CH15: Conversions and Exchanges Key concepts: Involuntary Conversions & Like kind exchanges Involuntary Conversions: Two types: Condemnations (Property taken by government) & Casualty Gains (Insurance proceeds – client’s basis) Deferral of Gain – Acquisition of We also discuss several other topics like genetics exam 2
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Replacement Property, includes: condemnation, seizure, casualty & theft Election: if the client wants to report the gain, don’t have to follow this rule. Pay tax in the future years. Replacement Period 1. For seizure, casualty & theft, generally 2 years, Eg: involuntary conversion took place on 10/25/2016, it becomes 12/31/2016, and the replacement must be made 12/31/2018 2. If the result of casualty is a condemnation of business or investment real estate, the client has 3 years to acquire replacement property. What type of property is appropriate replacement property? If it’s casualty type of event, taxpayer must acquire similar or related in service or use property. Eg: replace bowling alley for bowling alley, warehouse for warehouse. If it’s a condemnation or presidentially declared disasters, such as Santa Cruz take a property for park => like kind replacement property. Eg: replace bowling alley for apartment building The way the gain is deferred using the involuntary conversion rules: New Basis = Cost/Basis of replacement (What client paid for replacement) – Deferred gain Other formulas: Realized gain = proceeds from loss (Insurance paid) – adjusted basis Recognized gain: insurance > cost to rebuild Deferred gain= realized gainrecognized gain Gain recognized: 1) No gain is recognized if the cost of the replacement property > “the amount realized” (INSURANCE) 1537: L owned a leased warehouse that was totally destroyed by fire on October 31, 2015. The building had a basis to L of $45,000 and his insurance paid the replacement cost of $75,000. L completed construction of a new warehouse on the same land on December 2, 2017 at a cost of $80,000. a) How much gain must L recognize on this conversion? 解: Casualty type of involuntary conversion. To see whether it’s taxable/recognized gain, we have to see 1) if the replacement was made in time frame: 2 years. (If construction wasn’t completed till 2018, taxpayer don’t need to pay tax on the gain, and you count the construction cost up to Dec 31, 2017 and compare that with insurance proceeds. Or you can ask IRS to extend deadline.) Insurance: 75000 AB: 45000 Realized gain: 30000 > economic gain Taxable gain, recognized 0 > insurance < replacement cost Deferred gain: 30000 > non taxable gain b) What’s L’s basis in the replacement warehouse? 解: Replacement: 80,000 Deferred gain: <30,000> New Basis: 50,000 c) Summarize L’s reporting requirements. 解: When fire took place in 2015, report to IRS we had a fire damage to warehouse, we received $75000 from insurance company and we intended to rebuild a new warehouse. In 2017, told the IRS completed the construction, it cost $80000 and the new basis is $50000 under the tax rule. What if they report to IRS for replacement of new warehouse in 2015 and they never do? Taxable invent, and involuntary rule is not applicable and it’s taxable in the end of year 2015 tax return. d) How would your answers to parts (a), (b), and (c) differ if L had invested only $65,000 in the replacement property?解: You would recognize $10,000 gain on tax return in year 2015. Insurance: 75000 A.B: 45000 Realized Gain: 30000 Recognized Gain: 10000=7500065000 > Insurance > Replacement cost Deferred Gain: 20000 Replacement cost: 65000 Deferred Gain: <20000> New Basis: 45000 Like kind exchanges: mandatory rule, business property, investment property, not personal use, usually real estate for real estate. Eg: If I trade personal residence to another personal residence, this rule doesn’t apply. If I trade rental property to another rental property, this rule will apply. If I trade business delivery truck to another new business delivery truck, this rule will apply. If I exchange bowling alley for an apartment building, this is a like kind exchange b/c it’s trading business real estate for business real estate. Not Likekind exchanges: Inventory, Stock, Bonds, Securities, interest in partnership or property that is not a likekind. Eg1: I can’t trade stock for another stock and call it a likekind exchange. Eg2: In theory, I can trade rental real estate for well known painting (personal tangible property), both would be investment assets but that would not quality as a likekind b/c I’m not trading real estate for real estate. If the client has engaged in a qualified like kind exchange (trading equity and property), then no gain taxable or loss deductible will be recognized in the transaction. If there is gain realized on exchange, it will be recognized as a boot. Boot: non like kind property, like cash and liability relief Basis of Property Received: 1. Basis of Boot=FMV 2. Basis of Likekind property = FMV of the Property – Deferred Gain or + Deferred Loss Basis of Property Received in a likekind exchange METHOD 2 (Preferred): FMV of likekind property received $xxx Less: Deferred gain (realized gainrecognized gain) –xxx Or Plus: Realized loss (deferred) +xxx Basis of property received $xxx If there is boot that’s has been received, cash or non like kind property, that will 1) cause gain to be recognized 2) assign a basis to the boot itself, which is FMV of the property. 1543: Likekind exchange. T transferred his farmland (100% business) to V in exchange for a parcel of unimproved urban real estate held by V as an investment. The farm was valued at $400,000 and was subject to a mortgage obligation of $260,000. T’s basis in the farm was $340,000. The urban real estate was valued at $450,000 and was subject to a mortgage of $310,000. a) How much gain must T recognize on this exchange? 