Module 21 Tax Deferred Exchanges

Menu  Tax deferred exchanges and the concept of substituted basis  §1031 like-kind exchanges  §1033 involuntary conversions  Exchanges in qualifying corporate reorganizations  Miscellaneous tax deferred exchanges

Tax Deferred Exchanges and the Concept of Substituted Basis Key Learning Objectives (1)  Realized gain or loss  Recognized gain or loss  Postponed gain or loss

Realized Gain or Loss  The difference between Fair market value (FMV) and Adjusted basis (A/B)  Of property sold or disposed of.

Recognized Gain or Loss  Amount of realized gain or loss  Taxable or deductible for income tax purposes.

Postponed Gain or Loss  Difference between realized gain or loss and recognized gain or loss

Tax Deferred Exchanges and the Concept of Substituted Basis Key Learning Objectives (2)  Purchase price basis  Carryover basis  Substituted basis

Purchase Price Basis  Fully taxable transaction  Purchase price becomes the adjusted basis  Holding period begins on the date of purchase

Carryover Basis  The basis of the transferee Basis of the transferor + Any gain recognized  Holding period of the transferee Includes the transferor’s

Substituted Basis  Property received basis is  Its fair market value  Purchase price basis  Reduced by postponed gain  Increased by postponed loss

§1031 Like-Kind Exchanges

Key Learning Objectives (1)  Introduction to like-kind exchanges  Qualifying properties under §1031  The like-kind requirement: realty  The like-kind requirement: personality

§1031 Like-Kind Exchanges  In all cases need to determine  Gain/loss realized  Gain recognized  Losses are never recognized  Basis adjustment required to reflect gain/loss not recognized

Introduction to Like-Kind Exchanges  Not elective  No gain/loss recognition if property is exchanged for “like-kind” property  Used in T/B or held for investment  And no “boot” is received for gain  Loss is never recognized

Non-Qualifying Properties Under §1031  §1031 excludes Inventory Partnership interest Stock/bonds/securities Evidence of indebtedness Certain non-qualified preferred stock

The Like-Kind Requirement Real Estate  Like-kind broadly construed  Real estate for any real estate

The Like-Kind Requirement Personality  Like-kind broadly construed  Personality IF substantially the same use as original property

Boot  Any property received or given up in an exchange that does not qualify for tax deferral treatment Property not like-kind Non-qualifying property Net debt relief

Research Query: Gold for Silver?

 The taxpayer has gold bullion that she would like to exchange for silver bullion  Does this qualify as a like kind exchange under §1031?

Solution--Research Query: Gold for Silver? Not Like-Kind Rev Rul 82-166, 1982-2 CB 190  The values of silver and gold bullion are determined solely on the basis of metal content  They are "intrinsically” different  Used in different ways  Silver--essentially an industrial commodity  Gold--primarily utilized as investment in itself

§1031 Like-Kind Exchanges

Key Learning Objectives (2)  Computation of gain or loss under §1031  The effects of liabilities on recognized gain or loss  Special §1031 problems: deferred exchanges  Special §1031 problems: related party exchanges

Computation of Gain or Loss Under §1031  Gain realized is recognized to extent of FMV of boot  Losses never recognized even with boot

In Class Exercise: Recognition Under §1031 Case A/R Like-Kind Boot Total A/R A/B Like-Kind Boot Total A/R Realized A B C D E 100 100 100 100 100 6 15 15 100 106 100 115 115 110 110 15 0 80 8 105 0 90 0 125 110 88 105 90 (25) (4) 12 10 25

Solution--In Class Exercise: Recognition Under §1031  Losses not recognized if §1031 applies  No loss recognition Cases A & B  Gains not recognized if no boot  No gain recognition Case C  No recognition in excess of realization  10 recognized; but 15 boot Case D  Gain recognized to extent of boot  15 of 25 realized gain is recognized Case E

Computation of Substitute Basis Under §1031  Basis in new property = FMV of like-kind property received - Gain not recognized + Loss not recognized

In Class Exercise: Basis Calculation Under §1031 Case A/R Like-Kind Boot Total A/R A/B Like-Kind Boot Total A/R Realized A B C D E 100 100 100 100 100 6 15 15 100 106 100 115 115 110 110 15 0 80 8 105 0 90 0 125 110 (25) 88 (4) 12 105 90 10 25

