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Publication 225
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10. Gains and LossesImportant ReminderLower capital gain tax rates. The capital gain tax rates for qualified 5-year gain have been lowered. See Qualified 5-Year Gain, later. IntroductionDuring the year, you may have sold or exchanged property. This chapter explains how to figure your gain or loss on the sale or exchange and determine the effect it has on your taxes. TopicsThis chapter discusses:
Useful ItemsYou may want to see: Publication
Form (and Instructions)
See chapter 21 for information about getting publications and forms. Sales and ExchangesIf you sell, exchange, or otherwise dispose of your property, you usually have a gain or a loss. This section explains certain rules for determining whether any gain you have is taxable, and whether any loss you have is deductible. A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. An exchange is a transfer of property for other property or services. Determining Gain or LossYou usually realize a gain or loss when you sell or exchange property. A gain is the amount you realize from a sale or exchange of property if it is more than its adjusted basis. A loss is the adjusted basis of the property that is more than the amount you realize. See chapter 7 for the definition of basis, adjusted basis, and fair market value. Amount realized. The amount you realize from a sale or exchange is the total of all money you receive plus the fair market value of all property or services you receive. The amount you realize also includes any of your liabilities assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage. If the liabilities relate to an exchange of multiple properties, see Treatment of liabilities under Multiple Property Exchanges in chapter 1 of Publication 544. Amount recognized. Your gain or loss realized from a sale or exchange of property is usually a recognized gain or loss for tax purposes. A recognized gain is a gain you must include in gross income and report on your income tax return. A recognized loss is a loss you deduct from gross income. For example, if your recognized gain from the sale of your tractor is $5,300, you include that amount in gross income on Form 1040. However, your gain or loss realized from the exchange of property may not be recognized for tax purposes. See Like-Kind Exchanges, next. Also, a loss from the disposition of property held for personal use is not deductible. Like-Kind ExchangesCertain exchanges of property are not taxable. This means any gain from the exchange is not recognized, and any loss cannot be deducted. Your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive. The rules for like-kind property exchanges must be followed carefully to ensure the validity of these exchanges. The exchange of property for the same kind of property is the most common type of nontaxable exchange. To be a like-kind exchange, the property traded and the property received must be both of the following.
These two requirements are discussed later. Additional requirements apply to exchanges in which the property received is not received immediately upon the transfer of the property given up. See Deferred exchange, later. If the like-kind exchange involves the receipt of money or unlike property or the assumption of your liabilities, you may have a recognized gain. See Partially nontaxable exchange, later. Multiple-party transactions. The like-kind exchange rules also apply to property exchanges that involve three- and four-party transactions. Any part of these multiple-party transactions can qualify as a like-kind exchange if it meets all the requirements described in this section. Receipt of title from third party. If you receive property in a like-kind exchange and the other party who transfers the property to you does not give you the title, but a third party does, you can still treat this transaction as a like-kind exchange if it meets all the requirements. Basis of property received. If you receive property in a like-kind exchange, the basis of the property will be the same as the basis of the property you gave up. See chapter 7 for more information about basis. Money paid. If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized gain or loss. The basis of the property received is the basis of the property given up, increased by the money paid. Example. Bill Smith trades an old tractor with an adjusted basis of $1,500 for a new one. The new tractor costs $30,000. He is allowed $8,000 for the old tractor and pays $22,000 cash. He has no recognized gain or loss on the transaction regardless of the adjusted basis of his old tractor. If Bill sold the old tractor to a third party for $8,000 and bought a new one, he would have a recognized gain or loss on the sale of his old tractor equal to the difference between the amount realized and the adjusted basis of the old tractor. . Reporting the exchange. Report the exchange of like-kind property, even though no gain or loss is recognized, on Form 8824, Like-Kind Exchanges. The instructions for the form explain how to report the details of the exchange. If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040) or Form 4797, whichever applies. You may also have to report the recognized gain as ordinary income because of depreciation recapture on Form 4797. See chapter 11 for more information. Qualifying property. In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. Machinery, buildings, land, trucks, and rental houses are examples of property that may qualify. The rules for like-kind exchanges do not apply to exchanges of the following property.
However, you might have a nontaxable exchange under other rules. See Other Nontaxable Exchanges in chapter 1 of Publication 544. Like-kind property. To qualify as a nontaxable exchange, the properties exchanged must be of like kind as defined in the income tax regulations. Generally, real property exchanged for real property qualifies as an exchange of like-kind property. Personal property. Depreciable tangible personal property can be either like kind or like class to qualify for nontaxable exchange treatment. Like-class properties are depreciable tangible personal properties within the same General Asset Class or Product Class. Property classified in any General Asset Class may not be classified within a Product Class. General Asset Classes. General Asset Classes describe the types of property frequently used in many businesses. They include the following property.