解: FMVreceived (city property): 450,000 +Liability relief: 260,000 Liability assumed: <310,000> Amount realized: 400,000 A.B of farmland: <340,000> Gain realized: 60,000 (>Recognized, taxable? See if client receive any net boot. Relief of liability is considered as boot but we can net any new liability assumed with the relieved old liability. So is client better off or worse off, does client owe the bank more or less? Owe more, therefore, no boot received, no gain recognized.) Gain recognized: 0 Deferred Gain: $60,000 b) What is T’s basis in the urban real estate received? 解: Use method #2: FMV: $450,000 Deferred gain: <60,000> Basis: $390,000 (If the city property is sold, now the gain of $60,000 will be recognized)Change: receive cash: Cash: 10000 FMV: 45000 FMV received: 450000 Deferred gain: <60000> +Liability relief: 260000 New Basis: 39000 Liability assumed: <310,000> Amount realized: 410000 Account boot, assign a basis to boot of 10000 A.B: <340000> Gain realized: 70000 Gain recognized: <10000> Deferred gain: 60000 1544: Likekind exchange. Refer to 1543. Assume that V had a basis of $360,000 in the urban real estate transferred to T. a) How much gain must V recognize on the exchange? 解: FMV received (farm): $400,000 +Liability relief: 310,000 Liability assumed: <260,000> > receive net boot, client is better off, owe bank less. Amount realized: 450,000 A.B: <360,000> Gain realized: 90,000 Gain recognized: <50,000> > 310,000260,000 Deferred gain: 40,000 b) What is V’s basis in the farm property received? 解: FMV: $400,000 Deferred gain: <40,000> New Basis: $360,000 Change: this client receive cash: $10,000. It will increase the amount realize & gain realized & gain recognized by $10,000. Cash: 10,000 FMV: 400,000 FMV received: 400000 Deferred gain: <40,000> +Liability relief: 310,000 New Basis: $360,000 Liability assumed:<260,000> Amount realized: 460,000 We also nee to assign a basis to the boot, cash: 10,000 A.B: <360,000> Gain realized: 100,000 Gain recognized: <60,000> > 310,000260,000+10,000 Deferred gain: $40,000 1545: LikeKind Exchange. B exchanged undeveloped land worth $245,000 with C for developed land worth $225,000 and DEF corporation stock worth $20,000. B’s adjusted basis in the end was $176,000. C’s adjusted basis in the land and stock were $243,000 and $17,500. a) How much gain or loss must B recognize in this exchange, and what are his bases in the land and stock received? 解: FMV received: 225,000 Real estate FMV: $225,000 Stock: 20,000 Deferred gain: <49,000> Total 245,000 New basis: $176,000 A.B: <176,000> Gain: 69,000 Assign boot to stock of $20000. Gain recognized: <20,000>>boot received in form of stock Gain deferred: $49,000 b) How much gain or loss must C recognize in this exchange, and what is her basis in the land received? 解: FMV received: $245,000 A.BReal estate: 243,000 Stock(FMV): 20,000 Total: <263,000> Loss realized: <18,000> Loss recognized/taxable: 0 > Loss is never recognized in a like kind exchange, gain is not recognized either, unless the client has received boot. Even the client has received boot, loss is notrecognized. Deferred loss: <18,000> Basis: FMVreal estate: $245,000 +Deferred loss: 18,000 New basis: $263,000 Separate transaction for stock: FMV – stock: $20,000 A.B: <17,500> Gain: 2,500: realized and recognized, taxable. If the basis of the stock had been $30,000 rather than $17,500. Loss: 20,00030,000=<10,000>: loss deductible, investment or business property. If personal use automobile, all gains are taxable, but loss is not deductible. Special rules: 1. Boot paid may generally not be netted with boot received. An exception is made for boot paid in the form of liabilities assumed or cash paid. In this case, liability relief may be offset by the boot paid. 2. The exchange provisions are mandatory and are not elective. 3. Delayed exchanges: you trade property, but occasionally there is a transaction where title is not transferred property simultaneously. It doesn’t quality like kind exchange. You have 45 days from the day you give up title to the old property, to identify the various parcel of real estate you are thinking about acquiring, and you have to actually complete the title transfer within 180 days. Over that, it doesn’t quality like kind exchange. > The replacement property must be identified within 45 days of the exchange and be received within 180 days. Review Questions: Q1: Only business or investment property may qualify for likekind exchange treatment. >True: Personal use doesn’t qualify. Q2: If a business warehouse is destroyed by fire, the taxpayer may purchase an apartment building with the insurance proceeds and qualify to defer the recognition of income using the involuntary conversion rules. >False: b/c it’s casualty: similar and related in use, warehouse for warehouse, bowling alley for bowling alley. Q3: On July 1, 2016 the city of San Jose condemned your client’s office building in order to build a new park. Your client received $500,000 for the building and had an adjusted basis in the property of $300,000. Generally, your client need to acquire appropriate replacement property on or before July 1, 2019 to qualify to defer the recognition of gain. > False, b/c it’s casualty: 2 years + balance of current year. It should be Dec 31, 2019 Q4: Vacant land held for investment purposes may be exchanged for an apartment building to be used to generate rental income and qualify for likekind exchange treatment. > True, b/c real estate for real estate as long as it’s business or investment. Q5: If a taxpayer incurs a loss when engaging in a qualified likekind exchange, the loss is deductible. > False, either gain or loss not recognized unless boot. Q6: The receipt of cash in a likekind exchange of real estate would cause gain realized to be recognized. > True: if it creates loss, not recognized. Q7: The entire gain that results from an involuntary conversion may be deferred as long as the cost f the replacement property exceeds the gain realized. > False: if gain>cost, deferred.