1. Gain or Loss

Topics

This chapter discusses:

• Sales and exchanges
• Abandonments
• Foreclosures and repossessions
• Involuntary conversions
• Nontaxable exchanges
• Transfers to spouse
• Rollovers and exclusions for certain capital gains

Useful Items You may want to see:

Publication

• 523   Selling Your Home
• 537   Installment Sales
• 547   Casualties, Disasters, and Thefts
• 550   Investment Income and Expenses
• 551   Basis of Assets
• 908   Bankruptcy Tax Guide
• 954   Tax Incentives for Empowerment Zones and Other Distressed Communities

Form (and Instructions)

• Schedule D (Form 1040)   Capital Gains and Losses
• 1040   U.S. Individual Income Tax Return
• 1040X   Amended U.S. Individual Income Tax Return
• 1099-A   Acquisition or Abandonment of Secured Property
• 1099-C   Cancellation of Debt
• 4797   Sales of Business Property
• 8824   Like-Kind Exchanges

See chapter 5 for information about getting publications and forms.

Sales and Exchanges

The following discussions describe the kinds of transactions that are treated as sales or exchanges and explain how to figure gain or loss. 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.

Sale or lease.   Some agreements that seem to be leases may really be conditional sales contracts. The intention of the parties to the agreement can help you distinguish between a sale and a lease.

There is no test or group of tests to prove what the parties intended when they made the agreement. You should consider each agreement based on its own facts and circumstances. For more information on leases, see chapter 4 in Publication 535, Business Expenses.

Cancellation of a lease.   Payments received by a tenant for the cancellation of a lease are treated as an amount realized from the sale of property. Payments received by a landlord (lessor) for the cancellation of a lease are essentially a substitute for rental payments and are taxed as ordinary income.

Copyright.   Payments you receive for granting the exclusive use of (or right to exploit) a copyright throughout its life in a particular medium are treated as received from the sale of property. It does not matter if the payments are a fixed amount or a percentage of receipts from the sale, performance, exhibition, or publication of the copyrighted work, or an amount based on the number of copies sold, performances given, or exhibitions made. Nor does it matter if the payments are made over the same period as that covering the grantee's use of the copyrighted work.

If the copyright was used in your trade or business and you held it longer than a year, the gain or loss may be a section 1231 gain or loss. For more information, see Section 1231 Gains and Losses in chapter 3.

Easement.   The amount received for granting an easement is subtracted from the basis of the property. If only a specific part of the entire tract of property is affected by the easement, only the basis of that part is reduced by the amount received. If it is impossible or impractical to separate the basis of the part of the property on which the easement is granted, the basis of the whole property is reduced by the amount received.

Any amount received that is more than the basis to be reduced is a taxable gain. The transaction is reported as a sale of property.

If you transfer a perpetual easement for consideration and do not keep any beneficial interest in the part of the property affected by the easement, the transaction will be treated as a sale of property. However, if you make a qualified conservation contribution of a restriction or easement granted in perpetuity, it is treated as a charitable contribution and not a sale or exchange, even though you keep a beneficial interest in the property affected by the easement.

If you grant an easement on your property (for example, a right-of-way over it) under condemnation or threat of condemnation, you are considered to have made a forced sale, even though you keep the legal title. Although you figure gain or loss on the easement in the same way as a sale of property, the gain or loss is treated as a gain or loss from a condemnation. See Gain or Loss From Condemnations, later.

Property transferred to satisfy debt.   A transfer of property to satisfy a debt is an exchange.

Note's maturity date extended.   The extension of a note's maturity date is not treated as an exchange of an outstanding note for a new and different note. Nor is it a closed and completed transaction on which gain or loss is figured. This treatment will not apply when changes in the term of the note are so significant as to amount virtually to the issuance of a new security. Also, each case must be determined by its own facts.

Transfer on death.   The transfer of property to an executor or administrator on the death of an individual is not a sale or exchange.

Bankruptcy.   Generally, a transfer of property from a debtor to a bankruptcy estate is not treated as a sale or exchange. For more information, see The Bankruptcy Estate in Publication 908.

