CHAPTER 13

FALL 2015

AMOUNT REALIZED - ILLUSTRATION

AMOUNT REALIZED
CASH
MORTGAGE ASSUMED BY BUYER
LAND (FMV)
-BROKER'S COMMISSION (6%)
-PROP TAX PAID BY SELLER
AMOUNT REALIZED

50,000
30,000
20,000
-6,000
-2,000
92,000

-BASIS
ORIGINAL COST
ROOM ADDITION
CASUALTY LOSS

48,000

GAIN REALIZED

40,000
12,000
-4,000

44,000

MODEL FOR GAINS

=
-

AMOUNT REALIZED
ADJUSTED BASIS
REALIZED GAIN
POSTPONED GAIN
TAX-FREE GAIN
CAPITAL GAIN

= RECOGNIZED GAIN
ORD. INCOME

MODEL FOR LOSSES

=
-

AMOUNT REALIZED
ADJUSTED BASIS
REALIZED LOSS
POSTPONED LOSS
DISALLOWED LOSS

RECOGNIZED LOSS

CAPITAL LOSS
ORD. LOSS

CAPITAL RECOVERIES
COST OR OTHER BASIS
+CAPITAL ADDITIONS
-CAPITAL RECOVERIES
=ADJUSTED BASIS

ADJUSTED BASIS REPRESENTS THE AMOUNT

THAT CAN BE RECOVERED TAX-FREE

EXAMPLES OF CAPITAL RECOVERIES:

DEPRECIATION AND COST RECOVERY
ALLOWANCES
CASUALTIES AND THEFTS
AMORTIZABLE BOND PREMIUM
CERTAIN CORPORATE DISTRIBUTIONS
EASEMENTS

CORPORATE DISTRIBUTIONS
DISTRIBUTIONS MUST BE TREATED AS DIVIDENDS
BY THE SHAREHOLDER TO THE EXTENT OF THE
CORPORATION'S EARNINGS AND PROFITS (E & P)
E & P IS SOMEWHAT EQUIVALENT TO RETAINED
EARNINGS
DISTRIBUTIONS IN EXCESS OF E & P ARE
TREATED AS A RETURN OF CAPITAL
AFTER THE SHAREHOLDER HAS RECOVERED
HIS/HER BASIS IN THE STOCK, ANY ADDITIONAL
DISTRIBUTION IS TREATED AS A CAPITAL GAIN

BASIS CALCULATION FORMULAS

METHOD OF
ACQUISITION

CALCULATION
FORMULA

1.

PURCHASE

COST

2.

TAXABLE
EXCHANGE

FAIR MARKET VALUE

3.

NONTAXABLE
EXCHANGE

BASIS OF QUALIFYING
PROPERTY
TRANSFERRED
+BASIS OF BOOT
TRANSFERRED
+GAIN RECOGNIZED
-LOSS RECOGNIZED
-FMV OF BOOT
RECEIVED
OR

FAIR MARKET VALUE OF QUALIFYING

PROPERTY RECEIVED
- POSTPONED GAIN (I.E., REALIZED
GAIN NOT RECOGNIZED)
+POSTPONED LOSS

4.

GIFT

GAIN OR REGULAR BASIS

DONOR'S BASIS
+ GIFT TAX PAID ON THE
APPRECIATION*
LOSS BASIS
LOWER OF: GAIN BASIS OR
FAIR MARKET VALUE AT THE
DATE OF THE GIFT

*FOR GIFTS AFTER 1976. FOR GIFTS PRIOR

TO 1977, THE ENTIRE GIFT TAX IS ADDED,
SUBJECT TO THE LIMITATION THAT BASIS
CANNOT BE INCREASED ABOVE THE
PROPERTY'S FAIR MARKET VALUE.

GIFTS (CONTINUED)
FOR GIFTS OF DEPRECIABLE PROPERTY
THE BASIS FOR DEPRECIATION IS THE
GAIN BASIS

5.

INHERITANCE

FAIR MARKET VALUE

AT THE PRIMARY
VALUATION DATE
OR
FAIR MARKET VALUE
AT THE ALTERNATE
VALUATION DATE**

**THE ALTERNATE VALUATION AMOUNT CAN BE

ELECTED ONLY IF SUCH ELECTION RESULTS IN A
DECREASE IN BOTH THE GROSS ESTATE AND THE
ESTATE TAX LIABILITY.

