C 15 Property Transactions

C HA P TER 15
Property
Transactions
FOR SALE
Nonrecognition of Gains
and Losses
Photo by Artazum
Before studying this chapter you should know or, if necessary, review kali9/E+/Getty Images
2.6 Introduction to Property Transactions

12.4 The 3.8% Net Investment Income Tax
14.5 Section 1250 Depreciation Recapture
Chapter Introduction
Derek and Anne have a vacation home property in Vail, Colorado that they purchased 30 years
ago for $200,000. The property now has a value of $1,800,000. For many years, they have used the
house four to six weeks per year and rented it out at other times. Because their children are older
and they are too old to enjoy skiing, they would like to sell the property and buy a new vacation
home on the beach in south Florida. They will use the new home in Florida for personal purposes
six weeks each year and rent out the house the rest of the year. Derek and Anne are concerned
about the large amount of tax they will owe if they sell the Vail property, as it has appreciated
significantly. They ask you if there is any way to accomplish their goal and defer (or avoid) the tax
liability. You will learn how to develop a solution for Derek and Anne in this chapter, as one of the
topics in this chapter is like-kind exchanges. For now, the main point is that often with the right
knowledge, taxpayers can defer, or even exclude, large amounts of gain.
This is the last chapter of Part V on the taxation of property transactions, and we cover areas
for which gains and losses are deferred or excluded. The illustration below shows how this chap-
ter fits into the overall scheme of property transactions. For certain transactions, you defer real-
ized gain and losses, and the taxpayer then includes them on the return in a later tax year. In other
instances, taxpayers exclude the gain or loss, meaning it will never affect taxable income. These
deferrals and exclusions are beneficial to taxpayers in some instances, but not all. Generally, tax-
payers prefer to exclude or defer realized gains to avoid paying tax in the current tax year. On the
other hand, they usually favor recognizing losses in the current year to reduce their tax liability.
We explain four of the more common types of tax-deferred transactions in this chapter:
losses from sales between related parties, wash sales, like-kind exchanges, and involuntary con-
versions. There are a limited number of transactions for which you can exclude realized gains
or losses from income. We discuss two of the more common exclusions: losses on the sale of
personal use assets and the tax treatment for a sale of a principal residence.
15-1
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15-2 CHAPTER 15 Property Transactions
Taxation of Property Transactions
Cost
Other Personal Stocks Bonds Collectibles
Personalty
only
Loss
Losses
Deferred
nondeductible
loss gain
principal
residence
Loss
Rule-Ordinary
Income
Income
LEARNING
OBJECTIVES TOPICS PRACTICE OPPORTUNITIES
DEFERRED GAINS AND LOSSES

1 Calculate the 15.1 Related-Party Losses • Example 15.1.1 Related-Party Loss
recognized loss on • Defining Related Party • Example 15.1.2 Right of Offset
the sales of assets
• Evaluating Related-Party • Example 15.1.3 Qualified Appraisal
between related
parties. Transactions
• Advanced Topics—Drilling
Down:
• Business Entities as Related
Parties

Chapter Introduction 15-3
2 Compute the 15.2 Wash Sales • Example 15.2.1 Wash Sales: All Shares Sold Repurchased
deferred loss from • Defining a Wash Sale • Example 15.2.2 Wash Sales: New Shares Purchased
a wash loss sale Before Original Shares Sold
• Evaluating a Wash Sale
and the basis of
• Example 15.2.3 Wash Sales: Fewer Shares Repurchased
the newly acquired
Than Sold
security.
3 Analyze the tax 15.3 Like-Kind Exchanges • Example 15.3.1 Basic Like-Kind Exchange
consequences of a • Defining Like-Kind Exchanges • Example 15.3.2 Like-Kind Exchange with Cash Boot
like-kind exchange.
• Evaluating Like-Kind • Example 15.3.3 Like-Kind Exchange with Debt Relief
Exchanges • Example 15.3.4 Like-Kind Exchange with Debt Relief
• Boot Received and Debt Relief Given
• Advanced Topics—Drilling Down: • Example 15.3.5 Debt Relief Given Greater than Debt
• Debt Relief Provided by Relief Received
Taxpayer
• Deferred Like-Kind
Exchanges
4 Evaluate the 15.4 Involuntary Conversions • Example 15.4.1 Qualified Replacement Property
effect on income • Defining an Involuntary • Example 15.4.2 Qualified Replacement Period
of an involuntary Conversion • Example 15.4.3 Involuntary Conversion
conversion and the
• Computing an Involuntary •
basis of the new asset.
Conversion
EXCLUDED GAINS AND LOSSES

5 Identify 15.5 Loss on Sale of Personal • Example 15.5.1 Sale of a Personal Use Asset for Loss
transactions related Use Assets • Example 15.5.2 Sale of a Personal Use Asset for Gain
to personal activities
•
that generate
disallowed losses.
6 Describe the 15.6 Sale of Principal • Example 15.6.1 Principal Residence: Use Test for
tax treatment for a Residence Married Couple
sale of a principal • Defining a Principal Residence: • Example 15.6.2 Principal Residence: Frequency Test
residence including
• Ownership and Use Tests • Example 15.6.3 Principal Residence: Exclusion of Gain
recognized gain, if
any. • $250,000/$500,000 Exclusion • Example 15.6.4 Portion of Residence Used as a Home
• Frequency Test Office
• 3.8% Net Investment Income • Example 15.6.5 Principal Residence: Spouse Sold
Tax Residence in Last Two Years
• Evaluating the Sale of a • Example 15.6.6 Principal Residence: Rented During
Principal Residence Portion of Last Five Years
• Advanced Topics—Drilling Down:
• Home Office
• Spouse Violates Frequency
Test
• Rental Use of Home
Tax Forms in this chapter

Form 8824 Like-Kind Exchanges
Form 8949 Sales and Other Dispositions of Capital Assets

15.1 Related-Party Losses
Alison wishes to sell some land that she holds for investment purposes to her daughter for
$20,000. Alison bought the land for $32,000 three years ago, but she is willing to give her
daughter a good deal on the land. Further, she also believes this will generate a $12,000 loss
for her to deduct. Hopefully, Alison will contact you before finalizing the sale because you
have some bad news for her. Taxpayers cannot recognize realized losses from the sale of assets
between related parties, because the buyer may be able to benefit from the disallowed loss
in the future. Related-party rules apply to all asset types: personal use, investment use, and
business use.
Defining Related Party

The term related party includes the following members of a family: spouse, children, grand-
children/other descendants, parents, grandparents/other ancestors, and brothers and sisters.
Aunts, uncles, and cousins are not related parties. The related-party definition also does not
include in-laws (although in-laws are eligible to be claimed as dependents).
Related exercise: Discussion Question 1
The disallowed loss from a related-party sale creates a right of offset, which taxpayers
can use to reduce a gain upon the ultimate sale of the property to an unrelated taxpayer. The
right of offset cannot create a loss, nor can it make a loss greater. Once the related-party buyer
sells the asset to a third party, the buyer permanently loses any unused right of offset.1
Why are losses from related-party sales disallowed? Lisa owns 500 shares of stock
in LU Corporation, which she started eight years ago with her best friend from college. Her
adjusted basis in the stock is $150,000 and its current fair market value (FMV) is $180,000.
Lisa has sold other investments during the current year, and her net capital gain from these
sales is $30,000. She would rather not have to pay tax on the $30,000 gain, so she sells the 500
shares of LU stock to her son, Uriah, for $120,000 on July 10. This creates a $30,000 realized
loss ($120,000 amount realized less $150,000 adjusted basis) that she intends to use to reduce
her net capital gain to zero. However, because her son is related to her, Lisa cannot recognize
the $30,000 loss, and her net capital gain remains at $30,000. The related-party loss rules exist
to prevent this type of tax avoidance.
Lisa reduced her net worth by $30,000 when she sold the stock to her son because she sold
it for less than its fair market value. Why would she be willing to do this? While individually
Lisa has incurred a $30,000 loss, the family still holds the stock. Perhaps Lisa had already
planned to make a gift to her son of $30,000, and hoped this method would generate a $30,000
tax deduction for her. Or, her son may intend to give her a gift of $30,000 soon to restore her
economic worth.
Evaluating Related-Party Transactions

There are four steps to solving all issues for a related-party transaction. Illustration 15.1 pro-
vides a flow chart showing these steps.
1
IRC §267

15.1 Related-Party Losses 15-5
Step 1. Compute: The realized gain or loss from the transaction. If a realized gain,
then the taxpayer must recognize it. If a realized loss, go to Step 2.
Step 2. Ask: Are the buyer and seller related parties? If no, then you can recognize the
realized loss. If yes, then you cannot recognize the realized loss, and proceed to Step 3.
Step 3. Calculate: The right of offset is equal to the amount of the realized loss.
Step 4. Determine: The holding period of the new owner of the asset. It begins on
the day after the date the taxpayer purchased the property from the related party
and does not include the holding period of the seller.
ILLUSTRATION 15.1 The Four Steps for Assessing Related-Party Transactions
Assessing Related-Party Transactions
Loss Gain
Tax
parties?
No
Tax Tax
Tax
00
To determine the tax consequences for Lisa from this transaction, we will follow the Steps
outlined in Illustration 15.1.

EXAMPLE 15.1.1 Continue with the facts for Lisa from the Why section above. Determine the tax consequences of
Related-Party Loss
this transaction.
SOLUTION
Step 1. First, we compute Lisa’s realized gain or loss.
Amount realized $ 120,000
Less: Adjusted basis (150,000)
Realized loss ($ 30,000)
Step 2. Next, we ask: Are the buyer and seller related parties? Lisa and her son Uriah are
related parties, so the realized loss is not recognized. The deferred loss is $30,000.
Step 3. We then calculate the right of offset, which is equal to the amount of the realized loss.
Here, the right of offset available for Uriah to use in the future is $30,000.
Step 4. Finally, we determine the holding period of the new owner of the asset. Uriah’s hold-
ing period for the stock begins on July 11, the day after the date of the transaction.
Tax Return Guidance

Sales of capital assets are reported on Form 8949 (see Appendix X for a full copy of
Form 8949). In Example 15.1.1, Lisa would report the sale of the stock as shown in
Illustration 15.2. Her gain or loss is long-term because she had owned the stock for
eight years. The “L” in box (f) indicates that this is a nondeductible loss other than
a wash sale. The amount of the disallowed loss is shown in box (g).
ILLUSTRATION 15.2 Form 8949 (Example 15.1.1)
Now let’s examine the tax consequences for when Uriah later sells the stock.
EXAMPLE 15.1.2 Assume the same facts as in Example 15.1.1 and the Why section above. Determine Uriah’s recog-
Right of Offset nized gain or loss if he holds the stock for two years and then sells it to an unrelated party for $140,000.
Alternatively, assume the sales price is $160,000, and $115,000.

15.1 Related-Party Losses 15-7
SOLUTION
A B C
Sales Price $140,000 $160,000 $115,000
Amount realized $140,000 $160,000 $115,000
Less: Adjusted basis (120,000) (120,000) (120,000)
Gain (loss) before right of offset $ 20,000 $ 40,000 ($ 5,000)
Less: Right of offset (20,000) (30,000) -0-
Recognized gain (loss) $ -0- $ 10,000 ($ 5,000)
A situation that may sometimes occur is that a related party has a qualified appraisal that
verifies he sold the asset for its actual value and a loss is realized. In such cases, the loss is still
disallowed, as we will see in the next example.
How would the answer to Example 15.1.1 change if Lisa had a qualified appraisal that verified the fair EXAMPLE 15.1.3
market value of her shares was $120,000, rather than $180,000?
Qualified Appraisal
SOLUTION
You should tell Lisa that the answer would not change. The related-party loss rules apply any time
a realized loss occurs on a transaction between related parties, even if the seller uses the proper
fair market value and is not using a false value to create a tax loss.
Related exercises: Application Problem 1, Multiple Choice Question 2
Tax Planning Tip

If a taxpayer owns an asset that would create a loss if sold, she should not sell the
asset to a related party, as she cannot recognize the loss.
Tax Planning Tip

For assets used in someone’s personal activities, remind your clients that it does
not matter whether they sell the asset to a related party because the loss would
never be recognized in any event.
Related exercises: Discussion Questions 2, 3
Brief Exercises 1, 2
Tax Planning Problem 1

Advanced Topic—Drilling Down

Business Entities as Related Parties
The related-party loss rules apply to many situations other than sales between family mem-
bers. The definition of related party includes relationships between individuals and business
entities, and between certain business entities. Other examples of related parties include:
• An individual and a corporation in which the individual owns, directly or indirectly,
more than 50% by value of the outstanding stock.
• A partner and a partnership in which the partner owns, directly or indirectly, more than
50% of the capital interest or profits interest.
• Two S corporations if the same individual owns more than 50% of the value of the stock
of both.
• Two partnerships if the same individual owns more than 50% of the capital interest or
profits interest of both.
The related-party loss rules apply in the same manner in these situations as they do for indi-
vidual family members.
Related exercise: Multiple Choice Question 1

