This chapter explains how to figure, and report on your tax return, your gain or loss on the disposition of your property or debt and whether such gain or loss is ordinary or capital. Ordinary gain is taxed at the same rates as wages and interest income while capital gain is generally taxed at lower rates. Dispositions discussed in this chapter include sales, exchanges, foreclosures, repossessions, canceled debts, hedging transactions, and elections to treat cutting of timber as a sale or exchange.taxmap/pubs/p225-036.htm#TXMP0d5f76aa
You may want to see:
Publication 334 Tax Guide for Small Business 523 Selling Your Home 544 Sales and Other Dispositions of Assets 550 Investment Income and Expenses 908 Bankruptcy Tax Guide Form (and Instructions) Sch D (Form 1040): Capital Gains and Losses Sch F (Form 1040): Profit or Loss From Farming 1099-A: Acquisition or Abandonment of Secured Property 1099-C: Cancellation of Debt 4797: Sales of Business Property
See chapter 16 for information about getting publications and forms.taxmap/pubs/p225-036.htm#en_us_publink100073486
If you sell, exchange, or otherwise dispose of your property, you usually have a gain or a loss. This section explains certain rules for determining whether any gain you have is taxable, and whether any loss you have is deductible.
A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. An exchange is a transfer of property for other property or services. taxmap/pubs/p225-036.htm#en_us_publink100073487
You usually realize a gain or loss when you sell or exchange property. If the amount you realize from a sale or exchange of property is more than its adjusted basis, you will have a gain. If the adjusted basis of the property is more the amount you realize, you will have a loss.taxmap/pubs/p225-036.htm#en_us_publink100073488
The basis of property you buy is usually its cost. The adjusted basis of property is basis plus certain additions and minus certain deductions. See chapter 6 for more information about basis and adjusted basis.taxmap/pubs/p225-036.htm#en_us_publink100073489
The amount you realize from a sale or exchange is the total of all money you receive plus the fair market value (defined in chapter 6) of all property or services you receive. The amount you realize also includes any of your liabilities assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage.
If the liabilities relate to an exchange of multiple properties, see Treatment of liabilities under Multiple Property Exchanges in chapter 1 of Publication 544. taxmap/pubs/p225-036.htm#en_us_publink100073490
Your gain or loss realized from a sale or exchange of property is usually a recognized gain or loss for tax purposes. A recognized gain is a gain you must include in gross income and report on your income tax return. A recognized loss is a loss you deduct from gross income. For example, if your recognized gain from the sale of your tractor is $5,300, you include that amount in gross income on Form 1040. However, your gain or loss realized from the exchange of property may not be recognized for tax purposes. See Like-Kind Exchanges, next. Also, a loss from the disposition of property held for personal use is not deductible. taxmap/pubs/p225-036.htm#en_us_publink100073491
Certain exchanges of property are not taxable. This means any gain from the exchange is not recognized, and any loss cannot be deducted. Your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive.
The exchange of property for the same kind of property is the most common type of nontaxable exchange. To be a like-kind exchange, the property traded and the property received must be both of the following.
- Qualifying property.
- Like-kind property.
These two requirements are discussed later.
The like-kind exchange rules also apply to property exchanges that involve three- and four-party transactions. Any part of these multiple-party transactions can qualify as a like-kind exchange if it meets all the requirements described in this section. taxmap/pubs/p225-036.htm#en_us_publink100073493
If you receive property in a like-kind exchange and the other party who transfers the property to you does not give you the title, but a third party does, you can still treat this transaction as a like-kind exchange if it meets all the requirements. taxmap/pubs/p225-036.htm#en_us_publink100073494
If you receive property in a like-kind exchange, the basis of the property will be the same as the basis of the property you gave up. See chapter 6 for more information.taxmap/pubs/p225-036.htm#en_us_publink100073495
If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized gain or loss. The basis of the property received is the basis of the property given up, increased by the money paid.taxmap/pubs/p225-036.htm#en_us_publink100073496
You traded an old tractor with an adjusted basis of $1,500 for a new one. The new tractor costs $30,000. You were allowed $8,000 for the old tractor and paid $22,000 cash. You have no recognized gain or loss on the transaction regardless of the adjusted basis of your old tractor. If you had sold the old tractor to a third party for $8,000 and bought a new one, you would have a recognized gain or loss on the sale of your old tractor equal to the difference between the amount realized and the adjusted basis of the old tractor.
Report the exchange of like-kind property, even though no gain or loss is recognized, on Form 8824, Like-Kind Exchanges. The instructions for the form explain how to report the details of the exchange.
If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040) or Form 4797, whichever applies. You may also have to report the recognized gain as ordinary income because of depreciation recapture on Form 4797. See chapter 9 for more information. taxmap/pubs/p225-036.htm#en_us_publink100073498
In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. Machinery, buildings, land, trucks, breeding livestock, rental houses, and certain mutual ditch, reservoir, or irrigation company stock are examples of property that may qualify.taxmap/pubs/p225-036.htm#en_us_publink100073499
The rules for like-kind exchanges do not apply to exchanges of the following property.
