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Module 21Tax Deferred Exchanges

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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 betweenThe difference between

Fair market value (FMV) andFair market value (FMV) and

Adjusted basis (A/B) Adjusted basis (A/B) Of property sold or disposed of.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 Difference between realized gain or loss and recognized gain or lossloss 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 transactionFully taxable transaction Purchase price becomes the adjusted Purchase price becomes the adjusted

basisbasis Holding period begins on the date of Holding period begins on the date of

purchasepurchase

Carryover Basis

The basis of the transfereeThe basis of the transferee

Basis of the transferor Basis of the transferor

+ Any gain recognized+ Any gain recognized Holding period of the transfereeHolding period of the transferee

Includes the transferor’sIncludes the transferor’s

Substituted Basis

Property received basis is Property received basis is Its fair market value Its fair market value

Purchase price basisPurchase price basis Reduced by postponed gainReduced by postponed gain Increased by postponed lossIncreased 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 determineIn all cases need to determine Gain/loss realizedGain/loss realized Gain recognizedGain recognized

Losses are never recognizedLosses are never recognized Basis adjustment required to reflect Basis adjustment required to reflect

gain/loss not recognizedgain/loss not recognized

Introduction to Like-Kind Exchanges

NotNot elective elective No gain/loss recognition if property is No gain/loss recognition if property is

exchanged for “like-kind” propertyexchanged for “like-kind” property Used in T/B or held for investmentUsed in T/B or held for investment AndAnd no “boot” is received for gain no “boot” is received for gain

Loss is never recognizedLoss is never recognized

Non-Qualifying Properties Under §1031

§1031 excludes§1031 excludes

InventoryInventory

Partnership interestPartnership interest

Stock/bonds/securitiesStock/bonds/securities

Evidence of indebtednessEvidence of indebtedness

Certain non-qualified preferred Certain non-qualified preferred stock stock

The Like-Kind RequirementReal Estate

Like-kind broadly construedLike-kind broadly construed Real estate for any real estateReal estate for any real estate

The Like-Kind RequirementPersonality

Like-kind broadly construedLike-kind broadly construed Personality IF substantially the same Personality IF substantially the same

use as original propertyuse as original property

Boot

Any property received or given up in Any property received or given up in an exchange that does not qualify for an exchange that does not qualify for tax deferral treatment tax deferral treatment

Property not like-kindProperty not like-kind

Non-qualifying propertyNon-qualifying property

Net debt reliefNet debt relief

Research Query: Gold for Silver?

The taxpayer has gold bullion that she The taxpayer has gold bullion that she would like to exchange for silver would like to exchange for silver bullionbullion

Does this qualify as a like kind Does this qualify as a like kind exchange under §1031?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 Silver--essentially an industrial commodity Gold--primarily utilized as investment in itself 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 Gain realized is recognized to extent of FMV of bootFMV of boot

Losses never recognized even with Losses never recognized even with boot boot

In Class Exercise: Recognition Under §1031

Case A B C D E

A/R Like-Kind 100 100 100 100 100

Boot - 6 - 15 15

Total A/R 100 106 100 115 115

A/B Like-Kind 110 110 80 105 90

Boot 15 0 8 0 0

Total A/R 125 110 88 105 90

Realized (25) (4) 12 10 25

Solution--In Class Exercise: Recognition Under §1031

Losses not recognized if §1031 appliesLosses not recognized if §1031 applies No loss recognition No loss recognition Cases A & BCases A & B

Gains not recognized if no bootGains not recognized if no boot No gain recognition No gain recognition Case CCase C

No recognition in excess of realizationNo recognition in excess of realization 10 recognized; but 15 boot 10 recognized; but 15 boot Case DCase D

Gain recognized to extent of bootGain recognized to extent of boot 15 of 25 realized gain is recognized 15 of 25 realized gain is recognized Case ECase E

Computation of Substitute Basis Under §1031

Basis in new property =Basis in new property =

FMV of like-kind property FMV of like-kind property receivedreceived

- Gain not recognized- Gain not recognized

+ Loss not recognized+ Loss not recognized

In Class Exercise: Basis Calculation Under §1031

Case A B C D E

A/R Like-Kind 100 100 100 100 100

Boot - 6 - 15 15

Total A/R 100 106 100 115 115

A/B Like-Kind 110 110 80 105 90

Boot 15 0 8 0 0

Total A/R 125 110 88 105 90

Realized (25) (4) 12 10 25

Solution--In Class Exercise: Basis Calculation Under §1031

Start with FMV of like-kind receivedCase A B C D EFMV 100 100 100 100 100

- Gain deferred 0 0 12 0 10

+Loss deferred 25 4 0 0 0

New Basis 125 104 88 100 90

Special §1031 Problems: Deferred Exchanges

Three corner exchanges may be OKThree corner exchanges may be OK

A wants C’s property & tax deferralA wants C’s property & tax deferral

B wants A’s propertyB wants A’s property

B purchases C’s propertyB purchases C’s property

B exchanges with AB exchanges with A A should get tax deferralA should get tax deferral

