Publication 544 |
2001 Tax Year |
Nontaxable 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.
Like-Kind Exchanges
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 of the
following.
- Qualifying property.
- Like-kind 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 Exchanges, later.
If the like-kind exchange involves the receipt of money or unlike
property or the assumption of your liabilities, you may have to
recognize gain. See Partially Nontaxable Exchanges, 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 that
property is the same as the basis of the property you transferred.
For the basis of property received in an exchange that is only
partially nontaxable, see Partially Nontaxable Exchanges,
later.
Example.
You exchanged real estate held for investment with an adjusted
basis of $25,000 for other real estate held for investment. The fair
market value of both properties is $50,000. The basis of your new
property is the same as the basis of the old ($25,000).
Money paid.
If, in addition to giving up like-kind 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 cab for a new one. The new cab costs
$30,000. He is allowed $8,000 for the old cab and pays $22,000 cash.
He has no recognized gain or loss on the transaction regardless of the
adjusted basis of his old cab. If Bill sold the old cab to a third
party for $8,000 and bought a new one, he would have a recognized gain
or loss on the sale of his old cab equal to the difference between the
amount realized and the adjusted basis of the old cab.
Sale and purchase.
If you sell property and buy similar property in two mutually
dependent transactions, you may have to treat the sale and purchase as
a single nontaxable exchange.
Example.
You used your car in your business for 2 years. Its adjusted basis
is $3,500 and its trade-in value is $4,500. You are interested in a
new car that costs $20,000. Ordinarily, you would trade your old car
for the new one and pay the dealer $15,500. Your basis for
depreciation of the new car would then be $19,000 ($15,500 plus $3,500
adjusted basis of the old car).
Because you want your new car to have a larger basis for
depreciation, you arrange to sell your old car to the dealer for
$4,500. You then buy the new one for $20,000 from the same dealer.
However, you are treated as having exchanged your old car for the new
one because the sale and purchase are reciprocal and mutually
dependent. Your basis for depreciation for the new car is $19,000, the
same as if you traded the old car.
Reporting the exchange.
Report the exchange of like-kind property, even though no gain or
loss is recognized, on Form
8824. The instructions for the
form explain how to report the details of the exchange.
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. See
chapter 4. You may have to report the recognized gain as ordinary
income from depreciation. See Like-Kind Exchanges and Involuntary
Conversions in chapter 3.
Exchange expenses.
Exchange expenses are generally the closing costs you pay. They
include such items as brokerage commissions, attorney fees, and deed
preparation fees. Subtract these expenses from the consideration
received to figure the amount realized on the exchange. Also add them
to the basis of the like-kind property received. If you receive cash
or unlike property in addition to the like-kind property and realize a
gain on the exchange, subtract the expenses from the cash or fair
market value of the unlike property. Then use the net amount to figure
the recognized gain. See Partially Nontaxable Exchanges,
later.
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 inventories, raw materials, and real estate held by
dealers.
- Stocks, bonds, notes, or other securities or evidences of
indebtedness, such as accounts receivable.
- Partnership interests.
- Certificates of trust or beneficial interest.
- Choses in action.
However, you might have a nontaxable exchange under other
rules. See Other Nontaxable Exchanges, later.
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. However, see
Multiple Property Exchanges, later.
Like-Kind Property
There must be an exchange of like-kind property. Like-kind
properties are properties of the same nature or character, even if
they differ in grade or quality. The exchange of real estate for real
estate and the exchange of personal property for similar personal
property are exchanges of like-kind property. For example, the trade
of land improved with an apartment house for land improved with a
store building, or a panel truck for a pickup truck, is a like-kind
exchange.
An exchange of personal property for real property does not qualify
as a like-kind exchange. For example, an exchange of a piece of
machinery for a store building does not qualify. Nor does the exchange
of livestock of different sexes qualify.
Real property.
An exchange of city property for farm property, or improved
property for unimproved property, is a like-kind exchange.
The exchange of real estate you own for a real estate lease that
runs 30 years or longer is a like-kind exchange. However, not all
exchanges of interests in real property qualify. The exchange of a
life estate expected to last less than 30 years for a remainder
interest is not a like-kind exchange.
An exchange of a remainder interest in real estate for a remainder
interest in other real estate is a like-kind exchange if the nature or
character of the two property interests is the same.
Foreign real property exchanges.
Real property located in the United States and real property
located outside the United States are not considered like-kind
property under the like-kind exchange rules. If you exchange foreign
real property for property located in the United States, your gain or
loss on the exchange is recognized. Foreign real property is real
property not located in a state or the District of Columbia.
This foreign real property exchange rule does not apply to the
replacement of condemned real property. Foreign and U.S. real property
can still be considered like-kind property under the rules for
replacing condemned property to postpone reporting gain on the
condemnation. See Postponement of Gain under
Involuntary Conversions, earlier.
Personal property.
Depreciable tangible personal property can be either "like kind"
or "like class" to qualify for nonrecognition treatment.
Like-class properties are depreciable tangible personal properties
within the same General Asset Class or Product Class. Property
classified in any General Asset Class may not be classified within a
Product Class.
General Asset Classes.
General Asset Classes describe the types of property frequently
used in many businesses. They include the following property.
- Office furniture, fixtures, and equipment (asset class
00.11).
- Information systems, such as computers and peripheral
equipment (asset class 00.12).
- Data handling equipment except computers (asset class
00.13).
- 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).
