Multiple Property Exchanges

Under the like-kind exchange rules, you generally must 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 of the liabilities 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.

1. 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.
2. Certificates of deposit, U.S. Government securities, foreign currency, and actively traded personal property, including stock and securities.
3. 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.
4. 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.
5. Assets other than those listed in (1), (2), (3), (4), (6) and (7).
6. All section 197 intangibles except goodwill and going concern value.
7. Goodwill and going concern value.

Within each category, you can choose which properties to allocate to the residual group. If an asset described in any of the categories above, except (1), 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 (4), include it in (3).

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

the properties received in the exchange groups ($3,750), so 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

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.

1. The total adjusted basis of the transferred properties within that exchange group.
2. Your recognized gain on the exchange group.
3. The excess liabilities you assume that are allocated to the group.
4. 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.

1. Adjusted basis of the property transferred within that exchange group ($375).
2. Gain recognized for that exchange group ($0).
3. Excess liabilities assumed allocated to that exchange group ($0).
4. Exchange group surplus ($1,050).

Printer B is the only property received within the first exchange group, so 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.

1. Adjusted basis of the property transferred within that exchange group ($1,500).
2. Gain recognized for that exchange group ($1,050).
3. Excess liabilities assumed allocated to that exchange group ($0).

Then subtract the exchange group deficiency ($1,050).

Automobile B is the only property received within the second exchange group, so 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 pickup truck in her landscaping business. In December 2001, you exchanged your panel truck plus $200 for your sister's pickup truck. At that time, the fair market value (FMV) of your panel truck was $7,000 and its adjusted basis was $6,000. The fair market value of your sister's pickup truck 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 pickup truck minus the $200 you paid minus the $6,000 adjusted basis of the panel truck). Your sister realized a gain of $6,200 (the $7,000 fair market value of your panel truck plus the $200 you paid minus the $1,000 adjusted basis of the pickup truck).

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

In 2002, you sold the pickup truck to a third party for $7,000. You sold it within 2 years after the exchange, so the exchange is disqualified from nonrecognition treatment. On your 2002 tax return, you must report your $1,000 gain on the 2001 exchange. You also report a loss on the sale of $200 (the adjusted basis of the pickup truck, $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 2002 tax return the $6,000 balance of her gain on the 2001 exchange. Her adjusted basis in the panel 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.

1. 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.
2. You withdraw all amounts to which you are entitled or, if less, the maximum permitted under the state proceeding.
3. 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.
4. 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.
5. 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.

1. Give to the issuer of the new policy or contract a statement that includes all the following information.
   1. The gross amount of cash distributed.
   2. The amount reinvested.
   3. Your investment in the affected policy or contract on the date of the initial cash distribution.
2. Attach the following items to your timely filed tax return for the year of the initial distribution.
   1. 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.
   2. 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 generally is not 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.

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