How To Figure
Gain or Loss
You figure gain or loss on a sale or trade of property by comparing
the amount you realize with the adjusted basis of the property.
Gain. If the amount you realize from a sale or trade is more than
the adjusted basis of the property you transfer, the difference is a gain.
Loss. If the adjusted basis of the property you transfer is more
than the amount you realize, the difference is a loss.
Amount realized. The amount you realize from a sale or trade of
property is everything you receive for the property. This includes the money you receive
plus the fair market value of any property or services you receive.
If you finance the buyer's purchase of your property and the debt instrument does not
provide for adequate stated interest, the unstated interest will reduce the amount
realized. For more information, see Publication 537.
Fair market value. Fair
market value is the price at which property would change hands between a buyer and a
seller, neither being forced to buy or sell and both having reasonable knowledge of
all the relevant facts.
The fair market value of notes or other debt instruments you receive as a part of the
sale price is usually the best amount you can get from selling them to, or discounting
them with, a bank or other buyer of debt instruments.
Example. You trade A Company stock with an adjusted basis of
$7,000 for B Company stock with a fair market value of $10,000, which is your amount
realized. Your gain is $3,000 ($10,000 minus $7,000). If you also receive a note for
$6,000 that has a discount value of $4,000, your gain is $7,000 ($10,000 plus $4,000 minus
$7,000).
Debt paid off. A debt against the property, or against you,
that is paid off as a part of the transaction or that is assumed by the buyer must be
included in the amount realized. This is true even if neither you nor the buyer is
personally liable for the debt. For example, if you sell or trade property that is subject
to a nonrecourse loan, the amount you realize generally includes the full amount of the
note assumed by the buyer even if the amount of the note is more than the fair market
value of the property.
Example. You sell stock that you had pledged as security for a
bank loan of $8,000. Your basis in the stock is $6,000. The buyer pays off your bank loan
and pays you $20,000 in cash. The amount realized is $28,000 ($20,000 plus $8,000). Your
gain is $22,000 ($28,000 minus $6,000).
Payment of cash. If you trade property and cash for other
property, the amount you realize is the fair market value of the property you receive.
Determine your gain or loss by subtracting the cash you pay and the adjusted basis of the
property you traded in from the amount you realize. If the result is a positive number, it
is a gain. If the result is a negative number, it is a loss.
No gain or loss. You may have to use a basis for figuring gain that
is different from the basis used for figuring loss. In this case, you may have neither a
gain nor a loss. See No gain or loss in the discussion on the basis of property
you received as a gift under Basis Other Than Cost, earlier.
Nontaxable Trades
This section discusses trades that generally do not result in a
taxable gain or a deductible loss. For more information on nontaxable trades, see
chapter 1 of Publication 544.
Like-Kind Exchanges
If you trade business or investment property for other business or
investment property of a like kind, you do not pay tax on any gain or deduct any
loss until you sell or dispose of the property you receive. To be nontaxable, a trade must
meet all six of the following conditions.
- The property must be business or investment property. You must hold both the property
you trade and the property you receive for productive use in your trade or business or for
investment. Neither property may be property used for personal purposes, such as your home
or family car.
- The property must not be held primarily for sale. The property you trade and the
property you receive must not be property you sell to customers, such as merchandise.
- The property must not be stocks, bonds, notes, choses in action, certificates of trust
or beneficial interest, or other securities or evidences of indebtedness or interest,
including partnership interests. However, you can have a nontaxable trade of corporate
stocks under a different rule, as discussed later.
- There must be a trade of like property. The trade of real estate for real estate, or
personal property for similar personal property, is a trade of like property. The trade of
an apartment house for a store building, or a panel truck for a pickup truck, is a trade
of like property. The trade of a piece of machinery for a store building is not a trade of
like property. Real property located in the United States and real property located
outside the United States are not like property. Also, personal property used
predominantly within the United States and personal property used predominantly outside
the United States are not like property.
- The property to be received must be identified within 45 days after the date you
transfer the property given up in the trade.
- The property to be received must be received by the earlier of:
- The 180th day after the date on which you transfer the property given up in the trade,
or
- The due date, including extensions, for your tax return for the year in which the
transfer of the property given up occurs.