Gain or Loss From Sales and Exchanges

Gain or loss is usually realized when property is sold or exchanged. A gain is the amount you realize from a sale or exchange of property that is more than its adjusted basis. A loss is the adjusted basis of the property that is more than the amount you realize. 

Table 1-1. How To Figure Whether You Have a Gain or Loss

IF your...	THEN you have a...
Adjusted basis is more than the amount realized,	Loss.
Amount realized is more than the adjusted basis,	Gain.

Basis.   You must know the basis of your property to determine whether you have a gain or loss from its sale or other disposition. The basis of property you buy is usually its cost. However, if you acquired the property by gift, inheritance, or in some way other than buying it, you must use a basis other than its cost. See Basis Other Than Cost in Publication 551.

Adjusted basis.   The adjusted basis of property is your original cost or other basis plus certain additions and minus certain deductions, such as depreciation and casualty losses. See Adjusted Basis in Publication 551. In determining gain or loss, the costs of transferring property to a new owner, such as selling expenses, are added to the adjusted basis of the property.

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 that were 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, later.

Fair market value.   Fair market value (FMV) is the price at which the property would change hands between a buyer and a seller when both have reasonable knowledge of all the necessary facts and neither has to buy or sell. If parties with adverse interests place a value on property in an arm's-length transaction, that is strong evidence of FMV. If there is a stated price for services, this price is treated as the FMV unless there is evidence to the contrary.

Example.   In your business, you used a building that cost you $70,000. You made certain permanent improvements at a cost of $20,000 and deducted depreciation totaling $10,000. You sold the building for $100,000 plus property having an FMV of $20,000. The buyer assumed your real estate taxes of $3,000 and a mortgage of $17,000 on the building. The selling expenses were $4,000. Your gain on the sale is figured as follows.

Amount realized:
Cash	$100,000
FMV of property received	20,000
Real estate taxes assumed by buyer	3,000
Mortgage assumed by buyer	17,000	$140,000
Adjusted basis:
Cost of building	$70,000
Improvements	20,000
Total	$90,000
Minus: Depreciation	10,000
Adjusted basis	$80,000
Plus: Selling expenses	4,000	$84,000
Gain on sale		$56,000

Amount recognized.   Your gain or loss realized from a sale or exchange of property is usually a recognized gain or loss for tax purposes. Recognized gains must be included in gross income. Recognized losses are deductible from gross income. However, your gain or loss realized from certain exchanges of property is not recognized for tax purposes. See Nontaxable Exchanges, later. Also, a loss from the disposition of property held for personal use is not deductible.

Interest in property.   The amount you realize from the disposition of a life interest in property, an interest in property for a set number of years, or an income interest in a trust is a recognized gain under certain circumstances. If you received the interest as a gift, inheritance, or in a transfer from a spouse or former spouse incident to a divorce, the amount realized is a recognized gain. Your basis in the property is disregarded. This rule does not apply if all interests in the property are disposed of at the same time.

Example 1.   Your father dies and leaves his farm to you for life with a remainder interest to your younger brother. You decide to sell your life interest in the farm. The entire amount you receive is a recognized gain. Your basis in the farm is disregarded.

Example 2.   The facts are the same as in Example 1, except that your brother joins you in selling the farm. The entire interest in the property is sold, so your basis in the farm is not disregarded. Your gain or loss is the difference between your share of the sales price and your adjusted basis in the farm.

Canceling a sale of real property.   If you sell real property under a sales contract that allows the buyer to return the property for a full refund and the buyer does so, you may not have to recognize gain or loss on the sale. If the buyer returns the property in the year of sale, no gain or loss is recognized. This cancellation of the sale in the same year it occurred places both you and the buyer in the same positions you were in before the sale. If the buyer returns the property in a later tax year, however, you must recognize gain (or loss, if allowed) in the year of the sale. When the property is returned in a later year, you acquire a new basis in the property. That basis is equal to the amount you pay to the buyer.

Bargain Sale

If you sell or exchange property for less than fair market value with the intent of making a gift, the transaction is partly a sale or exchange and partly a gift. You have a gain if the amount realized is more than your adjusted basis in the property. However, you do not have a loss if the amount realized is less than the adjusted basis of the property.