- Automobiles and taxis (asset class 00.22).
- Buses (asset class 00.23).
- Light general purpose trucks (asset class 00.241).
- Heavy general purpose trucks (asset class 00.242).
- Railroad cars and locomotives except those owned by railroad
transportation companies (asset class 00.25).
- Tractor units for use over the road (asset class
00.26).
- Trailers and trailer-mounted containers (asset class
00.27).
- Vessels, barges, tugs, and similar water-transportation
equipment, except those used in marine construction (asset class
00.28).
- 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, Standard
Industrial Classification Manual (SIC 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
the National Technical Information Service at
1-800-553-NTIS
(1-800-553-6847). The cost of the manual is
$36 and the order number is PB87-100012.
Example 1.
You transfer a personal computer used in your business for a
printer to be used in your business. The properties exchanged are
within the same General Asset Class and are of a like class.
Example 2.
Trena transfers a grader to Ron in exchange for a scraper. Both are
used in a business. Neither property is within any of the General
Asset Classes. Both properties, however, are within the same Product
Class and are of a like class.
Intangible personal property and nondepreciable personal
property.
If you exchange intangible personal property or nondepreciable
personal property for like-kind property, no gain or loss is
recognized on the exchange. (There are no like classes for these
properties.) Whether intangible personal property, such as a patent or
copyright, is of a like kind to other intangible personal property
generally depends on the nature or character of the rights involved.
It also depends on the nature or character of the underlying property
to which those rights relate.
Example.
The exchange of a copyright on a novel for a copyright on a
different novel can qualify as a like-kind exchange. However, the
exchange of a copyright on a novel for a copyright on a song is not a
like-kind exchange.
Goodwill and going concern.
The exchange of the goodwill or going concern value of a business
for the goodwill or going concern value of another business is not a
like-kind exchange.
Foreign personal property exchanges.
Personal property used predominantly in the United States and
personal property used predominantly outside the United States are not
like-kind property under the like-kind exchange rules. If you exchange
property used predominantly in the United States for property used
predominantly outside the United States, your gain or loss on the
exchange is recognized.
This rule does not apply to any transfer under a written binding
contract in effect on June 8, 1997, or at any time thereafter before
the disposition of property. A contract will not fail to be binding
solely because it provides for a sale in lieu of an exchange or the
property to be acquired as replacement property was not identified
under that contract before June 9, 1997.
Predominant use.
You determine the predominant use of property you gave up based on
where that property was used during the 2-year period ending on the
date you gave it up. You determine the predominant use of the property
you acquired based on where that property was used during the 2-year
period beginning on the date you acquired it.
But if you held either property less than 2 years, determine its
predominant use based on where that property was used only during the
period of time you (or a related person) held it. This does not apply
if the exchange is part of a transaction (or series of transactions)
structured to avoid having to treat property as unlike property under
this rule.
However, you must treat property as used predominantly in the
United States if it is used outside the United States but, under
section 168(g)(4) of the Internal Revenue Code, is eligible for
accelerated depreciation as though used in the United States.
Deferred Exchange
A deferred exchange is one in which you transfer property you use
in business or hold for investment and later you 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.
If, before you receive the replacement property, you actually or
constructively receive money or unlike property in full payment for
the property you transfer, the transaction will be treated as a sale
rather than a deferred exchange. In that case, you must recognize gain
or loss on the transaction, even if you later receive the replacement
property. (It would be treated as if you bought it.)
You constructively receive money or unlike property when the money
or property is credited to your account or made available to you. You
also constructively receive money or unlike property when any limits
or restrictions on it expire or are waived.
Whether you actually or constructively receive money or unlike
property, however, is determined without regard to certain
arrangements you make to ensure that the other party carries out its
obligation to transfer the replacement property to you. For example,
if you have that obligation secured by a mortgage or by cash or its
equivalent held in a qualified escrow account or qualified trust, that
arrangement will be disregarded in determining whether you actually or
constructively receive money or unlike property. For more information,
see section 1.1031(k)-1(g) of the regulations. Also, see
Like-Kind Exchanges Using Qualified Intermediaries, later.
Identification requirement.
You must identify the property to be received within 45 days after
the date you transfer the property given up in the exchange. Any
property received during that time is considered to have been
identified.
If you transfer more than one property (as part of the same
transaction) and the properties are transferred on different dates,
the identification period and the receipt period begin on the date of
the earliest transfer.
Identifying replacement property.
You must identify the replacement property in a signed written
document and deliver it to the other person involved in the exchange.
You must clearly describe the replacement property in the written
document. For example, use the legal description or street address for
real property and the make, model, and year for a car. In the same
manner, you can cancel an identification of replacement property at
any time before the end of the identification period.
Identifying alternative and multiple properties.
You can identify more than one replacement property. Regardless of
the number of properties you give up, the maximum number of
replacement properties you can identify is the larger of the
following.
- Three.
- Any number of properties whose total fair market value (FMV)
at the end of the identification period is not more than double the
total fair market value, on the date of transfer, of all properties
you give up.
If, as of the end of the identification period, you have identified
more properties than permitted under this rule, the only property that
will be considered identified is:
- Any replacement property you received before the end of the
identification period, and
- Any replacement property identified before the end of the
identification period and received before the end of the receipt
period, but only if the fair market value of the property is at least
95% of the total fair market value of all identified replacement
properties. (Do not include any you canceled.) Fair market value is
determined on the earlier of the date you received the property or the
last day of the receipt period.