DISALLOWED LOSSES
RELATED PARTY TRANSACTIONS - COVERED IN
CHAPTER 6
WASH SALES:
A WASH SALE OCCURS WHEN A TAXPAYER SELLS
OR EXCHANGES STOCK OR SECURITIES, AND
WITHIN 30 DAYS BEFORE OR AFTER THE SALE
ACQUIRES "SUBSTANTIALLY IDENTICAL" STOCK
OR SECURITIES.
THE BASIS OF THE REPLACEMENT STOCK OR
SECURITIES IS THEIR COST INCREASED BY THE
AMOUNT OF THE DISALLOWED LOSS.

PROPERTY CONVERTED TO BUSINESS USE

THE LOSS BASIS OF PROPERTY CONVERTED TO
BUSINESS USE IS THE LOWER OF:
1) THE PROPERTY'S ADJUSTED BASIS
2) THE PROPERTY'S FAIR MARKET VALUE
THE LOSS RULE PREVENTS TAXPAYERS FROM
DEDUCTING PERSONAL LOSSES WHEN THEY
CONTRIBUTE AN ASSET TO A BUSINESS.

PROPERTY CONVERTED TO BUSINESS USE

THE BASIS FOR COST RECOVERY IS THE SAME AS
THE LOSS BASIS. THIS PREVENTS TAXPAYERS
FROM CONVERTING PERSONAL LOSSES INTO
BUSINESS DEDUCTIONS OVER TIME.
THE BASIS FOR GAIN IS ALWAYS THE ADJUSTED
BASIS FOR THE PROPERTY.

ILLUSTRATION - CONVERSION OF PERSONAL

PROPERTY TO BUSINESS PROPERTY
FACTS
BASIS IN PERSONAL RESIDENCE
FMV AT DATE OF CONVERSION

150,000
130,000

SOLUTION
A. LOSS BASIS
130,000
B. DEPRECIATION BASIS 130,000
C. GAIN BASIS
150,000

LIKE-KIND EXCHANGES
THE LANGUAGE OF SEC. 1031 PROVIDES THAT
CERTAIN PROPERTY IS NEITHER PRODUCTIVE
USE NOR INVESTMENT PROPERTY. INCLUDED
ARE:
(1) INVENTORY.
(2) PARTNERSHIP INTERESTS.
(3) STOCKS, BONDS, AND NOTES.
(4) CHOSES IN ACTION.
(5) CERTIFICATES OF TRUST OR BENEFICIAL
INTEREST.
(6) OTHER SECURITIES OR EVIDENCE OF
INDEBTEDNESS OR INTEREST.

LIKE-KIND PROPERTY.PROPERTY EXCHANGED

MUST BE LIKE-KIND PROPERTY.
THERE ARE THREE CATEGORIES OF EXCHANGES
THAT WILL NEVER QUALIFY. THESE ARE:
(1) THE EXCHANGE OF REAL PROPERTY FOR
PERSONAL PROPERTY AND VICE-VERSA.
(2) THE EXCHANGE OF LIVESTOCK OF
DIFFERENT SEXES.
(3) THE EXCHANGE OF REAL PROPERTY
LOCATED IN THE UNITED STATES FOR
FOREIGN REAL PROPERTY AND VICEVERSA.

THE ASSETS EXCHANGED MUST BE IN THE SAME

GENERAL BUSINESS ASSET CLASS. FOR A
PARTIAL LIST OF THE CLASSES SEE PAGE 13-24 IN
THE TEXT.

EFFECT OF BOOT
DEFINITION OF BOOT. BOOT IS PROPERTY
WHICH IS NOT LIKE-KIND PROPERTY. BOOT MAY
BE USED TO EFFECT AN EXCHANGE WHERE THE
VALUES OF THE LIKE-KIND PROPERTY
EXCHANGED ARE NOT EQUAL.
RECEIPT OF BOOT. THE RECEIPT OF BOOT WILL
TRIGGER RECOGNITION IF THERE IS REALIZED
GAIN. THE AMOUNT OF GAIN THAT IS
RECOGNIZED IS THE LOWER OF:
(1)
(2)

THE AMOUNT OF THE REALIZED GAIN.

THE AMOUNT OF BOOT RECEIVED.

IF BOOT IS RECEIVED AND LOSS IS REALIZED, NO

RECOGNITION WILL OCCUR.

GIVING OF BOOT. THE GIVING OF BOOT

NORMALLY DOES NOT TRIGGER RECOGNITION.
HOWEVER, IF THE ADJUSTED BASIS OF THE BOOT
TRANSFERRED IS NOT EQUAL TO ITS FAIR
MARKET VALUE, RECOGNITION OF GAIN OR LOSS
WILL OCCUR.

