module 21 tax deferred exchanges. menu n n tax deferred exchanges and the concept of substituted...
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Module 21Tax 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 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