Disregard incidental property.
Do not treat property incidental to a larger item of property as
separate from the larger item when you identify replacement property.
Property is incidental if it meets both the following tests.
- It is typically transferred with the larger item.
- The total fair market value of all the incidental property
is not more than 15% of the total fair market value of the larger item
of property.
Replacement property to be produced.
Gain or loss from a deferred exchange can qualify for
nonrecognition even if the replacement property is not in existence or
is being produced at the time you identify it as replacement property.
If you need to know the fair market value of the replacement property
to identify it, estimate its fair market value as of the date you
expect to receive it.
To determine whether the replacement property you received
qualifies as like kind by being substantially the same as the property
you identified, do not take into account any variations due to usual
production changes. Substantial changes in the property to be
produced, however, will disqualify it as like-kind property.
If your identified replacement property is personal property to be
produced, it must be completed by the date you receive it to qualify
as like-kind property.
If your identified replacement property is real property to be
produced and it is not completed by the date you receive the property,
it may still qualify as like-kind property. It will qualify as
like-kind property only if, had it been completed on time, the
property you received would have been considered to be substantially
the same as the property you identified. It is considered to be
substantially the same only to the extent the property received is
considered real property under local law. However, any additional
production on the replacement property after you receive it does not
qualify as like-kind property. (To this extent, the transaction is
treated as a taxable exchange of property for services.)
Receipt requirement.
The property must be received by the earlier of the following
dates.
- The 180th day after the date on which you transfer the
property given up in the exchange.
- The due date, including extensions, for your tax return for
the tax year in which the transfer of the property given up occurs.
You must receive substantially the same property that met the
identification requirement, discussed earlier.
Like-Kind Exchanges
Using Qualified Intermediaries
If you transfer property through a qualified intermediary, the
transfer of the property given up and receipt of like-kind property is
treated as an exchange. This rule applies even if you receive money or
other property directly from a party to the transaction other than the
qualified intermediary.
A qualified intermediary is a person who enters into a
written exchange agreement with you to acquire and transfer the
property you give up and to acquire the replacement property and
transfer it to you. This agreement must expressly limit your rights to
receive, pledge, borrow, or otherwise obtain the benefits of money or
other property held by the qualified intermediary.
A qualified intermediary cannot be either of the following.
- Your agent at the time of the transaction. This includes a
person who has been your employee, attorney, accountant, investment
banker or broker, or real estate agent or broker within the 2-year
period before the transfer of property you give up.
- A person who is related to you or your agent under the rules
discussed in chapter 2 under Nondeductible Loss,
substituting "10%" for "50%."
An intermediary is treated as acquiring and transferring property
if all the following requirements are met.
- The intermediary acquires and transfers legal title to the
property.
- The intermediary enters into an agreement with a person
other than you for the transfer to that person of the property you
give up and that property is transferred to that person.
- The intermediary enters into an agreement with the owner of
the replacement property for the transfer of that property and the
replacement property is transferred to you.
An intermediary is treated as entering into an agreement if the
rights of a party to the agreement are assigned to the intermediary
and all parties to that agreement are notified in writing of the
assignment by the date of the relevant transfer of property.
Like-Kind Exchanges Using Qualified Exchange Accommodation
Arrangements (QEAAs)
The like-kind exchange rules generally do not apply to an exchange
in which you acquire replacement property (new property) before
you transfer relinquished property (property you give up).
However, if you use a qualified exchange accommodation arrangement
(QEAA), the transfer may qualify as a like-kind exchange.
Under a QEAA, either the replacement property or the relinquished
property is transferred to an exchange accommodation titleholder
(EAT), discussed later, who is treated as the beneficial owner of the
property for federal income tax purposes. If the property is held in a
QEAA, the IRS will accept the qualification of property as either
replacement property or relinquished property and the treatment of an
EAT as the beneficial owner of the property for federal income tax
purposes.
Requirements for a QEAA.
Property is held in a QEAA only if all the following requirements
are met.
- You have a written agreement.
- The time limits for identifying and transferring the
property are met.
- The qualified indications of ownership of property are
transferred to an EAT.
Written agreement.
Under a QEAA, you and the EAT must enter into a written agreement
no later than 5 business days after the qualified indications of
ownership (discussed later) are transferred to the EAT. The agreement
must provide all the following.
- The EAT is holding the property for your benefit in order to
facilitate an exchange under the like-kind exchange rules and Revenue
Procedure 2000-37.
- You and the EAT agree to report the acquisition, holding,
and disposition of the property on your federal income tax returns in
a manner consistent with the agreement.
- The EAT will be treated as the beneficial owner of the
property for all federal income tax purposes.
Property can be treated as being held in a QEAA even if the
accounting, regulatory, or state, local, or foreign tax treatment of
the arrangement between you and the EAT is different from the
treatment required by the list above.
Bona fide intent.
When the qualified indications of ownership of the property are
transferred to the EAT, it must be your bona fide intent that the
property held by the EAT represents either replacement property or
relinquished property in an exchange intended to qualify for
nonrecognition of gain (in whole or in part) or loss under the
like-kind exchange rules.
Time limits for identifying and transferring property.
Under a QEAA, the following time limits for identifying and
transferring the property must be met.
- No later than 45 days after the transfer of qualified
indications of ownership of the replacement property to the EAT, you
must identify the relinquished property in a manner consistent with
the principles for deferred exchanges. See Identification
requirement earlier under Deferred Exchange.