15.2 Wash Sales 15-9
15.2 Wash Sales
Your client, Kiara, purchases 100 shares of UNA stock for $20 per share on February 28, Year 1.
The stock’s fair market value on December 28, Year 1 is $12 per share. Kiara would like to
sell the 100 shares and recognize a capital loss of $800 ($1,200 amount realized less $2,000
adjusted basis). However, Kiara is convinced that the stock will recover its losses and appreci-
ate significantly in the future, so she wants to maintain her economic investment in the stock.
Therefore, she repurchases 100 shares of UNA stock on January 2, Year 2 for $1,250. Will she
recognize her $800 loss?
An investor who sells securities at a loss can usually recognize the loss. But in this case,
Kiara must defer her loss because she purchased the same security within a short time of the
loss sale. As shown in the chapter introduction, wash sales apply only to investment securities
sold at a loss.
Defining a Wash Sale

A wash sale results when someone sells stock or securities at a loss and purchases or
has purchased substantially identical stock or securities within a 30-day window before
or after the sale date. The wash sale rules apply only to losses, not to gains. 2 To be
2
IRC §1091

substantially identical, the stock or security the taxpayer repurchases must be issued by
the same corporation. Stock dealers who are in the trade or business of selling stock are not
subject to the wash sale rules.
The 30-day window applies both before and after the date the taxpayer sells the substan-
tially identical securities (see the figure below), so you must review a 61-day window (includ-
ing the day of the sale) to ensure your client does not violate this provision.
Sale Date
1 Day
30 Days 30 Days
61 Days
Why are losses from wash sales deferred? Kiara’s economic position in the stock is the
same on January 2, Year 2 as it was before the December 28, Year 1 sale. Because her
economic position is the same, she cannot deduct the $800 loss. Rather, she must defer it and
recognize it in the future, whenever she sells the shares she purchased in Year 2. The loss is
deferred by increasing the basis of the newly purchased stock by the deferred loss.
Computing a Wash Sale

There are six steps to determining the issues raised in a wash sale. Illustration 15.3 provides
a flow chart showing these steps.
Step 1. Compute: The realized gain or loss, as follows:
Amount realized
Less: Adjusted basis
Realized gain or loss
Step 2. Ask: Did the taxpayer sell stocks or securities at a loss? If no, then you can
recognize the realized gain. If yes, then go to Step 3.
Step 3. Ask: Did the taxpayer purchase substantially identical stock or securities
either 30 days before or 30 days after the sale date? If no, then you can recog-
nize the realized loss. If yes, then go to Step 4.
Step 4. Compute: The deferred loss and the recognized loss is:
Number of shares repurchased within 30 days
Deferred loss = Realized loss ×
Number of shares sold to generate the loss
Recognized loss = Realized loss ‒ Deferred loss
Step 5. Determine: The taxpayer’s adjusted basis in the new stock purchased is:
Cost of new stock

Plus: Deferred loss
Basis in new stock
Step 6. Determine: The holding period of the new stock purchased. Because the
taxpayer is deferring a loss, the holding period of the new stock purchased includes
the holding period of the stock sold.

ILLUSTRATION 15.3 Six Steps to Determining Wash Sales Issues
Wash Sales
Loss Gain
Tax
No
date?
Tax Tax
recognized
00
new loss

EXAMPLE 15.2.1 Continue with the facts for Kiara from the introduction to this section. Compute Kiara’s deferred loss
and the basis and holding period in the new securities purchased.
Wash Sales, All
Shares Sold SOLUTION
Repurchased To determine Kiara’s deferred loss, and the basis and holding period from this transaction, we will
follow the Steps outlined in Illustration 15.3.
Step 1. First, we compute Kiara’s realized gain or loss:
Amount realized $1,200

Realized loss ($ 800)
Step 2. Next, we ask: Did the taxpayer sell stocks or securities at a loss? In this case, Kiara did
sell stock or securities at a loss.
Step 3. Now we ask: Did the taxpayer purchase substantially identical stock or securities
either 30 days before or 30 days after the sale date? Kiara sold 100 shares of stock at a
loss on December 28, Year 1. She then purchased 100 shares of substantially identical
stock on January 2, Year 2, which is within 30 days of the sale date. Therefore, this is a
wash sale.
Step 4. Compute Kiara’s deferred loss and recognized loss:
Number of shares repurchased within 30 days (100)
Deferred loss ($800) = Realized loss ($800) ×
Number of shares sold to generate the loss (100)
Recognized loss ($0) = Realized loss ($800) ‒ Deferred loss ($800)
Step 5. Using the result of Step 4, we can determine Kiara’s’s adjusted basis in the new stock
purchased as follows:
Cost of new stock $1,250

Plus: Deferred loss 800
Basis in new stock $2,050
Step 6. Finally, we determine the holding period of Kiara’s new stock purchase. Kiara’s hold-
ing period in the stock purchased on January 2, Year 2 includes the holding period
of ten months for the stock sold on December 28, Year 1.
Multiple Choice Question 3
Application Problem 2
Tax Planning Tip

To avoid a wash sale, investors can purchase stock of a different company in a sim-
ilar industry during the 61-day window, if they believe the prices of the stocks of
the two companies will change in a similar manner in the short run.
The wash sale rules also apply if the taxpayer purchased the new shares during the 30-day
period before the original shares are sold, as we’ll see in the following Example.

Continue with the same facts from Example 15.2.1 and the opening of this section, except that Kiara EXAMPLE 15.2.2
purchased the 100 new shares on December 9, Year 1 instead of January 2, Year 2. What difference
(if any) does this change make to her tax result? Wash Sales: New
Shares Purchased
SOLUTION Before Original
Because Kiara purchased the 100 new shares in the 30-day period before the original shares were Shares Sold
sold at a loss, the transaction meets the definition of a wash sale. The tax result is the same.
If the taxpayer purchases fewer shares of the stock within the 61-day prohibited period
than the number of shares sold, then the taxpayer will defer only a portion of the realized loss,
as we’ll see in the next Example.
Continue with the same facts from Example 15.2.1 and the introduction to this section, except that EXAMPLE 15.2.3
Kiara purchased 60 shares of UNA stock on January 2, Year 2 rather than 100 shares, for $750. What
difference (if any) does this change make to her tax result? Wash Sales: Fewer
Shares Repurchased
SOLUTION Than Sold
The tax consequences are the same except when determining the deferred and recognized loss
(Step 4) and Kiara’s adjusted basis in the new stock (Step 5).
Step 1. First, we compute Kiara’s realized gain or loss:

Realized loss ($ 800)
Step 2. Next, we ask: Did the taxpayer sell stocks or securities at a loss? In this case, Kiara did
sell stock or securities at a loss.
Step 3. Now we ask: Did the taxpayer purchase substantially identical stock or securities either
30 days before or 30 days after the sale date? Kiara sold 100 shares of stock at a loss
on December 28, Year 1. She then purchased 60 shares of substantially identical stock on
January 2, Year 2, which is within 30 days of the sale date. Therefore, this is a wash sale.
Step 4. Using the new facts, we can compute Kiara’s deferred loss and recognized loss as follows:
Number of shares repurchased within 30 days (60)

Deferred loss ($480) = Realized loss ($800) ×
Number of shares sold to generate the loss (100)
Recognized loss ($320) = Realized loss ($800) ‒ Deferred loss ($480)
Step 5. Using the new facts and the result of Step 4, we can determine Kiara’s’s adjusted basis
in the new stock purchased as follows:
Cost of new stock $ 750

Basis in new stock $1,230
Step 6. Finally, we determine the holding period of Kiara’s new stock purchase. Kiara’s hold-
ing period in the stock purchased on January 2, Year 2 includes the holding period of
ten months for the stock sold on December 28, Year 1.
Related exercises: Application Problems 3, 4, 5
Tax Planning Problem 2

Tax Return Guidance

Sales of capital assets are reported on Form 8949 (see Appendix X for a full copy of
Form 8949). In Example 15.2.3, Kiara would report the sale of the stock as shown
in Illustration 15.4. Her loss is short-term because the stock was not held for more
than one year. The “W” in box (f) indicates that this is a nondeductible loss from a
wash sale. The amount of the disallowed loss is shown in box (g).
ILLUSTRATION 15.4 Form 8949 (Example 15.2.3)

15.3 Like-Kind Exchanges 15-15
Spotlight on the Law

Wash Sales and IRAs
If you sell stock at a loss, you should be able to use the loss to offset gains on your income taxes,
right? Yes, except if you violate the wash-sale rule, which states that if you bought and sold the
same investment for a loss within 30 days before or after the sale, then the loss cannot be recog -
nized. However, you can increase your basis in the stock purchased by the loss disallowed, so the
loss is deferred. Wash sales apply to stocks, bonds, mutual funds, and options. But what happens
if you sell shares in a non-retirement account and then repurchase identical shares in an IRA
account? According to Revenue Ruling 2008-5, the wash sale rules apply, and the investor cannot
deduct the loss on the sale (see the Potential Pitfall).
Suppose that you own 100 shares of ABC stock with a basis of $800 in your brokerage account.
You sell the 100 shares of ABC for $600 on March 10, generating a $200 loss. On April 1, you buy 100
shares of ABC stock in your IRA account for $750. According to Revenue Ruling 2008-5, you cannot
deduct the $600 loss on the sale, and you cannot increase the basis of the stock purchased in your IRA.
IRS Revenue Ruling 2008-5 prevents investors from using a tax-deferred account such as an IRA to
circumvent the wash-sale rule. Because the taxpayer cannot increase the basis of the new stock in the
IRA by the deferred loss, then the taxpayer will never recognize the loss. This rule applies to traditional
and Roth IRAs, and regardless of whether the IRAs are held at different financial institutions.
15.3 Like-Kind Exchanges
Let’s take another look at situations like Derek and Anne’s regarding their vacation houses in
this chapter’s introduction. If they meet the proper rules, they can exchange their house in
Vail for a house in Florida and defer at least a portion of their gain. As shown in the chapter
introduction, the like-kind exchange rules apply to land and buildings that are used in a
business or held for investment purposes.
Tax Planning Tip

A taxpayer must recognize all realized gains and losses unless a tax law allows
deferral or exclusion.
Defining Like-Kind Exchanges

The definition of qualifying like-kind property includes all realty used for business or
investment purposes. You can exchange business realty for investment realty under the like-
kind exchange rules.
The like-kind exchange deferral rules are mandatory, not elective. 3 The taxpayer must
exchange qualifying like-kind property to defer the gain or loss. Qualifying like-kind property
includes only realty (land and buildings). So, even though from a visual inspection unim -
proved land looks very different from a five-story office building, the properties are like-kind
for tax purposes (see the Potential Pitfall).
3
IRC §1031

Recall from Chapter 2, LO6, Introduction to Property Transactions, that you cannot
recognize losses from dispositions of personal use property, except for losses from certain
casualties.
In determining whether the use of property is for business, investment, or personal
use, the use of the property by the individual from whom it is received is irrelevant. The way
the taxpayer used the property transferred and will use the property received determines the
appropriate tax treatment.
The following situations provide examples of whether an exchange is of qualifying
property:
• An exchange of an automobile (business use) for land (investment use) is not like-kind
because the automobile is not realty.
• An exchange of land (investment use) for property the taxpayer will use as a residence
(personal use) is not like-kind because the taxpayer will not use the asset received for
business or investment activities.
• An exchange of a building used for business purposes for property that was used as a
residence (personal use) by the other party to the exchange, but that will serve a business
use for the taxpayer receiving it, qualifies as a like-kind exchange. The taxpayer both used
the property transferred and will use the property received for business purposes.
The following types of property do not qualify for like-kind treatment, and taxpayers must
recognize gains and losses from their sale or disposition:
1. Inventory
2. Partnership interests
3. Stocks, bonds, and notes
4. Certificates of trust or beneficial interest
5. Other securities or evidence of indebtedness or interest
6. Life insurance and annuity products
7. Personal use property
8. Property located outside the United States (no matter its use)
Related exercises: Multiple Choice Questions 4, 5
Why are gains and losses from like-kind exchanges deferred? If a taxpayer exchanges
one piece of realty for another and no cash is received, the taxpayer does not have cash gen -
erated from the transaction to pay the tax if he must recognize a gain. Therefore, Congress
allows taxpayers to defer the gain in these situations. To the extent that the taxpayer receives
only like-kind property in the exchange, his economic situation has not changed significantly,
which also justifies deferring the gain.
Evaluating Like-Kind Exchanges

There are eight steps to follow when determining whether an exchange is like-kind, and for
computing the tax consequences of such activity.
Step 1. Compute: The realized gain or loss from the exchange.

Step 2. Ask: Does the property exchanged and the property received by the taxpayer
qualify as realty? If no, then the exchange does not qualify as a like-kind exchange
and you must recognize the realized gain or loss.

Step 3. Ask: Are both the property exchanged and the property received by the
taxpayer used for business or investment purposes? If no, then the exchange
does not qualify as a like-kind exchange and the taxpayer must recognize the real-
ized gain or loss.
Step 4. Determine: The recognized gain or loss.

The recognized gain is the lower of:
1) Realized gain, or
2) Fair market value of boot received (Boot is defined below, after Example
15.3.1.)
If the exchange results in a realized loss, the recognized loss is zero.
Step 5. Determine: The deferred gain or loss as follows:

Deferred gain = Realized gain ‒ Recognized gain
Deferred loss = Realized loss
Step 6. Calculate: The basis in the property received with two different formulas.
Both always provide the same answer.
Formula 1: Adjusted basis in property transferred

Plus: Recognized gain
Less: Fair market value of boot received
Less: Debt relief
Basis in property received
Formula 2: Fair market value of property received

Less: Deferred gain
Plus: Deferred loss
Basis in property received
Step 7. Determine: The basis in the boot received. The basis of the boot received is the
property’s fair market value.
Step 8. Determine: The holding period of the new asset. The holding period of the
new asset includes the holding period of the exchanged asset.
Illustration 15.5 provides a flow chart showing these steps.