BASIS OF PROPERTY RECEIVED

BASIS OF BOOT RECEIVED. THE BASIS OF BOOT
RECEIVED IS THE FAIR MARKET VALUE OF THE
PROPERTY.
BASIS OF LIKE-KIND PROPERTY RECEIVED.
SECTION 1031 PROVIDES THE FOLLOWING BASIS
CALCULATION FORMULA FOR THE LIKE-KIND
PROPERTY RECEIVED.
BASIS OF LIKE-KIND PROPERTY
TRANSFERRED
+ BASIS OF BOOT GIVEN
+ GAIN RECOGNIZED
- FAIR MARKET VALUE OF BOOT RECEIVED
- LOSS RECOGNIZED

THE BASIS OF THE LIKE-KIND PROPERTY

RECEIVED ALSO CAN BE CALCULATED USING
THE FOLLOWING FORMULA.
FAIR MARKET VALUE OF LIKE-KIND PROPERTY
RECEIVED
- POSTPONED GAIN, OR
+ POSTPONED LOSS
A POSTPONED GAIN OR LOSS IS A GAIN OR LOSS
THAT IS REALIZED, BUT NOT RECOGNIZED.

HOLDING PERIOD OF PROPERTY RECEIVED

HOLDING PERIOD. A SEPARATE HOLDING
PERIOD RULE APPLIES FOR THE BOOT AND THE
LIKE-KIND PROPERTY RECEIVED.
A.

THE BOOT HAS A NEW HOLDING PERIOD.

B.

THE LIKE-KIND PROPERTY RECEIVED

GENERALLY HAS A SUBSTITUTED HOLDING
PERIOD (I.E., INCLUDES THE HOLDING
PERIOD OF THE LIKE-KIND PROPERTY
TRANSFERRED).

LIKE-KIND GAIN (LOSS)

AMOUNT REALIZED:
L-K PROP (FMV)
BOOT
TOTAL
BASIS
GAIN (LOSS) REAL'D
GAIN (LOSS) RECOG'D
GAIN (LOSS) NOT REC

100
20
120
90
30
20
10

100
30
130
110
20
20
0

100
5
105
120
(15)
(0)
(15)

LIKE-KIND BASIS
LIKE-KIND (FMV)
-GAIN OR + LOSS
NOT RECOGNIZED
BASIS OF NEW PROP

100

100

100

10
90

0
100

15
115

NON-LIKE-KIND PROPERTY GIVEN AS BOOT

AMOUNT REALIZED:
LIKE-KIND PROP (FMV)
200
BASIS OF PROPERTY GIVEN:
LIKE-KIND (160 FMV)
(110)
NON-LIKE-KIND (40 FMV)
( 25)
GAIN REALIZED
65
GAIN RECOG'D (NON LK)
15
GAIN NOT RECOG'D (LK)
50
GAIN REALIZED, NOT RECOGNIZED (LK)
LOSS REALIZED, RECOGNIZED (NON LK)

200
(110)
( 75)
15

50
(35)

BASIS OF PROPERTY RECEIVED

LIKE-KIND (FMV)
-GAIN (LOSS) NOT REC
BASIS OF NEW PROP
NON-LIKE-KIND (FMV)

200
50
150
40

200
50
150
40

INVOLUNTARY CONVERSIONS - SEC. 1033

AN INVOLUNTARY CONVERSION IS THE RESULT
OF THE DESTRUCTION (COMPLETE OR PARTIAL),
THEFT, SEIZURE, REQUISITION OR
CONDEMNATION, OR THE SALE OR EXCHANGE
UNDER THREAT OR IMMINENCE OF REQUISITION
OR CONDEMNATION OF THE TAXPAYER'S
PROPERTY.

INDIRECT INVOLUNTARY CONVERSION.

AN INDIRECT INVOLUNTARY CONVERSION
OCCURS WHEN MONEY IS RECEIVED AND USED
TO REPLACE THE INVOLUNTARILY CONVERTED
PROPERTY.
A REALIZED GAIN IN AN INDIRECT INVOLUNTARY
CONVERSION MAY BE POSTPONED IF THE
TAXPAYER SPENDS THE PROCEEDS FROM THE
INVOLUNTARY CONVERSION FOR QUALIFIED
REPLACEMENT PROPERTY WITHIN A QUALIFIED
REPLACEMENT PERIOD.
HOWEVER, GAIN MUST BE RECOGNIZED TO THE
EXTENT THE PROCEEDS ARE NOT SPENT.
NONRECOGNITION IS AN ELECTIVE PROVISION,
NOT MANDATORY.