If you trade property with a related party in a like-kind exchange, a special rule may
apply. See Related Party Transactions, later in this chapter. Also, see chapter 1
of Publication 544 for more information on exchanges of business property and special
rules for exchanges using qualified intermediaries or involving multiple properties.
Partly nontaxable exchange. If you receive cash or unlike property
in addition to the like property, and the preceding six conditions are met, you have a
partly nontaxable trade. You are taxed on any gain you realize, but only up to the amount
of the cash and the fair market value of the unlike property you receive. You cannot
deduct a loss.
Like property and unlike property transferred. If you give
up unlike property in addition to the like property, you must recognize gain or loss on
the unlike property you give up. The gain or loss is the difference between the adjusted
basis of the unlike property and its fair market value.
Like property and money transferred. If conditions (1) - (6) are
met, you have a nontaxable trade even if you pay money in addition to the like property.
Basis of property received. You figure your basis in property
received in a nontaxable or partly nontaxable trade as explained earlier under Basis
Other Than Cost, earlier.
How to report. You must report
the trade of like property on Form 8824. If you figure a recognized gain or
loss on Form 8824, report it on Schedule D of Form 1040 or on Form 4797, Sales
of Business Property, whichever applies.
For information on using Form 4797, see chapter 4 of Publication 544.
Corporate Stocks
The following trades of corporate stocks generally do not result in a
taxable gain or a deductible loss.
Corporate reorganizations. In some instances, a company will give
you common stock for preferred stock, preferred stock for common stock, or stock in one
corporation for stock in another corporation. If this is a result of a merger,
recapitalization, transfer to a controlled corporation, bankruptcy, corporate division,
corporate acquisition, or other corporate reorganization, you do not recognize gain or
loss.
Example. On April 18, 2002, KP1 Corporation was acquired by KP2
Corporation. You held 100 shares of KP1 stock with a basis of $3,500. As a result of the
acquisition, you received 70 shares of KP2 stock in exchange for your KP1 stock. You do
not recognize gain or loss on the transaction. Your basis in the 70 shares of the new
stock is still $3,500.
Stock for stock of the same corporation. You can exchange common
stock for common stock or preferred stock for preferred stock in the same corporation
without having a recognized gain or loss. This is true for a trade between two
stockholders as well as a trade between a stockholder and the corporation.
Money or other property received. If in an otherwise
nontaxable trade you receive money or other property in addition to stock, then your gain
on the trade, if any, is taxed, but only up to the amount of the money or other property.
Any loss is not recognized.
Nonqualified preferred stock. Nonqualified preferred stock is generally treated as property other than
stock. Generally, this applies to preferred stock with one or more of the following
features.
- The holder has the right to require the issuer or a related person to redeem or purchase
the stock.
- The issuer or a related person is required to redeem or purchase the stock.
- The issuer or a related person has the right to redeem the stock, and on the issue date,
it is more likely than not that the right will be exercised.
- The dividend rate on the stock varies with reference to interest rates, commodity
prices, or similar indices.
For a detailed definition of nonqualified preferred stock, see section 351(g)(2) of the
Internal Revenue Code.
Convertible stocks and bonds. You
generally will not have a recognized gain or loss if you convert bonds into stock or
preferred stock into common stock of the same corporation according to a conversion
privilege in the terms of the bond or the preferred stock certificate.
Example. In November, you bought for $1 a right issued by XYZ
Corporation entitling you, on payment of $99, to subscribe to a bond issued by that
corporation.
On December 2, you subscribed to the bond, which was issued on December 9. The bond
contained a clause stating that you would receive one share of XYZ Corporation common
stock on surrender of one bond and the payment of $50.
Later, you presented the bond and $50 and received one share of XYZ Corporation common
stock. You did not have a recognized gain or loss. This is true whether the fair market
value of the stock was more or less than $150 on the date of the conversion.
The basis of your share of stock is $150 ($1 + $99 + $50). Your holding period is
split. Your holding period for the part based on your ownership of the bond ($100 basis)
begins on December 2. Your holding period for the part based on your cash investment ($50
basis) begins on the day after you acquired the share of stock.