- One of the following transfers must take place no later than
180 days after the transfer of qualified indications of ownership of
the property to the EAT.
- The replacement property is transferred to you (either
directly or indirectly through a qualified intermediary, defined
earlier under Like-Kind Exchanges Using Qualified
Intermediaries).
- The relinquished property is transferred to a person other
than you or a disqualified person. A disqualified person is either of
the following.
- Your agent at the time of the transaction. This includes a
person who has been your employee, attorney, accountant, investment
banker or broker, or real estate agent or broker within the 2-year
period before the transfer of the relinquished property.
- A person who is related to you or your agent under the rules
discussed in chapter 2 under Nondeductible Loss,
substituting "10%" for "50%."
- The combined time period the relinquished property and
replacement property are held in the QEAA cannot be longer than 180
days.
Exchange accommodation titleholder (EAT).
The EAT must meet all the following requirements.
- Hold qualified indications of ownership (defined next) at
all times from the date of acquisition of the property until the
property is transferred (as described in (2), earlier).
- Be someone other than you or a disqualified person (as
defined in 2(b), earlier).
- Be subject to federal income tax. If the EAT is treated as a
partnership or S corporation, more than 90% of its interests or stock
must be owned by partners or shareholders who are subject to federal
income tax.
Qualified indications of ownership.
Qualified indications of ownership are any of the following.
- Legal title to the property.
- Other indications of ownership of the property that are
treated as beneficial ownership of the property under principles of
commercial law (for example, a contract for deed).
- Interests in an entity that is disregarded as an entity
separate from its owner for federal income tax purposes (for example,
a single member limited liability company) and that holds either legal
title to the property or other indications of ownership.
Other permissible arrangements.
Property will not fail to be treated as being held in a QEAA as a
result of certain legal or contractual arrangements, regardless of
whether the arrangements contain terms that typically would result
from arm's-length bargaining between unrelated parties for those
arrangements. For a list of those arrangements, see Revenue Procedure
2000-37 in Internal Revenue Bulletin No. 2000-40.
Partially Nontaxable Exchanges
If, in addition to like-kind property, you receive money or unlike
property in an exchange on which you realize a gain, you have a
partially nontaxable exchange. You are taxed on the gain you realize,
but only to the extent of the money and the fair market value of the
unlike property you receive.
A loss is never deductible in a nontaxable exchange in which you
receive unlike property or cash.
To figure the taxable gain, first determine the fair market value
of any unlike property you receive and add it to any money you
receive. The total is the maximum gain that can be taxed. Next, figure
the gain on the whole exchange as discussed earlier under Gain or
Loss From Sales and Exchanges. Your recognized (taxable) gain is
the lesser of these two amounts.
Example.
You exchange real estate held for investment with an adjusted basis
of $8,000 for other real estate you want to hold for investment. The
fair market value of the real estate you receive is $10,000. You also
receive $1,000 in cash. You paid $500 in exchange expenses. Although
the total gain realized on the transaction is $2,500, only $500
($1,000 cash received minus the $500 exchange expenses) is recognized
(included in your income).
Assumption of liabilities.
If the other party to a nontaxable exchange assumes any of your
liabilities, you will be treated as if you received cash in the amount
of the liability. For more information on the assumption of
liabilities, see section 357(d) of the Internal Revenue Code.
Example.
The facts are the same as in the previous example, except the
property you give up is subject to a $3,000 mortgage for which you
were personally liable. The other party in the trade has agreed to pay
off the mortgage. Figure the gain realized as follows.
FMV of like-kind property received |
$10,000 |
Cash |
1,000 |
Mortgage treated as assumed by other
party |
3,000 |
Total received |
$14,000 |
Minus: Exchange expenses |
(500) |
Amount realized |
$13,500 |
Minus: Adjusted basis of property you
transferred |
(8,000) |
Realized gain |
$
5,500 |
The realized gain is taxed only up to $3,500, the sum of the cash
received ($1,000 - $500 exchange expenses) and the mortgage
($3,000).
Unlike property given up.
If, in addition to like-kind property, you give up unlike property,
you must recognize gain or loss on the unlike property you give up.
The gain or loss is equal to the difference between the fair market
value of the unlike property and the adjusted basis of the unlike
property.
Example.
You exchange stock and real estate you held for investment for real
estate you also intend to hold for investment. The stock you transfer
has a fair market value of $1,000 and an adjusted basis of $4,000. The
real estate you exchange has a fair market value of $19,000 and an
adjusted basis of $15,000. The real estate you receive has a fair
market value of $20,000. You do not recognize gain on the exchange of
the real estate because it qualifies as a nontaxable exchange.
However, you must recognize (report on your return) a $3,000 loss on
the stock because it is unlike property.
Basis of property received.
The total basis for all properties (other than money) you receive
in a partially nontaxable exchange is the total adjusted basis of the
properties you give up, with the following adjustments.
- Add both the following amounts.
- Any additional costs you incur.
- Any gain you recognize on the exchange.
- Subtract both the following amounts.
- Any money you receive.
- Any loss you recognize on the exchange.
Allocate this basis first to the unlike property, other than
money, up to its fair market value on the date of the exchange. The
rest is the basis of the like-kind property.
Multiple Property Exchanges
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.
In these situations, you figure your recognized gain and the
basis of the property you receive by comparing the properties within
each exchange group.
Exchange groups.