Solution--In Class Exercise: Basis Calculation Under §1031  Start with FMV of like-kind received Case FMV A B C D E 100 100 100 100 100 - Gain deferred +Loss deferred 0 0 25 4 12 0 0 10 0 0 New Basis 125 104 88 100 90

Special §1031 Problems: Deferred Exchanges  Three corner exchanges may be OK A wants C’s property & tax deferral B wants A’s property B purchases C’s property B exchanges with A  A should get tax deferral

Special §1031 Problems: Non-Simultaneous Exchange  A wants tax deferral but has not picked replacement property  B wants A’s property and is willing to acquire any property A wants  B gets A’s property right now  A’s property chosen within 45 days  A’s property delivered within 180 days

§1033 Involuntary Conversions Key Learning Objectives (1)  Tax deferral  Losses on involuntary conversions  Recognized gain  Basis of replacement property  Destruction and theft conversions

Defer Recognition by  Reinvesting in qualified property  Within specific time limits  Realization year + 2 tax years  Losses recognized  Unless personal use property

In Class Exercise: Involuntary Conversion--Gain Recognition Case A/R A/B Realized A 200 200 225 180 (25) B 20 C 200 200 180 180 20 D 20 E 200 180 20 Reinvest N/A -0 205 192 175  In each case determine the gain recognized

Solution--In Class Exercise: Recognition Under §1033  Case A Losses always recognized  Unless personal use property; then deductible only if casualty loss  Case B Full recognition of gain if no reinvestment  Case C Full deferral if A/R (or greater) reinvested

Solution--In Class Exercise: Recognition Under §1033  Case D Recognize gain to extent A/R not reinvested.  Recognize  Defer 8 12  Case E Recognize 20  Full recognition of gain since amount reinvested is 25 short of A/R and realized gain was 20

Involuntary Conversion Substituted Basis  Basis = cost of new - gain deferred  Generally an elective provision  So could choose to recognize gain

In Class Exercise: Involuntary Conversion--New Basis Case A/R A/B Realized A 200 200 225 180 (25) B 20 C 200 200 180 180 20 D 20 E 200 180 20 Reinvest N/A -0 205 192 175  In each case determine the basis in the new property

Solution--In Class Exercise: Basis in New Under §1033  Start with purchase price of new Case A B C D Purchase price N/A N/A - Gain deferred New Basis N/A N/A 205 192 20 185 12 180 E 175 0 175

Involuntary Conversion Theft or Destruction  Generally deals with gains only  As per casualty/theft  But suddenness not required  Occurs if insured for replacement cost and property is appreciated

§1033 Involuntary Conversions Key Learning Objectives (2)  Condemnations  Qualified replacement property: owner-user properties  Qualified replacement property: owner-lessor properties  Qualified replacement period

Involuntary Conversion Condemnation  Forced transfer to governmental authority w/ power to enforce sale  Taken for public use  Seizure  Requisition  Condemnation  Sold under threat of condemnation

Replacement Property--Similar or Related in Use or Service  Owner who is user must meet  Functional use test  Replacement serves same function in taxpayer's business

Replacement Property--Similar or Related in Use or Service  Owner who is lessor must meet  Taxpayer use test  Rental property replaced with any rental property

Special Rules for §162 or §212 Property  Get an extra year to reinvest  Replacement can be “like-kind”  See §1031 definition

Exchanges in Qualifying Corporate Reorganizations Key Learning Objectives  Character of gain to shareholders and security holders  Basis of the shareholder's replacement stock and/or securities

Character of Gain to Shareholders and Security Holders  Ordinary income if the receipt of the boot has the same effect as the distribution of a dividend

Basis of Shareholder’s Replacement Stock/Securities  Basis of stock/securities received is Adjusted basis of stock or securities surrendered + Gain recognized on the exchange - Boot received in the exchange

Seven Organizational Patterns Qualifying for Non-Recognition  Described in §368(a)(1)(A) through Sec. 368(a)(1(G).  Stock and securities received in a corporate reorganization is treated in much the same way as a like-kind exchange

Miscellaneous Tax Deferred Exchanges Key Learning Objectives (1)  An overview  Transfers between spouses  §1041  Exchanges of life insurance, endowment, and annuity contracts  §1035

Miscellaneous Tax Deferred Exchanges Key Learning Objectives (2)  Divestitures under conflict-of-interest rules  §1043  Investments in specialized small business investment companies  §1044  Reinvestments of proceeds of an ESOP sale  §1042