Bargain sales to charity.   A bargain sale of property to a charitable organization is partly a sale or exchange and partly a charitable contribution. If a deduction for the contribution is allowable, you must allocate your adjusted basis in the property between the part sold and the part contributed based on the fair market value of each. The adjusted basis of the part sold is figured as follows.

Adjusted basis of entire property   X	Amount realized (fair market value of part sold)
	Fair market value of entire property

Based on this allocation rule, you will have a gain even if the amount realized is not more than your adjusted basis in the property. This allocation rule does not apply if a deduction for the contribution is not allowable.

See Publication 526, Charitable Contributions, for information on figuring your charitable contribution.

Example.   You sold property with a fair market value of $10,000 to a charitable organization for $2,000 and are allowed a deduction for your contribution. Your adjusted basis in the property is $4,000. Your gain on the sale is $1,200, figured as follows.

Sales price	$2,000
Minus: Adjusted basis of part sold ($4,000 × ($2,000 ÷ $10,000))	800
Gain on the sale	$1,200

Property Used Partly for Business or Rental

If you sell or exchange property you used partly for business or rental purposes and partly for personal purposes, you must figure the gain or loss on the sale or exchange as though you had sold two separate pieces of property. You must divide the selling price, selling expenses, and the basis of the property between the business or rental part and the personal part. You must subtract depreciation you took or could have taken from the basis of the business or rental part.

Gain or loss on the business or rental part of the property may be a capital gain or loss or an ordinary gain or loss, as discussed in chapter 3 under Section 1231 Gains and Losses. Any gain on the personal part of the property is a capital gain. You cannot deduct a loss on the personal part.

Example.   You sold a condominium for $57,000. You had bought the property 9 years earlier in January for $30,000. You used two-thirds of it as your home and rented out the other third. You claimed depreciation of $3,272 for the rented part during the time you owned the property. You made no improvements to the property. Your expenses of selling the condominium were $3,600. You figure your gain or loss as follows.

		Rental	Personal
		(1/3)	(2/3)
1)	Selling price	$19,000	$38,000
2)	Minus: Selling expenses	1,200	2,400
3)	Amount realized (adjusted sales price)	17,800	35,600
4)	Basis	10,000	20,000
5)	Minus: Depreciation	3,272
6)	Adjusted basis	6,728	20,000
7)	Gain (line 3 - line 6)	$11,072	$15,600

Property Changed to Business or Rental Use

You cannot deduct a loss on the sale of property you acquired for use as your home and used as your home until the time of sale.

You can deduct a loss on the sale of property you acquired for use as your home but changed to business or rental property and used as business or rental property at the time of sale. However, if the adjusted basis of the property at the time of the change was more than its fair market value, the loss you can deduct is limited.

Figure the loss you can deduct as follows.

1. Use the lesser of the property's adjusted basis or fair market value at the time of the change.
2. Add to (1) the cost of any improvements and other increases to basis since the change.
3. Subtract from (2) depreciation and any other decreases to basis since the change.
4. Subtract the amount you realized on the sale from the result in (3). If the amount you realized is more than the result in (3), treat this result as zero.

The result in (4) is the loss you can deduct.

Example.   You changed your main home to rental property 5 years ago. At the time of the change, the adjusted basis of your home was $75,000 and the fair market value was $70,000. This year, you sold the property for $55,000. You made no improvements to the property but you have depreciation expense of $12,620 over the 5 prior years. Your loss on the sale is $7,380 [($75,000 - $12,620) - $55,000]. The amount you can deduct as a loss is limited to $2,380, figured as follows.

Lesser of adjusted basis or fair market value at time of the change	$70,000
Plus: Cost of any improvements and any other additions to basis after the change	-0-
	70,000
Minus: Depreciation and any other decreases to basis after the change	12,620
	57,380
Minus: Amount you realized from the sale	55,000
Deductible loss	$2,380

Gain.   If you have a gain on the sale, you generally must recognize the full amount of the gain. You figure the gain by subtracting your adjusted basis from your amount realized, as described earlier.

You may be able to exclude all or part of the gain if you owned and lived in the property as your main home for at least 2 years during the 5-year period ending on the date of sale. For more information, see Publication 523.

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