Each exchange group consists of properties transferred and received
in the exchange that are of like kind or like class. (See
Like-Kind Property, earlier.) If property could be included
in more than one exchange group, you can include it in any one of
those groups. However, the following may not be included in an
exchange group.
- Money.
- Stock in trade or other property held primarily for
sale.
- Stocks, bonds, notes, or other securities or evidences of
debt or interest.
- Interests in a partnership.
- Certificates of trust or beneficial interests.
- Choses in action.
Example.
Ben exchanges computer A (asset class 00.12), automobile A (asset
class 00.22), and truck A (asset class 00.241) for computer R (asset
class 00.12), automobile R (asset class 00.22), truck R (asset class
00.241), and $400. All properties transferred were used in Ben's
business. Similarly, all properties received will be used in his
business.
The first exchange group consists of computers A and R, the second
exchange group consists of automobiles A and R, and the third exchange
group consists of trucks A and R.
Treatment of liabilities.
Offset all liabilities you assume as part of the exchange against
all liabilities of which you are relieved. Offset these liabilities
whether they are recourse or nonrecourse and regardless of whether
they are secured by or otherwise relate to specific property
transferred or received as part of the exchange.
If you assume more liabilities than you are relieved of,
allocate the difference among the exchange groups in proportion to the
total fair market value of the properties you received in the exchange
groups. The difference allocated to each exchange group may not be
more than the total fair market value of the properties you received
in the exchange group.
The amount allocated to an exchange group reduces the total fair
market value of the properties received in that exchange group. This
reduction is made in determining whether the exchange group has a
surplus or a deficiency. (See Exchange group surplus and
deficiency, later.) This reduction is also made in determining
whether a residual group is created. (See Residual group,
later.)
If you are relieved of more liabilities than you assume,
treat the difference as cash, general deposit accounts (other than
certificates of deposit), and similar items when making allocations to
the residual group, discussed later.
The treatment of liabilities and any differences between amounts
you assume and amounts you are relieved of will be the same even if
the like-kind exchange treatment applies to only part of a larger
transaction. If so, determine the difference in liabilities based on
all liabilities you assume or are relieved of as part of the larger
transaction.
Example.
The facts are the same as in the preceding example. In addition,
the fair market value of and liabilities secured by each property are
as follows.
| Fair
Market
Value |
Liability |
Ben Transfers: |
Computer A |
$1,500 |
$ -0- |
Automobile A |
2,500 |
500 |
Truck A |
2,000 |
-0- |
Ben Receives: |
Computer R |
$1,600 |
$ -0- |
Automobile R |
3,100 |
750 |
Truck R |
1,400 |
250 |
Cash |
400 |
|
All liabilities assumed by Ben ($1,000) are offset by all
liabilities of which he is relieved ($500), resulting in a difference
of $500. The difference is allocated among Ben's exchange groups in
proportion to the fair market value of the properties received in the
exchange groups as follows.
- $131 ($500 × $1,600 × $6,100) is allocated to
the first exchange group (computers A and R). The fair market value of
computer R is reduced to $1,469 ($1,600 - $131).
- $254 ($500 × $3,100 × $6,100) is allocated to
the second exchange group (automobiles A and R). The fair market value
of automobile R is reduced to $2,846 ($3,100 - $254).
- $115 ($500 × $1,400 × $6,100) is allocated to
the third exchange group (trucks A and R). The fair market value of
truck R is reduced to $1,285 ($1,400 - $115).
In each exchange group, Ben uses the reduced fair market value
of the properties received to figure the exchange group's surplus or
deficiency and to determine whether a residual group has been created.
Residual group.
A residual group is created if the total fair market value of the
properties transferred in all exchange groups differs from the total
fair market value of the properties received in all exchange groups
after taking into account the treatment of liabilities (discussed
earlier). The residual group consists of money or other property that
has a total fair market value equal to that difference. It consists of
either money or other property transferred in the exchange or money or
other property received in the exchange, but not both.
Other property includes the following items.
- Stock in trade or other property held primarily for
sale.
- Stocks, bonds, notes, or other securities or evidences of
debt or interest.
- Interests in a partnership.
- Certificates of trust or beneficial interests.
- Choses in action.
Other property also includes property transferred that is not
of a like kind or like class with any property received, and property
received that is not of a like kind or like class with any property
transferred.
For asset acquisitions occurring after March 15, 2001,
money and properties allocated to the residual group are
considered to come from the following assets in the following order.
- Cash and general deposit accounts (including checking and
savings accounts but excluding certificates of deposit). Also include
here excess liabilities of which you are relieved over the amount of
liabilities you assume.
- Certificates of deposit, U.S. Government securities, foreign
currency, and actively traded personal property, including stock and
securities.
- Accounts receivable, other debt instruments, and assets that
you mark to market at least annually for federal income tax purposes.
However, see section 1.338-6(b)(2)(iii) of the regulations for
exceptions that apply to debt instruments issued by persons related to
a target corporation, contingent debt instruments, and debt
instruments convertible into stock or other property.
- Property of a kind that would properly be included in
inventory if on hand at the end of the tax year or property held by
the taxpayer primarily for sale to customers in the ordinary course of
business.
Within each category, you can choose which properties to
allocate to the residual group. If an asset described in (2), (3), or
(4) is includible in more than one category, include it in the lower
number category. For example, if an asset is described in both (3) and
in (4), include it in (3).