ILLUSTRATION 15.5 Eight Steps Like-Kind Exchanges

for Evaluating Like-Kind Exchanges
No
property?
Tax
No
investment? recognized
Step 5:
Step 4:
recognized
Step 7:
or
00
Step 8:
of the new asset
EXAMPLE 15.3.1 Zion is a fifth-generation farmer in rural Illinois. He has owned land for 10 years with a fair market
value of $250,000 and a basis of $140,000. Zion exchanges this land for another parcel of land with
Basic Like-Kind a fair market value of $250,000. Zion uses both parcels of land for farming. What are the tax conse-
Exchange quences of this exchange for Zion?

SOLUTION
To determine Zion’s tax consequences for the exchange, we will follow the Steps outlined in Illus-
tration 15.5.
Step 1. First, we compute Zion’s realized gain or loss:
Less: Adjusted basis in disposed asset (140,000)
Realized gain $110,000
Step 2. Next, we ask: Do both the property exchanged and the property received by the tax-
payer qualify as realty? Zion exchanged land for land, both of which qualify as realty.
Step 3. Now we ask: Are both the property exchanged and the property received by the
taxpayer used for business or investment purposes? Because Zion uses both parcels
of land in his farming business, the exchange does qualify as a like-kind exchange.
Step 4. Next, we determine the recognized gain by choosing the lower of:
1) Zion’s realized gain, or $110,000
2) Fair market value of boot received $0
Therefore, Zion has $0 recognized gain.
Step 5. Next, we determine Zion’s deferred gain using the following calculation:
Deferred gain ($110,000) = Realized gain ($110,000) ‒ Recognized gain ($0)
Step 6. Now we calculate the basis in the property received, as follows:
Formula 1: Adjusted basis in property transferred $140,000
Plus: Recognized gain 0
Less: Fair market value of boot received 0
Less: Debt relief 0
Basis in property received $140,000
Formula 2: Fair market value of property received $250,000

Less: Deferred gain (110,000)
Step 7. Next, we determine the basis of the boot received by Zion. There is no boot in this
problem.
Step 8. Finally, we determine the holding period of the new asset. Zion’s holding period in the
land received is 10 years, because it includes the holding period of the transferred land.
Related exercise: Application Problem 6
Tax Return Guidance

Like-kind exchanges are reported on Form 8824. For an example of a completed
Form 8824, see the Tax Return and Communications Application in the Review
and Practice section near the end of the chapter.
Boot
The tax law defines boot as any property exchanged that is not qualifying property. If the fair
market values of the realty the taxpayers are exchanging are not equal, then one party will
have to receive boot to make the exchange equal economically. For like-kind exchanges, boot
is any property other than realty.

• The receipt of boot can trigger gain recognition. Cash and personalty received are treated
as boot received.
• Boot does not cause the taxpayer to recognize realized losses.
• If a taxpayer has debt relief, the amount of debt relief is treated as boot received.
• The basis in the boot received is always the property’s fair market value.
There are additional tax consequences to consider when the taxpayer receives boot. The
next Example introduces cash received as boot.
EXAMPLE 15.3.2 If the other parcel of land received in Example 15.3.1 has a fair market value of $248,000 and Zion also
receives cash of $2,000 in exchange for his land, what are the tax consequences to Zion?
Like-Kind Exchange
with Cash Boot SOLUTION
The cash is boot received. The tax consequences for Zion are as follows. (Steps 2, 3 and 8 are the
same as in Example 15.3.1)

Land $248,000
Cash 2,000
Amount Realized $250,000
Less: Adjusted basis in disposed asset (140,000)
Step 2. Next, we ask: Do both the property exchanged and the property received by the tax -
Step 3. Now, we ask: Are both the property exchanged and the property received by the tax-
payer used for business or investment purposes? Because Zion uses both parcels of
land in his farming business, the exchange does qualify as a like-kind exchange.
1) Realized gain, or $110,000
2) Fair market value of boot received $ 2,000
The recognized gain is thus $2,000.
Deferred gain Realized gain Recognized gain
or loss of = or loss of – or loss of
$108,000 $110,000 $2,000
Step 6. Now we calculate Zion’s basis in the property received, using Formula 1 as follows:
Adjusted basis of land given up $140,000
Plus: Recognized gain 2,000
Less: Fair market value of boot received (2,000)
Formula 2 is as follows:
Fair market value of property received $248,000
Step 7. Now we determine the basis of the boot received by Zion. Zion’s basis in the boot
received is its fair market value of $2,000.
Related exercises: Multiple Choice Questions 6, 7
Application Problems 7, 11

If a taxpayer receives debt relief as part of a like-kind exchange, then you must treat the
debt relief as boot, just as if you had received cash, as we will see in the following Example.
Suppose in Example 15.3.2 that Zion’s land had a mortgage of $25,000 attached, which the other EXAMPLE 15.3.3
transferor assumed. The fair market value of the land received is $223,000. What are the tax conse -
quences of this transaction to Zion? Like-Kind Exchange
with Debt Relief
SOLUTION
The tax consequences for Zion are as follows. (Steps 2, 3, and 8 are the same as in Example 15.3.1.)
FMV of land received $ 223,000
Plus: Cash received 2,000
Plus: Debt relief 25,000
Amount realized $ 250,000
Less: Adjusted basis of land given up (140,000)
Realized gain $ 110,000
Zion has boot received of $27,000, of which $2,000 is for the cash and $25,000 for the
debt relief.
Step 2. Next, we ask: Do both the property exchanged and the prop erty received by the tax-
Step 3. Now, we ask: Are both the property exchanged and the property received by the tax-
payer used for business or investment purposes? Because Zion uses both parcels of
land in his farming business, the exchange does qualify as a like-kind exchange.
2) FMV of boot received $ 27,000

$83,000 $110,000 $27,000
Step 6. Now we calculate Zion’s basis in the property received, using Formula 1 as follows:
Adjusted basis of property given up $140,000
Less: Fair market value of boot received (27,000)*
*Debt relief also reduces the basis in the property received. Because you include the
debt relief as boot received for like-kind exchanges, you do need to also subtract debt
relief separately.
We can also compute Zion’s basis in the new land as:
Fair market value of land received $223,000
Basis in land received $140,000
Step 7. Now we determine the basis of the boot received by Zion. Zion’s basis in the boot received
is its fair market value of $27,000. This consists of $2,000 basis in the cash anda $25,000
increase in his net worth because his debt has decreased by $25,000.

Tax Planning Tip

If a like-kind exchange will produce a realized loss, you should advise your client
to consider selling the asset instead so that she can recognize the loss. The like-
kind exchange rules are mandatory for both losses and gains.
Advanced Topics—Drilling Down

Debt Relief Provided by Taxpayer
If the taxpayer assumes the other party’s debt as part of a like-kind exchange, this triggers
several adjustments to the computations. You must reduce the taxpayer’s amount realized
by the full amount of the other party’s debt assumed by the taxpayer. Recall that you must
increase the amount realized by debt relief. You can offset this increase in the amount realized
by the debt assumed by the other party.
EXAMPLE 15.3.4 Continue with Example 15.3.3 and assume that the land Zion received has a mortgage attached of
$22,000 that Zion assumes. Assume the fair market value of the land received is $245,000. What are
Like-Kind Exchange the tax consequences of this transaction to Zion?
with Debt Relief
Received and Debt SOLUTION
Relief Given The tax consequences for Zion are as follows. (Steps 2, 3, 7, and 8 are the same as in Example 15.3.3.)
FMV of land received $245,000
Less: Mortgage assumed by Zion (22,000)
Boot Received Computation:
Debt assumed by other party $ 25,000
Less: Debt assumed by Zion (22,000)
Net debt relief $ 3,000
Total boot received $ 5,000
Step 2. Next, we ask: Do both the property exchanged and the property received by the
taxpayer qualify as realty? Zion exchanged land for land, both of which qualify as
realty.
Step 3. Now, we ask: Are both the property exchanged and the property received by the
taxpayer used for business or investment purposes? Because Zion uses both par-
cels of land in his farming business, the exchange does qualify as a like-kind
exchange.
2) FMV of boot received $ 5,000
$105,000 $110,000 $5,000

Adjusted basis of land transferred $140,000

Less: Fair market value of boot received (5,000)
If the debt assumed is greater than the debt relief for the taxpayer, then the debt assumed
can reduce the boot from the debt relief to zero, but not below zero. This excess does not reduce
other boot received (cash or non like-kind property). In this circumstance, the excess of the debt
assumed over the debt relief does increase the basis in the property received.
Assume the same facts as in Example 15.3.4 but now suppose the land Zion received has a debt EXAMPLE 15.3.5
attached of $27,000 that Zion assumes. Assume the fair market value of the land received is $250,000.
What are the tax consequences of this transaction to Zion? Debt Relief Given
Greater than Debt
SOLUTION Relief Received
The tax consequences for Zion are as follows. (Steps 2, 3, and 8 are the same as in Example 15.3.4.)
FMV of land received $250,000

Boot Received Computation:
Debt assumed by other party $ 25,000
Net debt relief ($ 2,000)
The debt Zion assumed is $2,000 greater than the debt relief he received. Th is negative
debt relief cannot offset the $2,000 of cash (boot) received. So, the net boot received is
$2,000.
Step 2. Next, we ask: Do both the property exchanged and the property received by the taxpayer
qualify as realty? Zion exchanged land for land, both of which qualify as realty.
Step 3. Next, we ask: Are both the property exchanged and the property received by the taxpayer
used for business or investment purposes? Because Zion uses both parcels of land in his
farming business, the exchange does qualify as a like-kind exchange.


2) FMV of boot received (cash)
loss of $108,000
$110,000 $2,000
Adjusted basis of land given up $140,000

Plus: Gain recognized 2,000
Less: Boot received (cash) (2,000)
Plus: Net boot given (debt) 2,000
Deferred Like-Kind Exchanges

It is unlikely that two taxpayers who desire to own each other’s property know each other.
So most like-kind exchanges involve a third party who functions as an intermediary for the
property owners. The deferred like-kind exchange typically proceeds as follows:
1. Taxpayer X would like to exchange Property A in a like-kind exchange.
2. Taxpayer X transfers Property A to third party intermediary.
3. The third party then locates replacement property (Property R) suitable for Taxpayer A,
which Taxpayer Y owns.
4. The third party buys Property R from Taxpayer Y and then transfers it to the Taxpayer X
in a like-kind exchange.
5. The third party then sells Property A to whomever would like to purchase it.
In the above scenario, Taxpayer X meets the requirements for a deferred like-kind exchange.
Taxpayer Y has a taxable transaction when he sells his property to the third party.
For a deferred like-kind exchange to qualify for gain deferral, two timing rules must
be satisfied:
1. Taxpayer X must identify Property R as the desired replacement property within 45 days
after transferring Property A to the third party.
2. Taxpayer X must receive Property R from the third party within the earlier of 180 days or
the extended due date of X’s return, after transferring Property A to the third party.
Related exercise: Tax Planning Problem 3

15.3 Involuntary Conversions
A category 5 hurricane swept through the coast of Georgia this year and destroyed your cli-
ent’s waterfront restaurant. Your client, Melville, had an adjusted basis in the property of
$140,000 and had replacement cost insurance coverage, so he received insurance proceeds
of $380,000. He has a realized gain of $240,000 and he has contacted you to find out if there
are any opportunities to defer his gain. In this section, you will learn under what conditions
Melville can defer his gain.
If a taxpayer’s property is destroyed or condemned because of an event beyond their con-
trol, in some cases the realized gain from the transaction can be deferred. As shown in the
chapter introduction, the involuntary conversion rules apply to all asset types: personal use,
investment use, and business use.
Defining an Involuntary Conversion

The involuntary conversion rules apply to assets used in business, investment, and personal
use activities. The gain from an involuntary conversion of property can be deferred if elected
by a taxpayer.4 An involuntary conversion is the result of the destruction (complete or
partial), theft, seizure, casualty (an unexpected, unavoidable outside influence like a storm,
fire, shipwreck, or condemnation), or sale or exchange under threat of condemnation of the
taxpayer’s property. A condemnation is a taking of property by the government under its right
of eminent domain, which is the power to take property for public use. Under eminent
domain, the government must pay a fair value for the property. An imminent threat of con-
demnation is enough to trigger an involuntary conversion. A voluntary act of destruction by
the taxpayer is not a qualified involuntary conversion.
This deferral provision does not apply to losses. If certain conditions are met, a taxpayer
can deduct losses from involuntary conversions as casualty losses (see Chapter 9, LO7, Casu-
alty Losses, for more discussion).
The taxpayer must replace, or expect to replace, the converted property with qualified
replacement property during the qualified replacement time period to defer the gain.
• The qualified replacement period ends two years from the end of the tax year in
which the taxpayer realizes the gain from the conversion. The law extends the period to
three years for a condemnation of realty used in a business. The taxpayer can request an
extension of this period from the IRS, but only for one additional year.
• The taxpayer must use the qualified replacement property in a manner that is similar
or related in service or use the taxpayer had for the original property. This is a much
stricter condition to defer gain than the broad condition used for like-kind exchanges
(i.e., all realty is like-kind).
4
IRC §1033