Bonds for stock of another corporation. Generally, if you convert
the bonds of one corporation into common stock of another corporation, according to the
terms of the bond issue, you must recognize gain or loss up to the difference between the
fair market value of the stock received and the adjusted basis of the bonds exchanged. In
some instances, however, such as trades that are part of mergers or other corporate
reorganizations, you will have no recognized gain or loss if certain requirements are met.
For more information about the tax consequences of converting securities of one
corporation into common stock of another corporation, under circumstances such as those
just described, consult the respective corporations and the terms of the bond issue. This
information is also available on the prospectus of the bond issue.
Property for stock of a controlled corporation. If you transfer
property to a corporation solely in exchange for stock in that corporation, and
immediately after the trade you are in control of the corporation, you ordinarily will not
recognize a gain or loss. This rule applies both to individuals and to groups who transfer
property to a corporation. It does not apply if the corporation is an investment company.
If you are in a bankruptcy or a similar proceeding and you transfer property to a
controlled corporation under a plan, other than a reorganization, you must recognize gain
to the extent the stock you receive in the exchange is used to pay off your debts.
For this purpose, to be in control of a corporation, you or your group of transferors
must own, immediately after the exchange, at least 80% of the total combined voting power
of all classes of stock entitled to vote and at least 80% of the outstanding shares of
each class of nonvoting stock of the corporation.
If this provision applies to you, you must attach to your return a complete statement
of all facts pertinent to the exchange.
Money or other property received. If, in an otherwise
nontaxable trade of property for corporate stock, you also receive money or property other
than stock, you may have a taxable gain. However, you are taxed only up to the amount of
money plus the fair market value of the other property you receive. The rules for figuring
taxable gain in this situation generally follow those for a partially nontaxable exchange
discussed earlier under Like-Kind Exchanges. If the property you give up includes
depreciable property, the taxable gain may have to be reported as ordinary income because
of depreciation. (See chapter 3 of Publication 544.) No loss is recognized.
Nonqualified preferred stock (described earlier under Stock for stock of the same
corporation) received is generally treated as property other than stock.
Basis of stock or other property received. The basis of the
stock you receive is generally the adjusted basis of the property you transfer. Increase
this amount by any amount that was treated as a dividend, plus any gain recognized on the
trade. Decrease this amount by any cash you received and the fair market value of any
other property you received.
The basis of any other property you receive is its fair market value on the date of the
trade.
Insurance Policies
and Annuities
You will not have a recognized gain or loss if you trade:
- A life insurance contract for another life insurance contract or for an endowment or
annuity contract,
- An endowment contract for an annuity contract or for another endowment contract that
provides for regular payments beginning at a date not later than the beginning date under
the old contract, or
- An annuity contract for another annuity contract.
The insured or annuitant must be the same under both contracts. Exchanges of contracts
not included in this list, such as an annuity contract for an endowment contract, or an
annuity or endowment contract for a life insurance contract, are taxable.
Demutualization of Life
Insurance Companies
A life insurance company may change from a mutual company to a stock
company. This is commonly called demutualization. If you were a policyholder or
annuitant of the mutual company, you may have received either stock in the stock company
or cash in exchange for your equity interest in the mutual company.
If the demutualization transaction qualifies as a tax-free reorganization under section
368(a)(1) of the Internal Revenue Code, no gain or loss is recognized on the exchange.
Your holding period for the new stock includes the period you held an equity interest in
the mutual company as a policyholder or annuitant.
If the demutualization transaction does not qualify as a tax-free reorganization under
section 368(a)(1) of the Internal Revenue Code, you must recognize a capital gain or loss.
Your holding period for the stock does not include the period you held an equity interest
in the mutual company.
If you received cash in exchange for your equity interest, you must recognize a capital
gain. If you held an equity interest for more than 1 year, your gain is long-term.
U.S. Treasury
Notes or Bonds
You can trade certain issues of U.S. Treasury obligations for
other issues, designated by the Secretary of the Treasury, with no gain or loss recognized
on the trade.
See the discussion in chapter 1 under U.S. Treasury Bills, Notes, and Bonds for
information about income from these investments.
- Continue - |