For asset acquisitions occurring after January 5, 2000, and
before March 16, 2001, money and properties allocated to the
residual group are considered to come from the following assets in the
following order.
- Cash and general deposit accounts (including checking and
savings accounts but excluding certificates of deposit).
- Certificates of deposit, U.S. Government securities, foreign
currency, and actively traded personal property, including stock and
securities.
- Accounts receivable, mortgages, and credit card receivables
that arose in the ordinary course of business.
- Property of a kind that would properly be included in
inventory if on hand at the end of the tax year or property held by
the taxpayer primarily for sale to customers in the ordinary course of
business.
Example.
Fran exchanges computer A (asset class 00.12) and automobile A
(asset class 00.22) for printer B (asset class 00.12), automobile B
(asset class 00.22), corporate stock, and $500. Fran used computer A
and automobile A in her business and will use printer B and automobile
B in her business.
This transaction results in two exchange groups: (1) computer A and
printer B, and (2) automobile A and automobile B.
The fair market values of the properties are as follows.
| Fair Market
Value |
Fran Transfers: |
Computer A |
$1,000 |
Automobile A |
4,000 |
Fran Receives: |
Automobile B |
$2,950 |
Printer B |
800 |
Corporate Stock |
750 |
Cash |
500 |
Because the total fair market value of the properties
transferred in the exchange groups ($5,000) is $1,250 more than the
total fair market value of the properties received in the exchange
groups ($3,750), there is a residual group in that amount. It consists
of the $500 cash and the $750 worth of corporate stock.
Exchange group surplus and deficiency.
For each exchange group, you must determine whether there is an
"exchange group surplus" or "exchange group deficiency." An
exchange group surplus is the total fair market value of
the properties received in an exchange group (minus any excess
liabilities you assume that are allocated to that exchange group) that
is more than the total fair market value of the properties transferred
in that exchange group. An exchange group deficiency is the
total fair market value of the properties transferred in an exchange
group that is more than the total fair market value of the properties
received in that exchange group (minus any excess liabilities you
assume that are allocated to that exchange group).
Example.
Karen exchanges computer A (asset class 00.12) and automobile A
(asset class 00.22), both of which she used in her business, for
printer B (asset class 00.12) and automobile B (asset class 00.22),
both of which she will use in her business. Karen's adjusted basis and
the fair market value of the exchanged properties are as follows.
|
Adjusted Basis |
Fair Market Value |
Karen Transfers: |
Automobile A |
$1,500 |
$4,000 |
Computer A |
375 |
1,000 |
Karen Receives: |
Printer B |
$2,050 |
Automobile B |
2,950 |
The first exchange group consists of computer A and printer B.
It has an exchange group surplus of $1,050 because the fair market
value of printer B ($2,050) is more than the fair market value of
computer A ($1,000) by that amount.
The second exchange group consists of automobile A and automobile
B. It has an exchange group deficiency of $1,050 because the fair
market value of automobile A ($4,000) is more than the fair market
value of automobile B ($2,950) by that amount.
Recognized gain.
Gain or loss realized for each exchange group and the residual
group is the difference between the total fair market value of the
transferred properties in that exchange group or residual group and
the total adjusted basis of the properties. For each exchange group,
recognized gain is the lesser of the gain realized or the exchange
group deficiency (if any). Losses are not recognized for an exchange
group. The total gain recognized on the exchange of like-kind or
like-class properties is the sum of all the gain recognized for each
exchange group.
For a residual group, you must recognize the entire gain or loss
realized.
For properties you transfer that are not within any exchange group
or the residual group, figure realized and recognized gain or loss as
explained under Gain or Loss From Sales and Exchanges,
earlier.
Example.
Based on the facts in the previous example, Karen recognizes gain
on the exchange as follows.
For the first exchange group, the gain realized is the fair market
value of computer A ($1,000) minus its adjusted basis ($375), or $625.
The gain recognized is the lesser of the gain realized ($625) or the
exchange group deficiency ($0), or $0.
For the second exchange group, the gain realized is the fair market
value of automobile A ($4,000) minus its adjusted basis ($1,500), or
$2,500. The gain recognized is the lesser of the gain realized
($2,500) or the exchange group deficiency ($1,050), or $1,050.
The total gain recognized by Karen in the exchange is the sum of
the gains recognized with respect to both exchange groups ($0 +
$1,050), or $1,050.
Basis of properties received.
The total basis of properties received in each exchange group is
the sum of the following amounts.
- The total adjusted basis of the transferred properties
within that exchange group.
- Your recognized gain on the exchange group.
- The excess liabilities you assume that are allocated to the
group.
- The exchange group surplus (or minus the exchange group
deficiency).
You allocate the total basis of each exchange group
proportionately to each property received in the exchange group
according to the property's fair market value.
The basis of each property received within the residual group
(other than money) is equal to its fair market value.
Example.
Based on the facts in the two previous examples, the bases of the
properties received by Karen in the exchange, printer B and automobile
B, are determined in the following manner.
The basis of the property received in the first exchange group is
$1,425. This is the sum of the following amounts.
- Adjusted basis of the property transferred within that
exchange group ($375).
- Gain recognized for that exchange group ($0).
- Excess liabilities assumed allocated to that exchange group
($0).
- Exchange group surplus ($1,050).
Because printer B is the only property received within the
first exchange group, the entire basis of $1,425 is allocated to
printer B.
The basis of the property received in the second exchange group is
$1,500. This is figured as follows.