15.4 Involuntary Conversions 15-26
Which of the following pairs of assets are similar or related in service or use? EXAMPLE 15.4.1
a. A grocery store and a skating rink. Qualified
b. A billiard center and a bowling center. Replacement
c. Two buildings used for manufacturing and one building used for manufacturing. Property
d. A car wash and a printing business.
e. A restaurant and a restaurant.
SOLUTION
The use of the new property must be similar to the use of the damaged property. Only asset pairs
“c” and “e” meet this definition.
A special rule exists for the condemnation of realty which is more flexible than the gen -
eral rule for qualifying property. In the case of condemnation of realty used for business or
investment purpose, the similar or related in service or use test is deemed to be met as long as
the replacement property is realty. The taxpayer can use the realty for any service or use and
still qualify for deferral.
Elena's retail store is destroyed by flood on January 17, Year 4. When will her qualified replacement EXAMPLE 15.4.2
period end?
Qualified
SOLUTION Replacement Period
The replacement period ends two years from the end of Year 4, which is December 31, Year 6.
If the taxpayer does defer gain, they include the holding period of the destroyed property
in the holding period of the new property.
Tax Return Guidance

If the taxpayer expects to replace the destroyed property within the qualified
replacement period, then she can exclude the gain on the tax return for the year of
the conversion. If the taxpayer does not replace the property in a timely manner,
she must file an amended return and recognize gain in the year the conversion
occurred.
Related exercise: Multiple Choice Question 8
Why are involuntary conversions tax-deferred transactions? The deferral provision
for involuntary conversions applies to a taxpayer whose asset is destroyed, stolen, or
condemned if a gain is realized. The taxpayer can defer any realized gain from the trans - action
to the extent that he reinvests the proceeds realized from the transaction, which is usually
insurance proceeds, in qualifying property. To the extent the taxpayer reinvests the

proceeds, he does not have cash from the transaction to pay taxes on the realized gain.
Additionally, once the taxpayer replaces the property, his economic circumstances are very
similar to those before the conversion occurred. Therefore, Congress allows the taxpayer to
defer the gain.
Evaluating an Involuntary Conversion

We can compute the tax consequences for an involuntary conversion as follows. Illustra- tion
15.6 provides a flow chart showing these steps.
Step 1. Compute: The realized gain or loss from the transaction. The realized gain or
loss is computed by reducing the amount realized (insurance proceeds) by the basis
of the property damaged. If a loss, then the involuntary conversion rules do not
apply. The loss may be deductible as a casualty loss. If a gain, then go to Step 2.
Step 2. Ask: Was property destroyed, stolen, seized, or condemned? If no, then you
must recognize the realized gain. If yes, go to Step 3.
Step 3. Ask: Was the original property replaced with qualified property that is
similar or related in service or use? If no, then you must recognize the realized
gain. If yes, go to Step 4.
Step 4. Ask: Was the qualified property replaced (or was there an intention to
replace) within two years from the end of the year in which the involun-
tary conversion occurred (three years for condemned business property)?
If no, then you must recognize the realized gain. If yes, go to Step 5.
Step 5. Determine: The recognized and deferred gain. You do not recognize the realized
gain to the extent that the taxpayer reinvests the amount realized in qualifying
property. The recognized gain is the lower of
1) the realized gain, or
2) the excess of the proceeds from the conversion over the cost of the replace-
ment property.
The deferred gain is the realized gain – the recognized gain.
Step 6. Calculate: The adjusted basis of the new property. This is determined by its
cost reduced by any deferred gain, as follows:
Cost of replacement property
Less: Deferred gain
Adjusted basis of new property
Step 7. Determine: The holding period of the new property. The holding period of
the new property includes the holding period of the converted property.

ILLUSTRATION 15.6 Seven Steps for Evaluating Involuntary Conversions
Involuntary Conversions
destroyed,
condemned?
Tax
with qualified
property?
Tax
00
gain
property

EXAMPLE 15.4.3 Felipe had owned a warehouse for three years when a hurricane destroyed it. The warehouse had an
adjusted basis of $200,000, and Felipe received $245,000 in insurance proceeds. He invested $225,000
Involuntary in a new warehouse six months after the hurricane. What are the tax consequences to Felipe?
Conversion
SOLUTION
To determine Felipe’s tax consequences for the exchange, we will follow the Steps outlined in
Illustration 15.6.
Step 1. First, we compute Felipe’s realized gain or loss from the transaction:
Amount realized from conversion $245,000
Less: Adjusted basis of old property (200,000)
Realized gain (loss) $ 45,000
Step 2. Next, we ask: Was property destroyed, stolen, seized, or condemned? Felipe’s property
was destroyed by a hurricane, so this situation does meet the definition of an involun -
tary conversion.
Step 3. Then we ask: Was the original property replaced with qualified property that is similar
or related in service or use? Felipe replaced the warehouse with property similar or
related in service or use, as he uses the new property as a warehouse.
Step 4. Now we ask: Was the qualified property replaced within two years from the end of
the year in which the involuntary conversion occurred (three years for condemned
business property)? Because Felipe replaced the property within six months, he meets
this test.
Step 5. Next, we determine the recognized gain and the deferred gain. The recognized gain is
the lower of:
1) the realized gain of $45,000, or
2) the excess of the proceeds from the conversion over the cost of the replacement
property, $20,000,
Amount realized from conversion $245,000
Less: Cost of replacement property (225,000)
Excess $ 20,000
The recognized gain is $20,000.

The deferred gain is $25,000 ($45,000 realized gain ‒ $20,000 recognized gain).
Step 6. Next, we calculate Felipe’s adjusted basis of the new property. This is determined by
the property’s cost reduced by any deferred gain, as follows:
Cost of replacement property $245,000
Adjusted basis of new property $220,000
Step 7. Finally, we determine the holding period of Felipe’s new property. In this case, the
holding period is three years, because it includes the holding period of the original
property.
Related exercises: Discussion Questions 10, 11, 12
Application Problems 12, 13, 14
Before wrapping up this discussion, review Illustration 15.7 which compares the like-kind
exchange rules and the involuntary conversion rules.

ILLUSTRATION 15.7 Like-Kind Exchanges vs. Involuntary Conversions
Characteristic Like-Kind Exchange Involuntary Conversion

Required application of rules Mandatory Elective
Gains or losses Applies to gains and losses Applies only to gains
Qualifying property definition Like-kind Similar or related in service or use
Types of qualifying property Realty Realty and personalty
Applies to property used in what type Business and investment Business, investment, and personal
of activities
Time period 45 days to identify replacement property; Generally, two years from the end of tax year
180 days to finalize exchange conversion occurred.

15.5 Loss on Sale of Personal Use Assets
When Deena turned in her client tax portfolio to you this year so you could prepare her return,
she included information related to the sale of her dining room furniture. She purchased the
furniture six years ago for $8,200. She sold it this year on Facebook Marketplace for $2,600.
She wants to deduct a loss of $5,600 on her tax return. Will she be able to do so?
Unfortunately, no. You never recognize losses from the sale or disposition of assets used in
someone’s personal life. The only exception occurs when a casualty partially or fully destroys
a personal use asset (see Chapter 9, LO7, Casualty Losses, for a discussion of casualty losses).5 As
shown in the chapter introduction, this rule is limited to assets used in your personal life,
including your personal residence.
If a taxpayer is not using an asset in a trade or business, or for the production of income,
then it is a personal use asset. If a taxpayer sells a personal use asset at a loss, the loss is not
deductible, except for casualty losses which are deductible when connected with a federally
declared disaster (see Chapter 9, LO7, Casualty Losses).
EXAMPLE 15.5.1
Sale of a Personal
Use Asset for Loss
On March 21, Year 4, Zachary purchased a new laptop for $1,500 for personal use. In Year 6, he sells
the computer for $400. What are the tax consequences to Zachary?
SOLUTION
Zachary has a realized loss of $1,100 ($400 Amount Realized – $1,500 Adjusted Basis). Zachary
cannot recognize this loss because the laptop is a personal use asset.
While so far we have discussed only losses resulting from the sale of a personal use asset,
if a taxpayer sells a personal use asset at a gain, that gain must be included in taxable income,
as shown in the example below.
EXAMPLE 15.5.2
Sale of a Personal
Use Asset for Gain
Assume in Example 15.5.1 that due to a massive shortage of computers, Zachary was able to sell his
laptop on June 4, Year 5 for $1,800. How does this change his tax result?
SOLUTION
His realized gain is $300 ($1,800 Amount Realized – $1,500 Adjusted Basis), and Zachary must
recognize that gain. Because personal use assets are capital assets, and the asset was held for more
than one year, the $300 gain is a long-term capital gain.
Related exercises: Brief Exercise 9
Application Problems 15, 16

15.6 Sale of Principal Residence 15-32
Why is a loss on the sale of a personal use asset not recognized? Very few per-
sonal use assets, such as automobiles, furniture, computers, bicycles, clothing, and similar
items, are ever sold for a gain. Personal use assets lose their value quickly after purchase,
resulting in a realized loss when sold. Taxpayers cannot depreciate these assets because they
are not being used in a trade or business or for the production of income. So, the adjusted basis
of a personal use asset is its original cost. Because almost all personal use assets have
realized losses when sold or disposed of, the drain on the federal treasury would be massive if
these losses could be deducted.
15.6 Sale of Principal Residence
Deena sold her dining room furniture this year because she sold her principal residence and
did not need the furniture in her new house. She had owned her house in Nashville, Tennessee
for 15 years and the value of the home had doubled in value. Her realized gain on the sale is
$225,000 and she reinvested all of the sales proceeds in a new home in New Orleans. She
is quite panicked because she has no cash remaining to pay taxes on her large capital gain. Do
you have any good news for Deena?
Yes, you will likely be able to relieve her anxiety. Taxpayers generally recognize gain from
the sale of personal use assets. However, if the asset is a principal residence and the home-
owner meets certain requirements that you will learn in this section, then part or all of the
gain from its sale can be excluded from taxable income. As shown in the chapter introduction,
this rule applies only to sales of principal residences. (See the Potential Pitfall.)
Defining a Principal Residence

The law provides for an exclusion of gain from the sale of a principal residence once every two
years. If a taxpayer owns more than one residence, the principal residence is generally the
location where the taxpayer registers to vote, has a driver’s license, and lives most of the time. If
the taxpayer sells a residence other than the principal residence, he must recognize all the gain.6
6
IRC §121

A principal residence can be a house, trailer home, motor home or house boat. To be a residence,
the structure must have sleeping, cooking, and bathroom facilities.
Related exercises: Discussion Questions 14, 15, 16
When computing the realized gain or loss from the sale of a principal residence, recall that the
adjusted basis must be increased for any capital improvements made, such as adding a fence
to the yard or an additional room. However, repairs such as painting and fixing broken fixtures
in the home do not increase the basis. (See Chapter 8, LO5, Capital Expenditure or Repair, for
more detail.)
Ownership and Use Tests

To qualify for exclusion of gain, the taxpayer must meet the ownership test and the use test.
The homeowner must have owned and used the residence as a principal residence for at least two
of the preceding five years. The time need not be continuous; each test must total at least 730 days
during the previous five years. The ownership test and use test can be met for different time periods
within the five-year window. Several special rules apply when measuring the 730 days.
Absences. You can ignore short or temporary absences (e.g., vacations), and use is
imputed for taxpayers who are in facilities because they are unable to care for themselves. An
individual can also suspend the running of the five-year test period if serving in the uniformed
services, Foreign Service, Peace Corps, or intelligence community.
Divorces. If an individual transfers a residence to a spouse incident to a divorce, you add

the time during which the taxpayer’s spouse or former spouse owned the residence to the
taxpayer’s period of ownership. A taxpayer who owns a residence is deemed to use it as a
principal residence while the taxpayer’s spouse or former spouse is given use of the residence
under the terms of a divorce or separation.
Deaths. A taxpayer’s period of ownership of a residence includes the period during which
the taxpayer’s deceased spouse owned the residence so long as the taxpayer does not remarry
before the date of sale.
Rentals. A taxpayer may temporarily rent out their principal residence for a short period of
time, if the two-year requirement for the ownership and use tests is satisfied.
Related exercises: Discussion Questions, 17, 18, 19
Multiple Choice Questions 9, 11
Application Problem 18
$250,000/$500,000 Exclusion
If a single taxpayer meets the ownership and use tests, she may exclude realized gains up to
$250,000. Married couples filing jointly who meet the ownership and use tests can exclude up
to $500,000 on the sale of a residence. For married taxpayers, either spouse can meet the
ownership test, but both must meet the use test. If only one spouse meets the use test, then that
spouse can claim only a $250,000 exclusion.
Tax Return Guidance

Gain from the sale of the principal residence in excess of the allowable exclusion is
reported on Form 8949, Sales and Other Dispositions of Capital Assets.
Tax Planning Tip

When an existing homeowner marries and is considering selling a home, if the
realized gain will be more than $250,000, advise the homeowner to consider delay-
ing the sale until the spouse has used the home as a residence for two years.
If the sale of the principal residence occurs not later than two years after the death of a
spouse, the surviving spouse may exclude up to $500,000 of gain. For this provision to apply, at
the time of the spouse’s death, the ownership and use tests must have been satisfied.
Related exercises: Brief Exercise 10
Application Problems 17, 19, 23