DIRECT INVOLUNTARY CONVERSION.

A DIRECT INVOLUNTARY CONVERSION OCCURS
WHEN PROPERTY IS EXCHANGED FOR
PROPERTY.
A REALIZED GAIN IN A DIRECT INVOLUNTARY
CONVERSION (PROPERTY FOR PROPERTY) IS
POSTPONED. THIS PROVISION IS MANDATORY.
REALIZED LOSS ON THE INVOLUNTARY
CONVERSION.
A REALIZED LOSS ON THE INVOLUNTARY
CONVERSION OF BUSINESS OR INCOME
PRODUCING PROPERTY IS RECOGNIZED.

10

A REALIZED LOSS ON THE INVOLUNTARY

CONVERSION OF PERSONAL USE PROPERTY MAY
OR MAY NOT BE RECOGNIZED:
ON A CONDEMNATION, THE REALIZED LOSS IS
NOT RECOGNIZED
ON A CASUALTY OR THEFT, THE REALIZED LOSS IS
RECOGNIZED SUBJECT TO THE $100 AND 10%
FLOOR PROVISIONS FOR PERSONAL USE
CASUALTY AND THEFT LOSS PROPERTY.

REPLACEMENT PROPERTY
UNDER THE GENERAL RULE, REPLACEMENT
PROPERTY MUST BE "SIMILAR OR RELATED IN
SERVICE OR USE" TO THE PROPERTY REPLACED.
THIS REQUIREMENT IS MORE RESTRICTIVE THAN
THE SEC. 1031 REQUIREMENT FOR LIKE-KIND
PROPERTY.
THERE ARE TWO TESTS TO DETERMINE IF A
PROPERTY IS "SIMILAR OR RELATED IN SERVICE
OR USE" TO THE PROPERTY REPLACED

FUNCTIONAL USE TEST. THE FUNCTIONAL USE

TEST IS APPLICABLE FOR THE OWNER-OPERATOR
OF INVOLUNTARILY CONVERTED PROPERTY;
THE TAXPAYER'S USE OF THE REPLACEMENT
PROPERTY AND THE INVOLUNTARILY
CONVERTED PROPERTY MUST BE (EXACTLY) THE
SAME.
TAXPAYER USE TEST. THE TAXPAYER USE TEST
IS APPLICABLE FOR THE OWNER-LESSOR OF
INVOLUNTARILY CONVERTED PROPERTY; THE
PROPERTIES MUST BE USED BY THE TAXPAYER IN
SIMILAR ENDEAVORS; E.G., A WAREHOUSE
LEASED TO VARIOUS TENANTS COULD BE
REPLACED WITH AN OFFICE BUILDING THAT IS
LEASED TO VARIOUS TENANTS.

11

EXCEPTIONS FOR CERTAIN CONDEMNED

PROPERTY.
1)

IF THE FORM OF THE INVOLUNTARY

CONVERSION IS THE CONDEMNATION OF
REAL PROPERTY WHICH IS USED IN THE
TAXPAYER'S TRADE OR BUSINESS OR IS HELD
FOR INVESTMENT, THE "SIMILAR"
REQUIREMENT IS REPLACED WITH THE
REQUIREMENT THAT THE REPLACEMENT
PROPERTY BE "LIKE-KIND."

2)

INVOLUNTARY CONVERSIONS IN AREAS

DECLARED PRESIDENTIAL DISASTER AREAS
MAY USE ANY TANGIBLE REAL PROPERTY
AS REPLACEMENT PROPERTY.

EXAMPLE OF THE FIRST EXCEPTION: T'S

FACTORY BUILDING IS CONDEMNED TO MAKE
WAY FOR AN INTERSTATE HIGHWAY. THE
PROCEEDS RECEIVED ARE REINVESTED IN LAND
TO BE HELD FOR INVESTMENT. THE
ACQUISITION OF SUCH LAND QUALIFIES FOR
POSTPONEMENT TREATMENT UNDER SEC. 1033
BECAUSE THE REPLACEMENT PROPERTY NEED
ONLY BE LIKE-KIND RATHER THAN "SIMILAR OR
RELATED IN SERVICE OR USE."