First, add the following amounts.
- Adjusted basis of the property transferred within that
exchange group ($1,500).
- Gain recognized for that exchange group ($1,050).
- Excess liabilities assumed allocated to that exchange group
($0).
Then subtract the exchange group deficiency ($1,050).
Because automobile B is the only property received within the
second exchange group, the entire basis ($1,500) is allocated to
automobile B.
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.
Related persons.
Under these rules, related persons include, for example, you and a
member of your family (spouse, brother, sister, parent, child, etc.),
you and a corporation in which you have more than 50% ownership, you
and 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 interests
or profits.
For more information on related persons, see Nondeductible
Loss under Sales and Exchanges Between Related Persons
in chapter 2.
Example.
You used a panel truck in your house painting business. Your sister
used a station wagon in her landscaping business. In December 2000,
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 fair market value 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 fair market value 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 fair market
value 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 2001, 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 2001 tax return,
you must report your $1,000 gain on the 2000 exchange. 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 2001 tax return the
$6,000 balance of her gain on the 2000 exchange. Her adjusted basis in
the truck is increased to $7,000 (its $1,000 basis plus the $6,000
gain recognized).
Two-year holding period.
The 2-year holding period begins on the date of the last transfer
of property that was part of the like-kind exchange. If the holder's
risk of loss on the property is substantially diminished during any
period, however, that period is not counted toward the 2-year holding
period. The holder's risk of loss on the property is substantially
diminished by any of the following events.
- The holding of a put on the property.
- The holding by another person of a right to acquire the
property.
- A short sale or other transaction.
A put is an option that entitles the holder to sell
property at a specified price at any time before a specified future
date.
A short sale involves property you generally do not own.
You borrow the property to deliver to a buyer and, at a later date,
buy substantially identical property and deliver it to the lender.
Exceptions to the rules for related persons.
The following kinds of property dispositions are excluded from
these rules.
- Dispositions due to the death of either related
person.
- Involuntary conversions.
- Dispositions if it is established to the satisfaction of the
IRS that neither the exchange nor the disposition had as a main
purpose the avoidance of federal income tax.
Other Nontaxable Exchanges
The following discussions describe other exchanges that may not be
taxable.
Partnership Interests
Exchanges of partnership interests do not qualify as nontaxable
exchanges of like-kind property. This applies regardless of whether
they are general or limited partnership interests or are interests in
the same partnership or different partnerships. However, under certain
circumstances the exchange may be treated as a tax-free contribution
of property to a partnership. See Contribution of Property
in Publication 541,
Partnerships.
An interest in a partnership that has a valid choice in effect
under section 761(a) of the Internal Revenue Code to be excluded from
all the rules of Subchapter K of the Code is treated as an interest in
each of the partnership assets and not as a partnership interest. See
Exclusion From Partnership Rules in Publication 541.
U.S. Treasury Notes or Bonds
Certain issues of U.S. Treasury obligations may be exchanged for
certain other issues designated by the Secretary of the Treasury with
no gain or loss recognized on the exchange. See U.S. Treasury
Bills, Notes, and Bonds under Interest Income in
Publication 550
for more information on the tax treatment of income
from these investments.
|
For other information on these notes and bonds, call the Bureau of
the Public Debt at 1 (304) 480-7936, or write to the
following address.
Bureau of the Public Debt
Attn: Marketable Assistance Branch
P.O. Box 426
Parkersburg, WV 26106 |
|
Or, on the Internet, visit:
www.publicdebt.treas.gov |
Insurance Policies and Annuities
No gain or loss is recognized if you make any of the following
exchanges.
- A life insurance contract for another or for an endowment or
annuity contract.
- An endowment contract for an annuity contract or for another
endowment contract providing for regular payments beginning at a date
not later than the beginning date under the old contract.
- One annuity contract for another if the insured or annuitant
remains the same.
If you realize a gain on the exchange of an endowment contract or
annuity contract for a life insurance contract or an exchange of an
annuity contract for an endowment contract, you must recognize the
gain.
For information on transfers and rollovers of employer-provided
annuities, see Publication 575,
Pension and Annuity Income,
or Publication 571,
Tax-Sheltered Annuity Plans (403(b)
Plans).
Cash received.
The nonrecognition and nontaxable transfer rules do not apply to a
rollover in which you receive cash proceeds from the surrender of one
policy and invest the cash in another policy. However, you can treat a
cash distribution and reinvestment as meeting the nonrecognition or
nontaxable transfer rules if all the following requirements are met.
- When you receive the distribution, the insurance company
that issued the policy or contract is subject to a rehabilitation,
conservatorship, insolvency, or similar state proceeding.
- You withdraw all amounts to which you are entitled or the
maximum permitted under the state proceeding.
- You reinvest the distribution within 60 days after receipt
in a single policy or contract issued by another insurance company or
in a single custodial account.
- You assign all rights to future distributions to the new
issuer for investment in the new policy or contract if the
distribution was restricted by the state proceeding.
- You would have qualified under the nonrecognition or
nontaxable transfer rules if you had exchanged the affected policy or
contract for the new one.
If you do not reinvest all of the cash distribution, the rules
for partially nontaxable exchanges, discussed earlier, apply.
In addition to meeting these five requirements, you must do both
the following.
- Give to the issuer of the new policy or contract a statement
that includes all the following information.
- The gross amount of cash distributed.
- The amount reinvested.