Charles has owned and used his home as a principal residence for the last 20 years. On June 1, Year 10, EXAMPLE 15.6.1
he married Jenny and she moved into his residence. On December 30, Year 11, Charles sells the resi-
dence and realizes a gain of $300,000. How much gain does Charles recognize from the sale? If he had Principal Residence:
contacted you before the sale, what would you have advised him? Use Test for Married
SOLUTION Couple
Charles can exclude $250,000 of the gain and must recognize the other $50,000 as a long -term
capital gain. He owned and used the house as a principal residence for at least two years during
the last five years. Jenny did not own the house and used it for less than two years. So, Charles and
Jenny can exclude $250,000.
If Charles had sold the house after June 1, Year 12, the exclusion would have increased to
$500,000 because Jenny would now meet the use test also. You would have advised him of this if
he had contacted you.
Frequency Test
The frequency test provides that taxpayers are eligible to exclude gain if they have not
excluded gain from the sale of another principal residence during the two-year period ending
on the date of the sale. If a residence is sold before the two-year window is met, due to changes
in employment or health (or other unforeseen circumstances such as a natural disaster, mul -
tiple births, or change in wedding plans), then the maximum amount of the exclusion is pro-
rated based upon the number of qualifying months (ownership or use) divided by two years.
The qualifying months are the lesser of the number of ownership/use months or the number of
months since the last sale. The exception for change in employment is assumed to be met ifthe
individual's new place of employment is at least 50 miles farther from the residence sold than
the distance from the old place of employment to the residence sold.
Related exercises: Application Problems 20, 21, 22
Heather is single and has owned and occupied her residence for the past 18 months. Heather’s EXAMPLE 15.6.2
employer transferred her across the country and she subsequently sold her residence for a gain of
$200,000. Heather has asked you whether she can exclude her gain from income? Principal Residence:
Frequency Test
SOLUTION
She does not qualify for the maximum exclusion because she has not owned and occupied
her residence for two years. She does qualify for a pro-rated exclusion, because the sale of her
residence was due to a change in employment. Heather’s maximum exclusion for the $200,000
realized gain is:
75% (18 months/24 months) × $250,000 = $187,500 exclusion

Heather’s recognized gain is $12,500 ($200,000 realized gain ‒ $187,500 exclusion). (See the Poten-
tial Pitfall.)
3.8% Net Investment Income Tax

The 3.8% tax on net investment income discussed in Chapter 12, LO4, NIIT does not apply to the
gain from the sale of a principal residence that home sellers exclude from income. This means that
the 3.8% tax will not apply to most taxpayers who sell their homes, because their gain usually
does not exceed the $250,000/$500,000 threshold. However, if taxpayers sell their principal
residence and their gain does exceed these limits, the recognized gain is a capital gain for income
tax purposes and is also subject to the 3.8% net investment income tax.

Why are gains from the sale of a principal residence excluded? In some instances,
an individual can exclude from income a limited amount of gain from the sale of a principal
residence. This is an exclusion, so the taxpayer will never recognize the gain as income.
Congress includes provisions in the tax law that benefit homeowners because those who own
their own homes build equity as they pay off their mortgages, which leads to more financial
stability for the homeowner. It also contributes to economic growth when homeowners sell
one residence and purchase another because it stimulates growth in residential construction.
Many taxpayers who sell a principal residence have owned their home for many years and
have a sizeable “nest egg” in the equity in their home. The equity in a taxpayer’s home is often
the most valuable asset on the individual’s balance sheet as retirement nears. Beca use of this
exclusion, these older taxpayers have more cash to generate income for their living expenses.
Evaluating the Sale of a Principal Residence

We can use the six steps that follow to determine the tax consequences for the sale of a princi-
pal residence. Illustration 15.8 provides a flow chart showing these steps.
Step 1. Compute: The realized gain or loss for the sale of a personal residence.
Step 2. Ask: Was the residence the taxpayer’s principal residence? If the sale results
in a realized gain, was this the taxpayer’s principal residence? If no, then you must
recognize the gain. If yes, then go to Step 3. (Note that you cannot recognize a loss.)
Step 3. Determine: Are the ownership and use tests met? If no, then you must rec-
ognize the gain. If yes, then go to Step 4.
Step 4. Ask: Is the frequency test met or an exception to the frequency test met?
If no, then you must recognize the gain. If yes and the frequency test is met, then
gain is excluded up to $250,000/$500,000 depending on filing status.
If yes and an exception to the frequency test is met, you calculate the maximum
gain to exclude as follows:
Lesser of ownership / use months
or months since gain was excluded due to sale
× ($250,000 or $500,000)
24 months
If the taxpayer purchases a new residence, go to Steps 5 and 6.
Step 5. Determine: The taxpayer’s basis in the transaction. If the taxpayer purchases
another residence, the basis of the residence will be its cost. The homeowner does
not adjust the basis in the property for deferred gain because there is no deferred
gain under this provision—only excluded gain.
Step 6. Determine: The taxpayer’s holding period for the transaction. If the home-
owner purchases another residence, they will not include the holding period of
the sold residence in the holding period of the new residence because there is no
deferred gain for the transaction. The taxpayer’s holding period in the new house
will begin the day after they purchased it.

Sale of a Principal Residence ILLUSTRATION 15.8 Six Steps

for Evaluating a Sale of a Principal
Residence
Loss Gain
No
Residence?
Yes
Tax
No
Yes
No
test?
Yes
applies
00

EXAMPLE 15.6.3 Alphonso, a single taxpayer, sold the residence he owned and lived in for the previous 12 years for
$445,000. He had an adjusted basis in the residence of $80,000 and paid sales commissions of $25,000.
Principal Residence: He purchased another house of $600,000 that he will use as his residence. What are the tax conse-
Exclusion of Gain quences of these transactions for Alphonso?
SOLUTION
To determine the tax consequences for Alphonso from this transaction, we will follow the Steps
outlined in Illustration 15.8.
Step 1. We first need to compute Alphonso’s realized gain from the transaction, which can be
calculated as follows:
Cash received $445,000
Less: Sales commissions (25,000)
Step 2. Alphonso owned and lived in the house for the past 12 years leading up to its sale, so
the house was Alphonso’s principal residence. Thus, he potentially qualifies for exclu-
sion of gain.
Step 3. Alphonso meets the ownership and use tests, so we proceed to Step 4.
Step 4. Alphonso meets the frequency test, so the maximum gain can be excluded from the
transaction. Alphonso can exclude $250,000 of the realized gain. He must recognize
the remaining $90,000 of the realized gain as a long-term capital gain.
Step 5. Alphonso’s basis in his new house will be its cost of $600,000.
Step 6. Alphonso’s holding period in the new house will begin the day after he purchased it.
Tax Planning Tip

If a taxpayer owns more than one home and would like to sell a home that is not a
principal residence, review the requirements with the owner to decide whether this
house could become the principal residence. The owner would likely need to live in
this home more than in the other home(s) for the next two years, as well as obtain a
driver’s license, checking account, and voter registration in the house’s locality.
Related exercise: Tax Planning Problem 4
Advanced Topics—Drilling Down

Home Office
If the homeowner has ever used a portion of the residence as a home office, the taxpayer has
likely claimed depreciation for a portion of the basis of the house. The taxpayer may have to
recapture any depreciation taken as ordinary income as discussed in Chapter 14, LO5, Section
1250 Depreciation Recapture. The recaptured amount is not eligible for the exclusion and
is taxed as ordinary income. As long as the business portion is not a separate building, the
maximum gain eligible to be excluded does not need to be allocated between the business and
personal portions of the residence.
The next Example shows how deducting depreciation on a home office affects the exclu-
sion of gain on the sale of a principal residence.

Lukas sold his principal residence during the current year for a gain of $40,000. He had owned and EXAMPLE 15.6.4
used the house as a principal residence for the last nine years. He used one room of the residence for
a business and has accumulated depreciation of $12,000. What are the tax consequences of this sale? Portion of Residence
Used as a Home
SOLUTION Office
Lukas qualifies to exclude up to $250,000 gain from income. However, he cannot exclude gain to the
extent of depreciation claimed on the property. Therefore, Lukas must recognize $12,000 of his gain as
ordinary income, and the remaining gain of $28,000 ($40,000 ‒ $12,000) can be excluded from income.
Spouse Violates Frequency Test

If a taxpayer meets the ownership and use tests and marries a spouse who sold their own
principal residence during the previous two years, this sale will violate the frequency test for
the taxpayer’s spouse. The taxpayer can still qualify to exclude up to $250,000 of gain. The tax-
payer will not qualify for the $500,000 exclusion because his spouse violates the frequency test.
Janyce has owned and occupied her residence for the past six years. In March of this year, she marries EXAMPLE 15.6.5
Stevie, who moved into Janyce’s residence. Immediately prior to the marriage, Stevie had sold her res-
idence and excluded the gain from the sale. In June of the current year, Janyce and Stevie sold Janyce’s Principal Residence:
residence. What are the tax consequences of this sale? Spouse Sold Residence
in Last Two Years
SOLUTION
Janyce qualifies for the exclusion. Stevie violates the frequency test. Therefore, Janyce can exclude
up to $250,000 of gain on the sale.
Rental Use of Home

The exclusion will not apply to the extent that the homeowner did not use the property as a prin-
cipal residence during a portion of the five-year testing period. For example, if during the five-year
window the homeowner rented the property for two years and then used it as a residence for three
years, the taxpayer can exclude only 60% of the gain (three years ÷ five years) from income. This
limitation does not apply if the nonqualified use occurs after the homeowner used the property as
a principal residence.
On January 2, Year 4, Diane buys a residence for $400,000 and used it as rental property for two years, EXAMPLE 15.6.6
claiming $30,000 of depreciation deductions. On January 2, Year 6, Diane converted the property to
her principal residence. She moved out on January 4, Year 8, and sold the property for $700,000 on Principal Residence:
January 2, Year 9. How much gain must Diane recognize? Rented During
Portion of Last Five
Years

SOLUTION
Step 1. We first need to compute Diane’s realized gain from the transaction, which can be cal-
culated as follows:
Less: Adjusted basis (370,000) ($400,000 cost ‒ $30,000 depreciation)
Step 2. Diane owned and lived in the house for more than two years leading up to its sale, so
the house was Diane’s principal residence on the sale date even though it took her one
year to sell the property after she moved out. Thus, she potentially qualifies for exclu -
sion of gain.
Step 3. Diane meets the ownership and use tests. Diane does not count the period from
January 4, Year 8, to January 2, Year 9, in the use test because the property was not
being used as a principal residence. However, she does not have to treat it as part of
the period of nonqualified use, since it occurred before Diane used the home as her
principal residence.
Step 4. Diane meets the frequency test, so the maximum gain can potentially be excluded
from the transaction.
Diane must include the $30,000 of gain that is attributable to depreciation deductions
as ordinary income. Of the remaining $300,000 of gain, she must allocate $120,000 to
nonqualified use (40% (2 years ÷5 years) × $300,000) and it is not eligible for exclu -
sion. Because the remaining gain of $180,000 ($300,000 – $120,000) does not exceed
the maximum exclusion ($250,000), Diane can exclude a total of $180,000 of gain from
gross income. Diane must include $150,000 ($330,000 – $180,000) in gross income.
Steps 5 and 6 do not apply because Diane did not purchase a new residence.

Chapter Summary 15-40
Featured Professional: Roxi Steblea-Lora, CPA

Roxi has worked in accounting for Professional Skills Being committed to continuing educa-
15 years and currently works for tion is critical to success in tax accounting, given the rapidly-
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the Tax Executive Director. Her pro- needs to consider the tax consequences of evolving market
fessional roles span from Market instruments and structures. Early in my career, I embraced
Support Specialist for Mercedes reading the Internal Revenue Code and Treasury Regula-
Benz to several years in public tions, which I think helped me progress quickly. My progres-
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hedge fund taxation. helped me to develop a passion for tax accounting and have
a career that I find challenging and rewarding.
From Classroom to Career I put in a lot of effort to master IRC
§1092, Straddles*, in my early career because it was the pre- Future Tax Landscape A constant theme for many years has
dominant authoritative source of guidance for the tax filings I been technology causing a seismic shift in the way we work, and
performed. Straddles are a complex property transaction used I think it will continue. In the next 5–10 years, the focus will turn to
by hedge funds. Just as I thought I had mastered the tax laws for all aspects of data, including data integrity, security, and analyt-
straddles, I came across a situation where I was truly stumped. ics. Tax professionals will need to become more technologically
I was dealing with a “substantial overlap” issue that was not savvy, to work with complex tax accounting systems and under-
familiar to me at that time. I thought I must have missed some- stand new approaches, such as machine learning and how that
thing within IRC §1092, so I reviewed it backwards and forwards impacts a tax professional’s day-to-day activities and the trans-
again. After some time and discussion with others, I came to actions and tax events to which professionals will be exposed.
realize that my fact pattern was applicable to other code sec-
tions of which I was not aware. This experience showed me it’s

*A tax straddle is the practice in which two futures or options contracts, one
important to understand a broad set of tax concepts and code
expected to increase in value and one expected to decline in value, are sold in
sections that you can incorporate into your thinking as you two different tax years. The contract with a loss is sold at the end of one tax year
work with a wide range of products and circumstances—and while the one showing a profit is sold at the beginning of the following year.
that it is always important to consult with others because the The IRS defines a straddle as the holding of personalty in such a way that the
tax law is so complex. position—the offsetting position—substantially reduces the risk of loss.
Review and Practice