Special §1031 Problems:Non-Simultaneous Exchange

A wants tax deferral but has not picked A wants tax deferral but has not picked replacement property replacement property

B wants A’s property and is willing B wants A’s property and is willing to to acquire any property A wantsacquire any property A wants

B gets A’s property right nowB gets A’s property right now A’s property chosen within 45 daysA’s property chosen within 45 days A’s property delivered within 180 daysA’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 propertyReinvesting in qualified property Within specific time limitsWithin specific time limits Realization year + 2 tax yearsRealization year + 2 tax years

Losses recognized Losses recognized Unless personal use propertyUnless personal use property

In Class Exercise: InvoluntaryConversion--Gain Recognition

Case A B C D EA/R 200 200 200 200 200

A/B 225 180 180 180 180

Realized (25) 20 20 20 20

Reinvest N/A -0- 205 192 175 In each case determine the gain recognized

Solution--In Class Exercise: Recognition Under §1033

Case A Case A Losses always recognized Losses always recognized Unless personal use property; then Unless personal use property; then

deductible only if casualty lossdeductible only if casualty loss Case B Case B Full recognition of gain if no Full recognition of gain if no

reinvestment reinvestment Case CCase C Full deferral if A/R (or Full deferral if A/R (or

greater) reinvestedgreater) reinvested

Solution--In Class Exercise: Recognition Under §1033

Case D Case D Recognize gain to extent A/R not Recognize gain to extent A/R not reinvested. reinvested. RecognizeRecognize 8 8 DeferDefer 12 12

Case E Case E Recognize 20Recognize 20 Full recognition of gain since amount Full recognition of gain since amount

reinvested is 25 short of A/R and realized reinvested is 25 short of A/R and realized gain was 20gain was 20

Involuntary ConversionSubstituted Basis

Basis = cost of new - gain deferredBasis = cost of new - gain deferred Generally an elective provision Generally an elective provision

So could choose to recognize gainSo could choose to recognize gain

In Class Exercise: InvoluntaryConversion--New Basis

Case A B C D EA/R 200 200 200 200 200

A/B 225 180 180 180 180

Realized (25) 20 20 20 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 E

Purchase price N/A N/A 205 192 175

- Gain deferred 20 12 0

New Basis N/A N/A 185 180 175

Involuntary Conversion Theft or Destruction

Generally deals with gains onlyGenerally deals with gains only As per casualty/theft As per casualty/theft But suddennessBut suddenness not requirednot required Occurs if insured for replacement cost Occurs if insured for replacement cost

and property is appreciatedand 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 ConversionCondemnation

Forced transfer to governmentalForced transfer to governmental authority w/ power to enforce saleauthority w/ power to enforce sale Taken for public useTaken for public use SeizureSeizure RequisitionRequisition Condemnation Condemnation

Sold under threat of condemnationSold under threat of condemnation

Replacement Property--Similar or Related in Use or Service

Owner who is user must meetOwner who is user must meet Functional use testFunctional use test Replacement serves same functionReplacement serves same function

in taxpayer's businessin taxpayer's business

Replacement Property--Similar or Related in Use or Service

Owner who is lessor must meetOwner who is lessor must meet Taxpayer use test Taxpayer use test Rental property replaced with any Rental property replaced with any

rental propertyrental property

Special Rules for §162 or §212 Property

Get an extra year to reinvest Get an extra year to reinvest Replacement can be “like-kind”Replacement can be “like-kind”

See §1031 definitionSee §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 Ordinary income if the receipt of the boot has the same effect as the boot has the same effect as the distribution of a dividenddistribution of a dividend

Basis of Shareholder’s Replacement Stock/Securities

Basis of stock/securities received is Basis of stock/securities received is

Adjusted basis of stock or Adjusted basis of stock or securities securities surrenderedsurrendered

+ Gain recognized on the + Gain recognized on the exchangeexchange

- Boot received in the exchange- Boot received in the exchange

Seven Organizational Patterns Qualifying for Non-Recognition

Described in §368(a)(1)(A) through Described in §368(a)(1)(A) through Sec. 368(a)(1(G). Sec. 368(a)(1(G).

Stock and securities received in a Stock and securities received in a corporate reorganization is treated in corporate reorganization is treated in much the same way as a like-kind much the same way as a like-kind exchangeexchange

Miscellaneous Tax Deferred Exchanges

Key Learning Objectives (1) An overview Transfers between spouses

§1041§1041 Exchanges of life insurance,

endowment, and annuity contracts §1035§1035

Miscellaneous Tax Deferred Exchanges

Key Learning Objectives (2) Divestitures under conflict-of-interest rules

§1043§1043 Investments in specialized small business

investment companies §1044§1044

Reinvestments of proceeds of an ESOP sale §1042§1042