- Property you use for personal purposes, such as your home and your family car.
- Stock in trade or other property held primarily for sale, such as crops and produce.
- Stocks, bonds, or notes. However, see Qualifying property above.
- Other securities or evidences of indebtedness, such as accounts receivable.
- Partnership interests.
However, you may have a nontaxable exchange under other rules. See Other Nontaxable Exchanges
in chapter 1 of Publication 544.
To qualify as a nontaxable exchange, the properties exchanged must be of like kind as defined in the income tax regulations. Generally, real property exchanged for real property qualifies as an exchange of like-kind property.
An exchange of a tractor for a new tractor is an exchange of like-kind property, and so is an exchange of timber land for crop acreage. An exchange of a tractor for acreage, however, is not an exchange of like-kind property. Neither is the exchange of livestock of one sex for livestock of the other sex. An exchange of the assets of a business for the assets of a similar business cannot be treated as an exchange of one property for another property. Whether you engaged in a like-kind exchange depends on an analysis of each asset involved in the exchange. taxmap/pubs/p225-036.htm#en_us_publink100073501
Depreciable tangible personal property can be either like kind or like class to qualify for nontaxable exchange treatment. Like-class properties are depreciable tangible personal properties within the same General Asset Class or Product Class. Property classified in any General Asset Class may not be classified within a Product Class. Assets that are not in the same class will qualify as like-kind property if they are of the same nature or character.taxmap/pubs/p225-036.htm#en_us_publink100073502
General Asset Classes describe the types of property frequently used in many businesses. They include the following property.
- Office furniture, fixtures, and equipment (asset class 00.11).
- Information systems, such as computers and peripheral equipment (asset class 00.12).
- Data handling equipment except computers (asset class 00.13).
- Airplanes (airframes and engines), except planes used in commercial or contract carrying of passengers or freight, and all helicopters (airframes and engines) (asset class 00.21).
- Automobiles and taxis (asset class 00.22).
- Buses (asset class 00.23).
- Light general purpose trucks (asset class 00.241).
- Heavy general purpose trucks (asset class 00.242).
- Railroad cars and locomotives, except those owned by railroad transportation companies (asset class 00.25).
- Tractor units for use over-the-road (asset class 00.26).
- Trailers and trailer-mounted containers (asset class 00.27).
- Vessels, barges, tugs, and similar water-transportation equipment, except those used in marine construction (asset class 00.28).
- Industrial steam and electric generation and/or distribution systems (asset class 00.4).
Product Classes include property listed in a 6-digit product class (except any ending in 9) in sectors 31 through 33 of the North American Industry Classification System (NAICS) of the Executive Office of the President, Office of Management and Budget, United States, 2007 (NAICS Manual). It can be accessed at http://www.census.gov/naics
. Copies of the hard cover manual may be purchased from the National Technical Information Service (NTIS) at http://www.ntis.gov/products/naics.aspx
or by calling 1-800-553-NTIS (1-800-553-6847) or (703) 605-6000. A CD-ROM version with search and retrieval software is also available from NTIS.
If, in addition to like-kind property, you receive money or unlike property in an exchange on which you realize gain, you have a partially nontaxable exchange. You are taxed on the gain you realize, but only to the extent of the money and the fair market value of the unlike property you receive. A loss is not deductible. taxmap/pubs/p225-036.htm#en_us_publink100073505
You trade farmland that cost $30,000 for $10,000 cash and other land to be used in farming with a fair market value of $50,000. You have a realized gain of $30,000, but only $10,000, the cash received, is recognized (included in income). taxmap/pubs/p225-036.htm#en_us_publink100073506
Assume the same facts as in Example 1, except that, instead of money, you received a tractor with a fair market value of $10,000. Your recognized gain is still limited to $10,000, the value of the tractor (the unlike property).taxmap/pubs/p225-036.htm#en_us_publink100073507
Assume in Example 1 that the fair market value of the land you received was only $15,000. Your $5,000 loss is not recognized. taxmap/pubs/p225-036.htm#en_us_publink100073508
If, in addition to like-kind property, you give up unlike property, you must recognize gain or loss on the unlike property you give up. The gain or loss is the difference between the fair market value of the unlike property and the adjusted basis of the unlike property. taxmap/pubs/p225-036.htm#en_us_publink100073509
Special rules apply to like-kind exchanges between related persons. These rules affect both direct and indirect exchanges. Under these rules, if either person disposes of the property within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. The gain or loss on the original exchange must be recognized as of the date of the later disposition. The 2-year holding period begins on the date of the last transfer of property that was part of the like-kind exchange. taxmap/pubs/p225-036.htm#en_us_publink100073510
Under these rules, related persons include, for example, you and a member of your family (spouse, brother, sister, parent, child, etc.), you and a corporation in which you have more than 50% ownership, you and a partnership in which you directly or indirectly own more than a 50% interest of the capital or profits, and two partnerships in which you directly or indirectly own more than 50% of the capital interests or profits.