EARLIEST DATE FOR REPLACEMENT. IF THE

PROPERTY IS CONDEMNED, THE EARLIEST DATE
FOR REPLACEMENT IS THE DATE OF THE THREAT
OR IMMINENCE OF REQUISITION OR
CONDEMNATION OF THE PROPERTY. IF THE
FORM OF THE INVOLUNTARY CONVERSION IS
OTHER THAN CONDEMNATION, THE EARLIEST
DATE IS THE DATE THE INVOLUNTARY
CONVERSION OCCURS.

12

LATEST DATE FOR REPLACEMENT. THE

STARTING POINT FOR DETERMINING THE LATEST
DATE FOR REPLACEMENT IS THE DATE OF THE
REALIZATION OF GAIN. THIS IS THE DATE THE
TAXPAYER RECEIVES AN ASSET INFLOW (CASH
OR OTHER PROPERTY) ASSOCIATED WITH THE
INVOLUNTARY CONVERSION THAT IS LARGE
ENOUGH TO PRODUCE A REALIZED GAIN.

A.

THE GENERAL RULE IS THAT THE

TAXPAYER HAS TWO YEARS FROM THE END
OF THE TAXABLE YEAR IN WHICH GAIN WAS
FIRST REALIZED.

B.

THE REPLACEMENT PERIOD IS THREE YEARS

RATHER THAN TWO YEARS IF THE FORM OF
THE INVOLUNTARY CONVERSION IS THE
CONDEMNATION OF REAL PROPERTY THAT
IS USED IN THE TAXPAYER'S TRADE OR
BUSINESS OR HELD FOR INVESTMENT.

INVOLUNTARY CONVERSIONS
AMOUNT REALIZED
-BASIS
GAIN REALIZED

100
75
25

100
75
25

100
75
25

AMOUNT REALIZED
AMOUNT REINVESTED
GAIN RECOGNIZED
GAIN NOT RECOG'D

100
100
0
25

100
90
10
15

100
120
0
25

BASIS COMPUTATION
AMOUNT REINVESTED
GAIN NOT RECOG'D
BASIS OF NEW PROP

100
25
75

90
15
75

120
25
95

13

SALE OF PERSONAL RESIDENCE 121

UP TO $250,000 OF REALIZED GAIN MAY BE
EXCLUDED ON THE SALE OF A TAXPAYERS
PRINCIPAL RESIDENCE.
PRINCIPAL RESIDENCE MEANS THE RESIDENCE
WHERE THE TAXPAYER RESIDES MOST OF THE
TIME. IS A FACT AND CIRCUMSTANCES TEST.
TO QUALIFY FOR 121 TREATMENT THE
RESIDENCE MUST HAVE BEEN THE PRINCIPAL
RESIDENCE OF THE TAXPAYER FOR 2 OF THE 5
YEARS PRECEDING THE SALE.
THE 121 EXCLUSION MAY BE USED ONLY ONCE
EVERY 2 YEARS.

THESE REQUIREMENTS ARE WAIVED UNDER

THE FOLLOWING CIRCUMSTANCES:

CHANGE IN PLACE OF EMPLOYMENT.

HEALTH.
TO THE EXTENT PROVIDED IN THE
REGULATIONS, OTHER UNFORESEEN
CIRCUMSTANCES.

THE EFFECT OF THE WAIVER IS TO ALLOW A

PORTION OF THE DEDUCTION. THE EXCLUSION
IS CALCULATED USING THE FOLLOWING
FORMULA:
NO. OF QUALIFYING MONTHS X 121 XCLUSION
24 MONTHS
AMT.

THE AMOUNT OF THE EXCLUSION IS $250,000.

THE AMOUNT FOR MFJ IS $500,000 IF THE
FOLLOWING CRITERIA ARE MET.
(1)

EITHER SPOUSE MEETS THE AT-LEAST TWO

YEARS OWNERSHIP REQUIREMENT,

(2)

BOTH SPOUSES MEET THE AT-LEAST TWO

YEARS USE REQUIREMENT, AND,

(3)

NEITHER SPOUSE IS INELIGIBLE FOR THE

121 EXCLUSION ON THE SALE OF THE
CURRENT PRINCIPAL RESIDENCE BECAUSE
OF THE SALE OF ANOTHER PRINCIPAL
RESIDENCE WITHIN THE PRIOR TWO YEARS.

14

Reduction in exclusion due to use as a

vacation home.
For disqualifying use (use as a vacation
home) occurring after 2008 the amount
of the exclusion must be prorated.
See example 75 on page 13-47(It is flat
out wrong!!) See the footnote 101 on
page 13-47

15