Chapter Summary
In this chapter, we have reviewed the more common ways that taxpayers can defer or exclude gains and
losses from the sale or disposition of assets. Most of these provisions are mandatory if the transaction
meets the criteria for deferral or exclusion. One notable exception is that taxpayers defer realized gain
from an involuntary conversion only if an election is made to do so. If taxpayers expect to have a loss from
a transaction, they will usually try to avoid meeting the conditions for deferral so they can recognize the
loss in the current year.
parents, grandparents/other ancestors, and brothers and sis-

❶ Calculate the recognized loss on the sales of assets ters. Aunts, uncles and cousins are not related parties. The
between related parties. related party definition also does not include in-laws (although
in-laws are eligible to be claimed as dependents).
• The term related party includes the following members of • Disallowed losses create a right of offset, which taxpayers can
a family: spouse, children, grandchildren/other descendants, use to reduce a gain upon the subsequent sale of the property

to an unrelated taxpayer. The right of offset cannot create a

loss, nor can it make a loss greater. Once the related -party ❹ Evaluate the effect on income of an involuntary
buyer sells the asset to a third party, he permanently loses any conversion and the basis of the new asset.
unused right of offset.
• The taxpayer can defer gain from an involuntary conversion of
property if elected by the taxpayer. An involuntary conver-
❷ Compute the deferred loss from a wash loss sale and sion is the result of the destruction (complete or partial), theft,
the basis of the newly acquired security. seizure, casualty (an unexpected, unavoidable outside influ -
ence like a storm, fire, shipwreck, or condemnation), or sale or
• A wash sale results when one sells stock or securities at a loss exchange under threat of condemnation of the taxpayer’s
and substantially identical stock or securities are or were pur - property. A condemnation is a taking by the government.
chased within a 30-day window before or after the sale date. An imminent threat of condemnation is enough to trigger an
The wash sale rules apply only to losses, not to gains. involuntary conversion.
• To be substantially identical the stock or security the tax- • This deferral provision does not apply to losses. If certain con-
payer repurchases must be issued by the same corporation. ditions are met, a taxpayer can deduct losses from involuntary
conversions as casualty losses.
• The 30-day window applies both before and after the date
the taxpayer sells the substantially identical securities, so you • The involuntary conversion rules apply to assets used in busi-
must review a 61-day window (including the day of the sale) ness, investment, and personal use activities.
to ensure your client does not violate this provision. • The taxpayer must replace, or expect to replace, the converted
property with qualified replacement property during the qual-
ified replacement time period to defer the gain.
❸ Analyze the tax consequences of a like-kind exchange. 1. The qualified replacement period ends two years
from the end of the tax year in which the gain from the
• The like-kind exchange deferral rules are mandatory, not conversion is realized.
elective. 2. The taxpayer must use the qualified replacement
• The taxpayer must exchange qualifying property for the tax- property in a manner that is similar or related in
payer to defer the gain or loss. service or use the taxpayer had for the original property.
• Only realty used in business and investment activities qualifies This is a much stricter condition to defer gain than the
for deferral. If the property transferred or property received by broad condition used for like-kind exchanges (i.e., all
the taxpayer is for personal use, the like-kind exchange rules realty is like-kind).
do not apply. • If the taxpayer does defer gain, then the holding period of
• The following types of property do not qualify for like-kind the destroyed property is included in the holding period of the
treatment and gains and losses from their sale of disposition new property.
must be recognized
1. Inventory ❺ Identify transactions related to personal activities
2. Partnership interests that generate disallowed losses.
3. Stocks, bonds, and notes
4. Certificates of trust or beneficial interest • If a taxpayer sells a personal use asset at a loss, the loss is not
5. Other securities or evidence of indebtedness or interest deductible, except for casualty losses which are deductible in
certain circumstances.
6. Life insurance and annuity products
• If a taxpayer sells a personal use asset at a gain, then the gain
7. Personal use property
must be included in taxable income.
8. Property located outside the United States (no matter its use).
• The tax law defines boot as any property exchanged that is not
qualifying property.
❻ Describe the tax treatment for a sale of a principal
residence including recognized gain, if any.
1. The receipt of boot can trigger gain recognition.
2. Because cash and personalty received are not defined as
• The law provides for an exclusion of gain from the sale of a
realty, they are treated as boot received.
principal residence once every two years.
3. Boot does not cause the taxpayer to recognize realized
• To qualify for exclusion of gain, the taxpayer must meet the
losses.
ownership test and the use test. The homeowner must have
4. A taxpayer is treated as receiving boot to the extent that owned and used the residence as a principal residence for
she had debt relief. at least two of the preceding five years. The time need not be
5. The basis in the boot received is always the property’s fair continuous; each test must total at least 730 days during the
market value. previous five years.
• The holding period of like-kind property surrendered tacks on • If a single taxpayer meets the ownership and use tests, she may
to the holding period of like-kind property received. exclude realized gains up to $250,000. Married couples filing

Tax Return and Communication Applications 15-42
jointly who meet the ownership and use tests can exclude up the number of qualifying months (ownership or use) divided
to $500,000 on the sale of a residence. For married taxpayers, by two years. The qualifying months are the lesser of the num-
either spouse can meet the ownership test, but both must meet ber of ownership/use months or the number of months since
the use test. If only one spouse meets the use test, then that the last sale.
spouse can claim only a $250,000 exclusion. • The 3.8% tax on net investment income does not apply to gain
• Taxpayers are eligible to exclude gain if they meet the fre- from the sale of a principal residence that is excluded from
quency test and have not excluded gain from the sale of income. This means that the 3.8% tax will not apply to most
another principal residence during the two-year time period taxpayers who sell their homes, because their gain usually does
ending on the date of the sale. If a residence is sold before the not exceed the $250,000/$500,000 threshold. If taxpayers sell
two-year window is met, due to changes in employment or their principal residence and their gain does exceed these limits,
health (or other unforeseen circumstances such as a natural the excess realized gain is taxed as a capital gain for income tax
disaster, multiple births, or change in wedding plans), then purposes and could be taxed at 3.8% for the net investment
the maximum amount of the exclusion is prorated based upon income tax.
Tax Return and Communication Applications Compliance Communication
Like-Kind Exchanges exchange five acres of vacant land for a building. Kerry will report the
like-kind exchanges on Form 8824. Use the following information to
(LO3) Kerry Okee, single, owns several bars and restaurants in
complete Form 8824, Parts I and III. Then, prepare a short memo
Nashville, TN and has been doing business as Singing in the Rain
to Kerry explaining the tax result of this like-kind exchange.
LLC since 2015. Kerry is looking to expand the business and wants to
Asset Date Date Adjusted Fair market

Transferred Purchased Transferred Basis Value
Land 7/28/16 8/14/20 $280,000 $295,000
Asset Date Date Adjusted Fair market

Received Identified Received Basis Value
Building 7/31/20 8/31/20 $200,000 $250,000
Cash 7/31/20 8/31/20 $ 45,000 $ 45,000

Tax Return Answer:

Ethics and Professional Responsibilities Application 15-44
Communication Answer:
Memo to Client
Dear Kerry,
Thank you for letting us assist you with your recent exchange of properties. Your exchange does qualify
for like-kind exchange treatment because you are exchanging vacant land for a building, which both
qualify as realty. Because you also received $45,000 cash, you will have to recognize your realized gain up
to a maximum of $45,000.
Amount realized Building $250,000

Cash 45,000
$295,000
Less: Adjusted basis of assets given up (280,000)
Realized gain $ 15,000
Recognized gain equals the lower of

2) Boot received $45,000.
Your recognized gain is a $15,000 capital gain. The gain is Section 1231 gain resulting in a long-
term capital gain because no other assets were sold. Even though the transaction qualifies as a like -kind
exchange, you must recognize all your gain because of the $45,000 cash you received. Your basis in the
building is its fair market value of $250,000.
Please let me know if I can assist you any further, or if you have any questions concerning this ex -
change. It is always a pleasure to work with you!
Sincerely,
Carnes and Youngberg, CPAs
Ethics and Professional Responsibilities Application Ethics
Completeness of Information effort to obtain from the taxpayer the information necessary to provide
appropriate answers to all questions on a tax return before signing as
(LO3) A client has completed a like-kind exchange during the year preparer. However, it also states that if the information is not readily
and you have requested the information you need to complete Form available and the answer is not significant in terms of taxable income
8824. The client did not send the description of the like-kind property or loss, then the tax preparer can omit the question. Circular 230,
transferred. She also indicated that she does not know the exact date Regulations Governing Practice before the IRS, states under §10.22
she acquired the property other than that it was sometime in 2010, and Diligence as to accuracy. (a) A practitioner must exercise due dili-
she said she is too busy to send this information. What respon - sibility gence in preparing or assisting in the preparation of, approving, and
do you have to gather this information before signing the tax return?
filing tax returns, documents, affidavits, and other papers relating to
In addition to the chapter content, see Statements on Standards for Internal Revenue Service matters. The tax professional must know the
Tax Services at https://future.aicpa.org/resources/toolkit/statements - description of the like-kind property transferred and provide that in-
on-standards-for-tax-services, Circular 230 at https://www.irs.gov/ formation on the return to establish that the taxpayer has met the like-
tax-professionals/circular-230-tax-professionals, and Chapter 3, LO4, kind exchange rules. The tax professional could also search property
Tax Professional Responsibilities. tax records online to possibly locate the date. However, the exact date
Answer: Statements on Standards for Tax Services No. 2, Answers to that the client purchased the property in 2010 will not affect the tax
Question on Returns, provides that a member should make a reasonable result, so the tax professional can note on the return that the date of
purchase in 2010 is not known.

Key Terms
Boot 15-19 Like-Kind Exchange 15-15 Related Party 15-4

Condemnation 15-26 Ownership Test 15-34 Right of Offset 15-4
Deferred Like-Kind Exchange 15-24 Personal use asset 15-32 Similar or Related in Service or Use 15-26
Eminent Domain 15-26 Principal Residence 15-33 Substantially Identical 15-9
Frequency Test 15-35 Qualifying Like-Kind Property 15-15 Use Test 15-34
Involuntary Conversion 15-26 Qualified Replacement Period 15-26 Wash Sale 15-9
End-of-Chapter Questions
Discussion Questions
1. (LO1) Define a related-party transaction. 11. (LO4) Gabby’s business greenhouse was destroyed by a fire on
2. (LO1) Does the related-party loss disallowance rule apply even October 31, Year 9. Her adjusted basis in the greenhouse was
when the selling price is equal to the fair market value and can be $225,000. Gabby files a claim with her insurance company and
substantiated by a qualified appraisal? receives a check for $275,000 on January 17, Year 10. Gabby is a cash
method taxpayer who files her tax return using a calendar year end.
3. (LO1, 5) Does the related-party loss disallowance rule apply to the
By what date must Gabby replace her damaged greenhouse to satisfy
sale of personal use property
the qualified replacement period test and why?
4. (LO2) Describe a wash sale.
12. (LO4) How would your answer to Discussion Question 11 change
5. (LO2) Do the wash sale rules apply to taxpayers engaged in the busi- if Gabby’s greenhouse were condemned by the city?
ness of buying and selling stock (i.e., stockbroker)? Why or why not?
13. (LO4) Ricardo has owned and operated Ricardo’s Chicken Shack
6. (LO2) What are the rules concerning the holding period of the in California for 10 years. Unfortunately, the restaurant was destroyed
newly purchased stock if a wash sale occurs? by wildfire. What would qualify as a replacement property and why?
7. (LO2) Bruce purchased 100 shares of ABC stock on January 10, 14. (LO6) What types of assets qualify as a principal residence?
Year 8. Bruce purchased 50 additional shares of ABC stock on March
15. (LO6) Can a taxpayer have more than one principal residence at
9, Year 8. State whether each of the following situations qualifies for
the same time? Why or why not?
wash sale treatment, and explain why or why not?
16. (LO6) What factors determine whether a property qualifies as an
a. Bruce sold 100 shares of ABC stock on February 15, Year 8
individual’s principal residence?
and had a realized loss.
17. (LO6) Discuss the three tests that need to be satisfied to qualify
b. Bruce sold 150 shares of ABC stock on March 31, Year 8 and
for exclusion of gain treatment for the sale of a principal residence.
had a realized loss.
18. (LO6) Does short-term rental of the principal residence deny the
c. Bruce sold 100 shares on of ABC stock on April 10, Year 8 and
use of the exclusion treatment? Why or why not?
had a realized loss.
19. (LO6) Javier owns a home in Texas which he has used as his prin-
8. (LO3) Discuss why a loss can never be taken if the like-kind
cipal residence since Year 10. Javier moved to New Mexico for a new
exchange rules are met.
job on May 10, Year 20. Initially, Javier tried to sell his home, but he
9. (LO4) Describe the different types of involuntary conversions. could not sell it due to a severe downturn in the market. Javier instead
10. (LO4) If the insurance proceeds or condemnation award is not rents his home for fair market value beginning September 1, Year 20
reinvested completely in the replacement property, does this prevent until June 10, Year 22, when he sells it. Is Javier eligible for the gain
the taxpayer from taking advantage of the nonrecognition of gain pro- exclusion on the sale of a principal residence?
vision? Why or why not?
Multiple Choice Questions
1. (LO1) Which of the following fall under the related-party relation- c. Brother and sister
ship rules for loss disallowance on sale of an asset? Select all that apply. d. Mother-in-law and daughter-in-law
a. Two cousins
2. (LO1) On April 16, Year 10, Alvin sold 200 shares of Chipmunk
b. A shareholder who owns 60% of a corporation’s stock stock to his father, Tang, for $18,000. Alvin had purchased the stock