Product Classes. Product Classes include property listed in a 4-digit product class (except any ending in 9, a miscellaneous category) in Division D of the Standard Industrial Classification codes of the Executive Office of the President, Office of Management and Budget, Standard Industrial Classification Manual (SIC Manual). Copies of the manual may be obtained from the National Technical Information Service, an agency of the U.S. Department of Commerce. To order the manual, call 1-800- 553-NTIS (1-800-553-6847). The cost of the manual is $39 and the order number is PB87-100012. Examples. An exchange of a tractor for a new tractor is an exchange of like-kind property, and so is an exchange of timber land for crop acreage. An exchange of a tractor for acreage, however, is not an exchange of like-kind property. Neither is the exchange of livestock of one sex for livestock of the other sex. An exchange of the assets of a business for the assets of a similar business cannot be treated as an exchange of one property for another property. Whether you engaged in a like-kind exchange depends on an analysis of each asset involved in the exchange. Partially nontaxable exchange. If, in addition to like-kind property, you receive money or unlike property in an exchange on which you realize gain, you have a partially nontaxable exchange. You are taxed on the gain you realize, but only to the extent of the money and the fair market value of the unlike property you receive. A loss is not deductible. Example 1. You trade farm land that cost $30,000 for $10,000 cash and other land to be used in farming with a fair market value of $50,000. You have a realized gain of $30,000, but only $10,000, the cash received, is recognized (included in income). Example 2. Assume the same facts as in Example 1, except that, instead of money, you received a tractor with a fair market value of $10,000. Your recognized gain is still limited to $10,000, the value of the tractor (the unlike property). Example 3. Assume in Example 1 that the fair market value of the land you received was only $15,000. Your $5,000 loss is not deductible. Unlike property given up. If, in addition to like-kind property, you give up unlike property, you must recognize gain or loss on the unlike property you give up. The gain or loss is the difference between the fair market value of the unlike property and the adjusted basis of the unlike property. 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. The 2-year holding period begins on the date of the last transfer of property that was part of the like-kind exchange. 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 the complete list of related persons, see Nondeductible Loss under Sales and Exchanges Between Related Persons in chapter 2 of Publication 544. Example. You used a 1997 pickup truck in your farming business. Your sister used a 1998 pickup truck in her landscaping business. In December 2001, you exchanged your 1997 pickup truck, plus $200, for your sister's 1998 pickup truck. At that time, the fair market value (FMV) of your 1997 pickup truck was $7,000 and its adjusted basis was $6,000. The FMV of your sister's 1998 pickup truck was $7,200 and its adjusted basis was $1,000. You realized a gain of $1,000 (the $7,200 FMV of the 1998 pickup truck minus the $200 you paid, minus the $6,000 adjusted basis of the 1997 pickup truck). Your sister realized a gain of $6,200 (the $7,000 FMV of your 1997 pickup truck plus the $200 you paid, minus the $1,000 adjusted basis of the 1998 pickup truck). However, because this was a like-kind exchange, you recognized no gain. Your basis in the 1998 pickup truck was $6,200 (the $6,000 adjusted basis of the 1997 pickup truck plus the $200 you paid). Your sister recognized gain only to the extent of the money she received, $200. Her basis in the 1997 pickup truck was $1,000 (the $1,000 adjusted basis of the 1998 pickup truck minus the $200 received, plus the $200 gain recognized). In 2002, you sold the 1998 pickup truck to a third party for $7,000. Because you sold it within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. On your tax return for 2002, you must report your $1,000 gain on the exchange in 2001. You also report a loss on the sale of $200 (the adjusted basis of the 1998 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 tax return for 2002 the $6,000 balance of her gain on the 2001 exchange. Her adjusted basis in the 1997 pickup truck is increased to $7,000 (its $1,000 basis plus the $6,000 gain recognized). Exceptions to the rules for related persons. The following property dispositions are excluded from these rules.
Multiple property exchanges. Under the like-kind exchange rules, you must generally 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.
For more information, see Multiple Property Exchanges in chapter 1 of Publication 544. Deferred exchange. A deferred exchange is one in which you transfer property you use in business or hold for investment and later receive like-kind property you will use in business or hold for investment. (The property you receive is replacement property.) The transaction must be an exchange (that is, property for property) rather than a transfer of property for money used to buy replacement property unless the money is held by a qualified intermediary (defined later). A deferred exchange for like-kind property may qualify for nonrecognition of gain or loss if the like-kind property is identified and transferred within the following time limits.
A qualified intermediary is a person who enters into a written exchange agreement with you to acquire and transfer the property you give up and to acquire the replacement property and transfer it to you. This agreement must expressly limit your rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property held by the qualified intermediary. A qualified intermediary cannot be your agent at the time of the transaction or certain persons related to you or your agent. For more information, see Deferred Exchange in chapter 1 of Publication 544. Transfer to SpouseNo gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or a former spouse if incident to divorce. This rule does not apply if the recipient is a nonresident alien. Nor does this rule apply to a transfer in trust to the extent the liabilities assumed and the liabilities on the property are more than the property's adjusted basis. Any transfer of property to a spouse or former spouse on which gain or loss is not recognized is not considered a sale or exchange. The recipient's basis in the property will be the same as the adjusted basis of the giver immediately before the transfer. This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than either its fair market value at the time of transfer or any consideration paid by the recipient. This rule applies for determining loss as well as gain. Any gain recognized on a transfer in trust increases the basis. For more information on transfers of property incident to divorce, see Property Settlements in Publication 504, Divorced or Separated Individuals. - Continue - |