For the complete list of related persons, see Related persons in chapter 2 of Publication 544.taxmap/pubs/p225-036.htm#en_us_publink100073511
You used a grey pickup truck in your farming business. Your sister used a red pickup truck in her landscaping business. In December 2007, you exchanged your grey pickup truck, plus $200, for your sister's red pickup truck. At that time, the fair market value (FMV) of the grey truck was $7,000 and its adjusted basis was $6,000. The FMV of the red pickup truck was $7,200 and its adjusted basis was $1,000. You realized a gain of $1,000 (the $7,200 FMV of the red pickup truck, minus the grey pickup's $6,000 adjusted basis, minus the $200 you paid). Your sister realized a gain of $6,200 (the $7,000 FMV of the grey pickup truck plus the $200 you paid, minus the $1,000 adjusted basis of the red pickup truck).
However, because this was a like-kind exchange, you recognized no gain. Your basis in the red pickup truck was $6,200 (the $6,000 adjusted basis of the grey pickup truck plus the $200 you paid). She recognized gain only to the extent of the money she received, $200. Her basis in the grey pickup truck was $1,000 (the $1,000 adjusted basis of the red pickup truck minus the $200 received, plus the $200 gain recognized).
In 2008, you sold the red pickup truck to a third party for $7,000. Because you sold it within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. On your tax return for 2008, you must report your $1,000 gain on the 2007 exchange. You also report a loss on the sale as $200 (the adjusted basis of the red pickup truck, $7,200 (its $6,200 basis plus the $1,000 gain recognized), minus the $7,000 realized from the sale).
In addition, your sister must report on her tax return for 2008 the $6,000 balance of her gain on the 2007 exchange. Her adjusted basis in the grey pickup truck is increased to $7,000 (its $1,000 basis plus the $6,000 gain recognized).taxmap/pubs/p225-036.htm#en_us_publink100073512
The following property dispositions are excluded from these rules.
- Dispositions due to the death of either related person.
- Involuntary conversions.
- Dispositions where it is established to the satisfaction of the IRS that neither the exchange nor the disposition has, as a main purpose, the avoidance of federal income tax.
Under the like-kind exchange rules, you must generally make a property-by-property comparison to figure your recognized gain and the basis of the property you receive in the exchange. However, for exchanges of multiple properties, you do not make a property-by-property comparison if you do either of the following.
- Transfer and receive properties in two or more exchange groups.
- Transfer or receive more than one property within a single exchange group.
For more information, see Multiple Property Exchanges in chapter 1 of Publication 544.taxmap/pubs/p225-036.htm#en_us_publink100073514
A deferred exchange is one in which you transfer property you use in business or hold for investment and later receive like-kind property you will use in business or hold for investment. (The property you receive is replacement property.) The transaction must be an exchange (that is, property for property) rather than a transfer of property for money used to buy replacement property unless the money is held by a qualified intermediary (defined later).
A deferred exchange for like-kind property may qualify for nonrecognition of gain or loss if the like-kind property is identified in writing and transferred within the following time limits.
- You must identify the property to be received within 45 days after the date you transfer the property given up in the exchange.
- The property must be received by the earlier of the following dates.
- The 180th day after the date on which you transfer the property given up in the exchange.
- The due date, including extensions, for your tax return for the tax year in which the transfer of the property given up occurs.
To comply with the 45-day written notice requirement to identify property to be received, you must designate and clearly describe the replacement property in a written document signed by you. For more information, see Identifying replacement property in chapter 1 of Publication 544.
A qualified intermediary is a person who enters into a written exchange agreement with you to acquire and transfer the property you give up and to acquire the replacement property and transfer it to you. This agreement must expressly limit your rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property held by the qualified intermediary. A qualified intermediary cannot be your agent at the time of the transaction or certain persons related to you or your agent.
A taxpayer who transfers property given up to a qualified intermediary in exchange for replacement property formerly owned by a related person is not entitled to nonrecognition treatment if the related person receives cash or unlike property for the replacement property.
For more information, see Deferred Exchange in chapter 1 of Publication 544.taxmap/pubs/p225-036.htm#en_us_publink100073517
No gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or a former spouse if incident to divorce. This rule does not apply if the recipient is a nonresident alien. Nor does this rule apply to a transfer in trust to the extent the liabilities assumed and the liabilities on the property are more than the property's adjusted basis.
Any transfer of property to a spouse or former spouse on which gain or loss is not recognized is not considered a sale or exchange. The recipient's basis in the property will be the same as the adjusted basis of the giver immediately before the transfer. This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than either its fair market value at the time of transfer or any consideration paid by the recipient. This rule applies for determining loss as well as gain. Any gain recognized on a transfer in trust increases the basis.
For more information on transfers of property incident to divorce, see Property Settlements in Publication 504, Divorced or Separated Individuals.