- Your investment in the affected policy or contract on the
date of the initial cash distribution.
- Attach the following items to your timely filed tax return
for the year of the initial distribution.
- A statement titled "Election under Rev. Proc. 92-44"
that includes the name of the issuer and the policy number (or similar
identifying number) of the new policy or contract.
- A copy of the statement given to the issuer of the new
policy or contract.
Property Exchanged for Stock
If you transfer property to a corporation in exchange for stock in
that corporation (other than nonqualified preferred stock, described
later), and immediately afterward you are in control of the
corporation, the exchange is usually not taxable. This rule applies
both to individuals and to groups who transfer property to a
corporation. It does not apply in the following situations.
- The corporation is an investment company.
- You transfer the property in a bankruptcy or similar
proceeding in exchange for stock used to pay creditors.
- The stock is received in exchange for the corporation's debt
(other than a security) or for interest on the corporation's debt
(including a security) that accrued while you held the debt.
Control of a corporation.
To be in control of a corporation, you or your group of transferors
must own, immediately after the exchange, at least 80% of the total
combined voting power of all classes of stock entitled to vote and at
least 80% of the outstanding shares of each class of nonvoting stock.
Example 1.
You and Bill Jones buy property for $100,000. You both organize a
corporation when the property has a fair market value of $300,000. You
transfer the property to the corporation for all its authorized
capital stock, which has a par value of $300,000. No gain is
recognized by you, Bill, or the corporation.
Example 2.
You and Bill transfer the property with a basis of $100,000 to a
corporation in exchange for stock with a fair market value of
$300,000. This represents only 75% of each class of stock of the
corporation. The other 25% was already issued to someone else. You and
Bill recognize a taxable gain of $200,000 on the transaction.
Services rendered.
The term property does not include services rendered or
to be rendered to the issuing corporation. The value of stock received
for services is income to the recipient.
Example.
You transfer property worth $35,000 and render services valued at
$3,000 to a corporation in exchange for stock valued at $38,000. Right
after the exchange, you own 85% of the outstanding stock. No gain is
recognized on the exchange of property. However, you recognize
ordinary income of $3,000 as payment for services you rendered to the
corporation.
Property of relatively small value.
The term property does not include property of a
relatively small value when it is compared to the value of stock and
securities already owned or to be received for services by the
transferor if the main purpose of the transfer is to qualify for the
nonrecognition of gain or loss by other transferors.
Property transferred will not be considered to be of relatively
small value if its fair market value is at least 10% of the fair
market value of the stock and securities already owned or to be
received for services by the transferor.
Stock received in disproportion to property transferred.
If a group of transferors exchange property for corporate stock,
each transferor does not have to receive stock in proportion to his or
her interest in the property transferred. If a disproportionate
transfer takes place, it will be treated for tax purposes in
accordance with its true nature. It may be treated as if the stock
were first received in proportion and then some of it used to make
gifts, pay compensation for services, or satisfy the transferor's
obligations.
Money or other property received.
If, in an otherwise nontaxable exchange of property for corporate
stock, you also receive money or property other than stock, you may
have to recognize gain. You must recognize gain only up to the amount
of money plus the fair market value of the other property you receive.
The rules for figuring the recognized gain in this situation generally
follow those for a partially nontaxable exchange discussed earlier
under Like-Kind Exchanges. If the property you give up
includes depreciable property, the recognized gain may have to be
reported as ordinary income from depreciation. See chapter 3. No loss
is recognized.
Nonqualified preferred stock.
Nonqualified preferred stock is treated as property other than
stock. Generally, it is preferred stock with any of the following
features.
- The holder has the right to require the issuer or a related
person to redeem or buy the stock.
- The issuer or a related person is required to redeem or buy
the stock.
- The issuer or a related person has the right to redeem or
buy the stock and, on the issue date, it is more likely than not that
the right will be exercised.
- The dividend rate on the stock varies with reference to
interest rates, commodity prices, or similar indices.
For a detailed definition of nonqualified preferred stock, see
section 351(g)(2) of the Internal Revenue Code.
Liabilities.
If the corporation assumes your liabilities, the exchange is not
generally treated as if you received money or other property. There
are two exceptions to this treatment.
- If the liabilities the corporation assumes are more than
your adjusted basis in the property you transfer, gain is recognized
up to the difference. However, if the liabilities assumed give rise to
a deduction when paid, such as a trade account payable or interest, no
gain is recognized.
- If there is no good business reason for the corporation to
assume your liabilities, or if your main purpose in the exchange is to
avoid federal income tax, the assumption is treated as if you received
money in the amount of the liabilities.
For more information on the assumption of liabilities, see
section 357(d) of the Internal Revenue Code.
Example.
You transfer property to a corporation for stock. Immediately after
the transfer, you control the corporation. You also receive $10,000 in
the exchange. Your adjusted basis in the transferred property is
$20,000. The stock you receive has a fair market value (FMV) of
$16,000. The corporation also assumes a $5,000 mortgage on the
property for which you are personally liable. Gain is realized as
follows.
FMV of stock received |
$16,000 |
Cash received |
10,000 |
Liability assumed by corporation |
5,000 |
Total received |
$31,000 |
Minus: Adjusted basis of property
transferred |
20,000 |
Realized gain |
$11,000 |
The liability assumed is not treated as money or other property.
The recognized gain is limited to $10,000, the cash received.
Previous| First | Next
Publication Index | IRS-Forms Main | Home
|