Brief Exercises 15-46
in Year 5 for $23,000. Tang sold the stock to Amber, an unrelated third for her customers in her business. The land she receives has a fair
party, for $30,000 on December 28, Year 10. market value of $150,000 so she also receives cash of $50,000. Assume
What amount of gain from the sale of the stock to Amber should that Sariya’s recognized gain from this transaction is $50,000. What is
Tang report on his 2010 income tax return? Sariya’s basis in the new parcel of land?
a. $0 c. $5,000 a. $80,000 c. $150,000

b. $2,000 d. $7,000 b. $130,000 d. $200,000
3. (LO2) Sabin purchased 100 shares of Risky company stock in Year 8. (LO4) Fenwick operates a grocery store and his retail building was
9 for $10,000. He sold these shares on December 27, Year 10 when the completely destroyed by a hurricane on August 22, Year 10. The fair
value had dropped to $2,000. On January 3, Year 11 he repurchased market value of the building before the hurricane was $1,200,000 with
100 shares of Risky for $3,000. an adjusted basis of $800,000. His insurance company reimbursed him
What gain or loss can Sabin recognize from this sale in Year 10 $1,200,000 of December 2, Year 10. When is the last date that
and what basis does he have in the shares purchased in Year 11? Fenwick can replace this building with qualifying property and avoid
Gain/Loss Basis recognizing gain from this transaction?
a. $0 $3,000 a. December 31, Year 10 c. December 31, Year 12

b. ($8,000) $3,000 b. August 22, Year 12 d. December 31, Year 13
c. $0 $11,000 9. (LO6) Which of the following is not a valid exception to the two-
d. ($8,000) $11,000 year frequency test for gain exclusion on sale of a principal residence?
Select all that apply.
4. (LO3) Which of the following qualifies as a like-kind exchange?
a. Health issues
a. An apartment building for commercial store front property
b. Moving closer to a vacation home
b. Machinery for equipment
c. Change in place of employment
c. IBM stock for Google stock
d. Unforeseen circumstances
d. An interest in Red partnership for an interest in Green
partnership 10. (LO6) Potter, who is 48 years old, sold his principal residence this
year for $350,000. He had purchased the residence six years ago for
e. The taxpayer’s personal residence for an investment rental
$200,000 and has lived in it since then except for six months last year
house
when he was in a rehabilitation center after a car accident. He paid a
5. (LO3) Which of the following transactions qualify for deferral of realtor’s commission of $15,000. He has not bought a new home by
gain and loss under the like-kind exchange rules? the end of the tax year and does not plan to do so soon.
a. Exchange of business computer for personal use computer What amount of gain is recognized from the sale of the former
b. Exchange of business office building for investment land residence on Potter’s tax return?
c. Exchange of business automobile for business equipment a. $0 c. $150,000
d. Exchange of business office building for business equipment b. $135,000 d. $350,000
11. (LO6) Mariah purchased her house on February 22, Year 10 and
6. (LO3) Abdul exchanges land used in his business for another parcel
uses it as her principal residence since that time. How long does she
of land which is more suitable for parking for his customers. Abdul’s
need to live in the home to qualify for the exclusion of gain on the sale
land has a fair market value of $160,000 and adjusted basis of
of a principal residence?
$100,000. The land he receives has a fair market value of $120,000 so
he also receives cash of $40,000. What is Abdul’s recognized gain or a. until December 31, Year 10
loss from this transaction? b. until April 15, Year 11
a. $0 c. $60,000 c. until February 22, Year 12

b. $40,000 d. $160,000 d. until February 22, Year 13
7. (LO3) Sariya exchanges a vacant lot used for investment pur-

poses for another parcel of land which is more suitable for parking
Brief Exercises
per share in 2016. She sold it to her brother, Ethan, in the
1. (LO1) Harriet owns 500 shares of Coca-Cola stock and paid $36
current year for $30 per share. Ethan then sold it to his
per share in 2016. She sold it to her cousin, Ethyl, in the current year
neighbor for $50 per share.
for $30 per share. Ethyl then sold it to her neighbor for $50 per share.
What is Harriet’s recognized gain or loss on the sale? What is Ethyl’s
recognized gain or loss on the sale?
2. (LO1) Harriet owns 500 shares of Coca-Cola stock and paid $36
What is Harriet’s recognized gain or loss on the sale? What is Ethan’s recognized
gain or loss on the sale?
3. (LO2) Lakshmi purchased 300 shares of Toole Inc on April 15, Year 7 for $18
per share. She purchased an additional 100 shares on January 22, Year 8 for $17
per share. Lakshmi sold her original 300 shares on February 16, Year 8 for $20 per
share. What is Lakshmi’s realized and recognized gain or loss on the sale of the 300
shares? What is Lakshmi’s basis in the shares purchased on January 22, Year 8?

4. (LO2) Lakshmi purchased 300 shares of Toole Inc on April 15, Year7 $480,000 nine months later. What is Annika’s recognized gain or loss
for $18 per share. She purchased an additional 100 shares on Janu - ary on the condemnation?
22, Year 8 for $17 per share. Lakshmi sold her original 300 shares on 8. (LO4) Annika owned a home in Oak Brook, IL which she
February 16, Year 8 for $15 per share. What is Lakshmi’s realized and purchased for $450,000 seven years ago. The city of Oak Brook is
recognized gain or loss on the sale of the 300 shares? What is planning on building a highway through her backyard and taking her
Lakshmi’s basis in the shares purchased on January 22, Year 8? property through eminent domain. The city of Oak Brook pays her
5. (LO3) Tabby Company exchanged inventory (FMV $4,800, $535,000, which is the property’s fair market value on the date of
Adjusted basis $4,200) for inventory from Persian Company (FMV condemnation, and Annika buys another personal residence in Hins -
$4,000, Adjusted basis $3,000) and cash of $800. Both Tabby and Per- dale, IL for $480,000 nine months later. What is Annika’s recognized
sian sell cat supplies. What is Tabby Company’s realized and recog - gain or loss on the condemnation? What is Annika's deferred gain?
nized gain or loss on the exchange? 9. (LO5) Chevy owns a boat which he purchased for $58,000. Three
6. (LO3) a. How would your answer to Brief Exercise 5 change if, years later, he sells the boat for $45,000. What is Chevy’s realized and
instead of inventory, machinery was exchanged for machinery? recognized gain or loss on the sale?
b. What if land was exchanged for land? 10. (LO6) Iker and Roslyn file a joint tax return. They have owned
and lived in their principal residence for 12 years. Their original pur -
7. (LO4) Annika owned a home in Oak Brook, IL which she pur-
chase price was $345,000. They remodeled the kitchen for $25,000,
chased for $450,000 seven years ago. The city of Oak Brook is planning
added a garage for $22,000, and planted maple trees for $1,000. Iker
on building a highway through her backyard and taking her property
and Roslyn sold their home in the current year for $520,000. What is
through eminent domain. The city of Oak Brook pays her $400,000
their realized and recognized gain or loss on the sale?
which is the property’s fair market value on the date of condemna -
tion, and Annika buys another personal residence in Hinsdale, IL for
Application Problems
1. (LO1) Eric owns investment land with an adjusted basis of $40,000 Year 3 for $8,500. What is Robert’s recognized capital loss from the sale
and fair market value of $35,000. He sells the land to his brother, of his TKO Inc. shares? What is his basis in the newly acquired stock?
Scott, for $32,000. Scott then sells the land to an unrelated third party
5. (LO2) Greg purchased 300 shares of Sunshine Inc. shares for
for $50,000.
$3,000 on August 5, Year 7. Greg purchased 100 more Sunshine
a. What is Eric’s realized gain/loss and recognized gain/loss? shares on August 25, Year 7 for $1,000. He then sold 350 Sunshine
What is Scott’s basis in the land purchased? shares on August 31, Year 7 for $3,800. What is Greg’s recognized
b. What is Scott’s realized gain/loss and recognized gain/loss? gain or loss from the sale on August 31, Year 7? What is Greg’s basis
in his remaining shares?
c. Assume the same facts except Scott then sells the land to an
unrelated third party for $35,000. What is Scott’s realized 6. (LO3) Fabian has owned a vacant lot that he held for investment
gain/loss and recognized gain/loss? purposes in Nebraska for six years that he exchanges for an apartment
building in the current year. The vacant lot has an adjusted basis of
d. Assume the same facts except Scott then sells the land to an
$550,000 and a fair market value of $800,000. The apartment building
unrelated third party for $30,000. What is Scott’s realized
has an adjusted basis to the owner of $375,000 and a fair market value
gain/loss and recognized gain/loss?
of $800,000.
2. (LO2) Jamie enjoys researching, buying, and selling stock. She
a. What is Fabian’s realized gain/loss?
purchased 500 shares of Sterile Inc. stock on March 10, Year 12 for
$5,000. Unfortunately, Sterile Inc.’s stock price took a downturn, b. What is Fabian’s recognized gain/loss?
so Jamie sold her entire position on June 5, Year 12 for $2,000. She c. What is Fabian’s basis in the apartment building?
wanted to reestablish her position in the Sterile Inc. stock, so she d. What is the holding period for Fabian in the apartment
repurchased 500 shares on June 30, Year 12 for $2,500.
building?
a. What is Jamie’s recognized capital loss from the sale of her
7. (LO3) Fabian has owned a vacant lot that he held for investment
Sterile Inc. shares?
purposes in Nebraska for six years that he exchanges for an apartment
b. What is her basis in the newly acquired stock? building in the current year. The vacant lot has an adjusted basis of
c. When does her holding period in the newly acquired stock $550,000 and a fair market value of $800,000. The apartment building
begin? has an adjusted basis to the owner of $375,000 and a fair market value
3. (LO2) Aran owns 200 shares of Omni Inc. (basis of $15,000). He of $750,000. Fabian also receives cash of $50,000 in exchange for his
sold 100 shares of his Omni stock for $4,000 on August 1, Year 6. On land.
August 8, Year 6, Aran purchased 60 shares of Omni for $2,500. What a. What is Fabian’s realized gain/loss?
is his recognized capital loss from the sale of his Omni Inc. shares? b. What is Fabian’s recognized gain/loss?
What is Aran’s basis in the newly acquired stock?
c. What is Fabian’s basis in the apartment building?
4. (LO2) Robert purchased 100 shares of TKO Inc. stock on January 26, d. What is the holding period for Fabian in the apartment
Year 3 for $10,000. He purchased 75 more TKO shares on February 14, building?
Year 3 for $7,000. He then sold his original 100 shares on February 20,

