreclosure or repossession should send you Form 1099-A showing information you need to figure your gain or loss. However, if the lender also cancels part of your debt and must file Form 1099-C, the lender may include the information about the foreclosure or repossession on that form instead of on Form 1099-A. The lender must file Form 1099-C and send you a copy if the amount of debt canceled is $600 or more and the lender is a financial institution, credit union, federal government agency, or any organization that has a significant trade or business of lending money. For foreclosures or repossessions occurring in 2000, these forms should be sent to you by January 31, 2001.

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