Application Problems 15-48
8. (LO3) Fabian has owned a vacant lot that he held for investment a. What is Ally’s realized gain/loss?
purposes in Nebraska for six years that he exchanges for an apartment b. What is Ally’s recognized gain/loss?
building in the current year. The vacant lot has an adjusted basis of
c. What is Ally’s basis in the new restaurant?
$550,000 and a fair market value of $800,000. The apartment building
has an adjusted basis to the owner of $375,000 and a fair market value 13. (LO4) Ally owned a restaurant in Key West, Florida that was
of $425,000. Fabian also receives cash of $50,000 in exchange for his destroyed by a hurricane. The restaurant had an adjusted basis of
land. Fabian's land had a mortgage attached of $325,000 and the mort- $578,000 when the hurricane hit. Ally had insurance coverage on
gage was assumed by the other transferor. the restaurant and received a check for $750,000. She purchased a
new restaurant four months after receiving the insurance check for
$630,000. Assume Ally wants to minimize gain if possible.
b. What is Fabian’s recognized gain/loss?
a. What is Ally’s realized gain/loss?
c. What is Fabian’s basis in the apartment building?
b. What is Ally’s recognized gain/loss?
d. What is the holding period for Fabian in the apartment
c. What is Ally’s basis in the new restaurant?
building?
14. (LO4) Ally owned a restaurant in Key West, Florida that was
9. (LO3 Advanced) Fabian has owned a vacant lot that he held for
destroyed by a hurricane. The restaurant had an adjusted basis of
investment purposes in Nebraska for six years that he exchanges for an
$578,000 when the hurricane hit. Ally had insurance coverage on
apartment building in the current year. The vacant lot has an adjusted
the restaurant and received a check for only $500,000 because Ally
basis of $550,000 and a fair market value of $800,000. The apartment
was underinsured. She purchased a new restaurant four months after
building has an adjusted basis to the owner of $375,000, a fair mar -
receiving the insurance check for $800,000. Assume Ally wants to
ket value of $625,000, and a mortgage attached of $200,000 which
minimize gain if possible.
Fabian assumes. Fabian also receives cash of $50,000 in exchange for
his land. Fabian's land had a mortgage attached of $325,000 and the 15. (LO5) Brody and Sally file a joint tax return and have lived in
mortgage was assumed by the other transferor. their principal residence in Minnesota for the last 5 years. The
adjusted basis for the home is $460,000. Due to an economic down -
turn in the real estate market, they are able to sell their home for only
b. What is Fabian’s recognized gain/loss? $390,000. They move to Florida and purchase a new principal resi-
c. What is Fabian’s basis in the apartment building? dence with the proceeds. What is Brody and Sally’s realized gain or
d. What is the holding period for Fabian in the apartment loss and recognized gain or loss?
building? 16. (LO5) Daniel’s favorite hobby is restoring cars. His latest project
10. (LO3 Advanced) Fabian has owned a vacant lot that he held for is refurbishing a 1965 Corvette to its original glory. Daniel purchased
investment purposes in Nebraska for six years that he exchanges for an the car for $4,000 and has spent $8,000 for a new engine, tires, and
apartment building in the current year. The vacant lot has an adjusted transmission. He drove the car for four years and then needed to sell
basis of $550,000 and a fair market value of $800,000. The apartment it. Because of an overabundance of 1965 Corvettes in the market, he
building has an adjusted basis to the owner of $375,000, a fair mar - sold it for only $10,000. What is Daniel’s realized gain or loss and rec-
ket value of $775,000, and a mortgage attached of $350,000 which ognized gain or loss?
Fabian assumes. Fabian also receives cash of $50,000 in exchange for 17. (LO5 & 6) Gary and Roberta own a beautiful home in St. Charles,
his land. Fabian's land had a mortgage attached of $325,000 and the IL which they have used as their principal residence for 10 years. The
mortgage was assumed by the other transferor. home cost $600,000 and they have made capital improvements of
a. What is Fabian’s realized gain/loss? $125,000. Gary and Roberta decide to sell their home for $650,000.
What is their recognized gain or loss?
b. What is Fabian’s recognized gain/loss?
18. (LO6) Diego purchased a home in Miami in October Year 10. He
c. What is Fabian’s basis in the apartment building? also purchased a home in Daytona in January Year 16. He used the
d. What is the holding period for Fabian in the apartment Miami home as his principal residence until he moved closer to Day -
building? tona on June 1, Year 16 after retiring. From June 1, Year 16 until he
sold the home on August 31, Year 20, Diego used the Miami home
11. (LO3) Emily owns and operates as a sole proprietorship, Made for
only periodically when he visited his family; he used h is Daytona
You, a manufacturing company of cruelty-free makeup and personal prod-
home more often. Does Diego meet the ownership and use tests to
ucts. On April 15, Year 4, Emily exchanges equipment with an adjusted
qualify for the exclusion of the gain on the sale of the Miami principal
basis of $4,000 and a fair market value of $3,000 for equipment with an
residence? Why or why not?
adjusted basis of $3,600 and a fair market value of $2,500 and $700 cash.
19. (LO6) Chuck and Mary have lived in Madison, WI for 35 years
a. What is Emily’s realized gain/loss?
and want to sell their home and move to Florida. The home cost them
b. What is Emily’s recognized gain/loss? $80,000 in 1975.
c. What is Emily’s basis in the new equipment received? a. What is their realized gain and recognized gain if they sell the
d. What is the holding period for Emily in the new equipment home for $500,000?
received? b. What is their realized and recognized gain if they sell the
12. (LO4) Ally owned a restaurant in Key West, Florida that was home for $600,000?
destroyed by a hurricane. The restaurant had an adjusted basis of 20. (LO6) Faisal, single, has owned and lived in his principal resi-
$578,000 when the hurricane hit. Ally had insurance coverage on dence in Geneva, IL since October Year 9. Its purchase price was
the restaurant and received a check for $750,000. She purchased a $225,000. Faisal works in Chicago, IL which is 45 miles away. He just
new restaurant four months after receiving the insurance check for found out that his employer would like him to transfer to the Milwau-
$800,000. Assume Ally wants to minimize gain if possible. kee, Wisconsin office. The distance between Geneva and Milwaukee

is 110 miles. Faisal’s new home in Milwaukee is only five miles from husband, Peter, moves into her home. Peter was renting an apartment
his new work location. Faisal sells his Geneva home for $400,000. prior to moving in with Pamela. Pamela and Peter sell their Tacoma
Does he qualify to exclude any of the gain from the sale of his resi- home in March Year 10 and purchase a new home in Seattle in Feb-
dence? Why or why not? ruary Year 10. They have a realized gain of $100,000 on the sale of the
21. (LO6) Ben and Gerrie, married filing jointly, have lived in San Tacoma home. How much of this realized gain may be excluded from
Diego for 15 years where they have owned a home. They decide to sell income, and why?
their personal residence on February 1, Year 19 and have a realized 23. (LO6) Fred and Francine were married 60 years ago and pur-
gain of $285,000. This gain was excluded under the sale of principal chased their family home shortly thereafter for $69,000. They have
residence rule. Ben and Gerrie purchase another home in San Diego lived in the same home and made capital improvements to it of
on March 1, Year 19 for $175,000. Ben’s employer transfers him to the $25,000. Fred’s untimely death in July Year 8 saddened Francine, and
San Francisco office in December Year 19. Ben and Gerrie sell their she could not bring herself to sell their home. She finally did so in
second San Diego home on January 2, Year 20 for $400,000. What are June Year 10 for $600,000 and moved into a nursing home. What is
the tax results of the second sale? Francine’s recognized gain on the sale of the principal residence?
22. (LO6) Pamela was divorced in March Year 8. She and her ex-hus- 24. (LO6 Advanced) Jose, who is single, is a tax accountant who has
band had owned and used their principal residence for 15 years. They worked from his home for the past six years. He has taken a home
sold the home in April Year 8 and their realized gain of $425,000 was office deduction that includes accumulated depreciation expense of
excluded under the sale of principal residence rule. Pamela moved $43,000 in previous years. Jose sells his home in the current year for
to Tacoma, Washington for a fresh start and purchased a new home $475,000. He paid $250,000 for his home six years ago. What is Jose’s
on May 10, Year 8. Pamela remarries on June 5, Year 9 and her new recognized gain on the sale of his principal residence?
Tax Planning Problems Planning
1. (LO1) Benjamin owns equipment that is used 100% in his business 4. (LO6) Kashif is single, very wealthy, and owns several homes in
with a fair market value of $11,000 and an adjusted basis of $15,000. various states across the country. The following is a list of the homes
He would like to sell the equipment and is looking for the best net he has owned and sold. Assume he began using each home as a prin -
after-tax cash flow. His tax rate is 35%. Would it be better to sell the cipal residence on the date of purchase.
equipment to his dad for $11,000 or his best friend for $10,000? Why?
Date of Purchase/
2. (LO2) Dayana has been buying and selling shares of stock for
many years. On April 15, Year 14, Dayana purchased 1,000 shares of
Location purchase Date of sale Sale
Halo Inc. stock for $15,000. On April 25, Year 14, she purchased 500
more shares of Halo Inc. stock for $7,500. She thought Halo Inc. was Boston February Year 7 $ 225,000
going to be a good investment, but the price has been dropping. If Boston April Year 12 $ 500,000
Dayana would like to minimize her tax liability and deduct a capital
Hilton Head November Year 11 $ 400,000
loss on her tax return, on what date should she sell her Halo Inc. stock
and not be subject to the wash sale rules? Hilton Head May Year 13 $ 700,000
Pebble Beach December Year 12 $ 800,000
3. (LO3) Detwan would like to structure an exchange of his vacant Pebble Beach March Year 15 $1,200,000
land for another piece of land. He knows that it might take some time
What are the tax consequences of Kashif’s purchase and sale of
to identify the new property and for the exchange to take place. Are
his various homes?
delayed like-kind exchanges allowed and if so, what requirements
need to be met for Detwan to receive deferred gain status?
Professional Development Skills

Communication Problem Communication
1. (LO3) What Qualifies for a Like-Kind Exchange? Sharon owns a tennis court construction busi-
ness in Bradenton, FL. and specializes in designing unique tennis facilities in all areas of Florida and
Georgia. She is aware of an opportunity to do a like-kind exchange and would like guidance from you.
Sharon provides the following information regarding assets she would be willing to exchange:
1. Ball machine (Adjusted basis $2,250, FMV $1,850)

2. Nets, brackets, and posts assembly package (Adjusted basis $7,400, FMV $6,300)

Excel Problem 15-50
3. Land located in Bradenton, FL (Adjusted basis $45,000, FMV $60,000)

4. Land located in Alpharetta, GA (Adjusted basis $37,750, FMV $60,000)
5. Truck used for business (Adjusted basis $12,000, FMV $10,000)
Write a letter to Sharon regarding the proposed like-kind exchange and information you need from her to
determine the tax consequences of any planned exchanges.
Ethics Problem Ethics
1. (LO6) Sale of a Principal Residence Brad DeTail, CPA, has owned his own public accounting firm
since 2002. Brad has been hired to prepare Sly Sylvestor’s 2021 Federal and state individual income tax
returns. When reviewing the 2021 information, Brad makes note that a closing statement has been provided
for the sale of Sly’s principal residence in Columbus, OH on August 14, 2021. The sales price was $365,000
with closing costs of $25,000. Sly told Brad that his gain should be excluded because it was his principal res-
idence and he had purchased the home in 2018 for $225,000. As a thorough accountant should, Brad asked
to review the last three years of Sly’s tax returns. Brad noticed that Sly had different addresses listed on the
2018 and 2019 tax returns, but there were no property transactions listed on either return. When asked, Sly
stated that he had moved twice in the last three years and sold his principal residences. What are Brad’s
ethical obligations to Sly, himself, and the IRS?
In addition to the chapter content, see Statements on Standards for Tax Services at https://future.
aicpa.org/resources/toolkit/statements-on-standards-for-tax-services, Circular 230 at https://www.irs.gov/
tax-professionals/circular-230-tax-professionals, and Chapter 3, LO4, Tax Professional Responsibilities.
Research Problem Research
1. (LO3) Requirements for a Like-Kind Exchange Chase owns a two-unit apartment building in
Nashville, TN. He purchased the apartment ten years ago for $200,000 and its current adjusted basis is
$127,000. He identified another apartment building in Memphis on August 15th for potential purchase.
At the time, Chase had not decided whether he would purchase the second apartment building outright or
exchange his current two-unit apartment building. Chase has arranged to have a third -party accom-
modator purchase the Memphis apartment building with money Chase loaned to the accommodator.
He now has decided he would like to exchange his Nashville property for the Memphis property. Can
this qualify as a deferred like-kind exchange, and if so, are there any time constraints concerning when
Chase must exchange his Nashville property in order for the transaction to qualify for like-kind exchange
treatment?
Excel Problem Technology
1. (LO1) Related-Party Sale Chike owns 100 shares of stock in Belvidere Corporation. He purchased
the stock for $40,000 three years ago. Chike sells the shares to his sister, Naomi, in the current year for
$32,000 resulting in a realized loss of $8,000 to Chike. Create an Excel spreadsheet to indicate the recog-
nized gain if Naomi sells the stock to an outside third party for:
1. $42,000
2. $36,000
3. $30,000

CPA Exam Preparation: Task-Based Simulation
1. (LO1, 3-6) Property Transactions Reggie and Regina Rinker own Renegade Activities Company
(RAC) specializing in exhilarating events for high end businesses and individuals. In the current year,
Reggie and Regina and RAC have had several property transactions. For each transaction, you will iden-
tify whether it is:
• all recognized
• partially recognized
• 100% deferred
• 100% excluded.
Go to Wiley Course Resources to complete the Task-Based Simulation.
Part IV (Chapters 12–15): Comprehensive Tax Return Problem
Lloyd Bolander owns and operates the Sipapu Ski Resort in Taos, New Mexico, as a sole proprietor. Lloyd
has asked for your help in completing his 2021 tax return related to 10 property transactions, including a
property exchange, equipment sales and purchase, and stock purchases and sales, among others. You will
complete Form 4562, Form 8824, Form 4797, Schedule D, and Form 8949 based on provided information.
Go to Wiley Course Resources for the complete Comprehensive Tax Return Problem for Part IV (Chapters
12–15).

C 15 Property Transactions

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C HA P TER 15

2.6 Introduction to Property Transactions

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Taxation of Property Transactions

Other Personal Stocks Bonds Collectibles

DEFERRED GAINS AND LOSSES

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EXCLUDED GAINS AND LOSSES

Tax Forms in this chapter

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15.1 Related-Party Losses

Defining Related Party

Evaluating Related-Party Transactions

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ILLUSTRATION 15.1 The Four Steps for Assessing Related-Party Transactions

Assessing Related-Party Transactions

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Tax Return Guidance

ILLUSTRATION 15.2 Form 8949 (Example 15.1.1)

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Related exercises: Application Problem 1, Multiple Choice Question 2

Tax Planning Tip

Tax Planning Tip

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Advanced Topic—Drilling Down

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15.2 Wash Sales

Defining a Wash Sale

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Computing a Wash Sale

Cost of new stock

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ILLUSTRATION 15.3 Six Steps to Determining Wash Sales Issues

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Step 1. First, we compute Kiara’s realized gain or loss:

Amount realized $1,200

Recognized loss ($0) = Realized loss ($800) ‒ Deferred loss ($800)

Cost of new stock $1,250

Tax Planning Tip

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Step 1. First, we compute Kiara’s realized gain or loss:

Number of shares repurchased within 30 days (60)

Cost of new stock $ 750

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Tax Return Guidance

ILLUSTRATION 15.4 Form 8949 (Example 15.2.3)

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Spotlight on the Law

15.3 Like-Kind Exchanges

Tax Planning Tip

Defining Like-Kind Exchanges

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Related exercises: Multiple Choice Questions 4, 5

Evaluating Like-Kind Exchanges

Step 1. Compute: The realized gain or loss from the exchange.

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Step 4. Determine: The recognized gain or loss.

Step 5. Determine: The deferred gain or loss as follows:

Formula 1: Adjusted basis in property transferred

Formula 2: Fair market value of property received

Illustration 15.5 provides a flow chart showing these steps.

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ILLUSTRATION 15.5 Eight Steps Like-Kind Exchanges