us internal revenue service: p544--1997

8/14/2019 US Internal Revenue Service: p544--1997

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ContentsImportant Changes ............................ 1

Important Reminders ......................... 2

Introduction ........................................ 2

1. Gain or Loss ................................ 2Sales and Exchanges ..................... 2Abandonments ................................ 4Foreclosures and Repossessions .. 4Involuntary Conversions ................. 5

Nontaxable Exchanges ................... 10Transfers Between Spouses .......... 16Rollover of Capital Gain ................. 16

2. Ordinary or Capital Gain or Loss 16

Capital Assets ................................. 17Noncapital Assets ........................... 17Sales and Exchanges Between

Related Parties ........................ 17Other Dispositions .......................... 19

3. Treatment of Capital Gains andLosses .......................................... 22

Long and Short Term ..................... 22Net Gain or Loss ............................ 22

Treatment of Capital Losses .......... 23Maximum Tax Rates on Net Capital

Gain ......................................... 23

4. Ordinary or Capital Gain or Lossfor Business Property ................ 24

Section 1231 Gains and Losses .... 24Depreciation Recapture .................. 25

5. Reporting Gains and Losses ..... 31Information Returns ........................ 32Schedule D (Form 1040) ................ 32Form 4797 ...................................... 32Example .......................................... 32

6. How To Get More Information ... 37

Index .................................................... 38

Important ChangesLike-kind exchanges of personal property.For transfers of property after June 8, 1997,in tax years ending after that date, personalproperty used predominantly in the UnitedStates and personal property used predomi-nantly outside the United States are not like-kind property under the like-kind exchangerules. For more information, see Special rulefor foreign personal property exchanges un-der Like-Kind Exchangesin chapter 1.

Maximum tax rates on capital gains. Forsome sales and exchanges after May 6,1997, the maximum tax rate on the net capitalgain is reduced. For more information, seeMaximum Tax Rates on Net Capital Gain inchapter 3.

Postponement of gain on condemnations.For condemnations occurring after June 8,1997, you cannot postpone reporting gain ifyou acquire replacement property or stockfrom a related party and your gains from in-voluntary conversions total more than$100,000 for the year. For details, see Buyingreplacement property from a related partyunder Condemnationsin chapter 1.

Departmentof theTreasury

InternalRevenueService

Publica tion 544Cat. No. 15074K

Sales and OtherDispositions ofAssets

For use in preparing

1997 Returns

Get f orms and other informat ion faster and easier by:COMPUTER

World Wide Web www.irs.ustreas.gov FTP ftp.irs.ustreas.gov IRIS at FedWorld (703) 321-8020

FAX From your FAX machine, dial (703) 368-9694See How To Get More Information in this publication.


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Related parties. In tax years beginning afterAugust 5, 1997, an executor and a beneficiaryof an estate may be treated as related partiesunder the related party rules. For more infor-mation, see Sales and Exchanges BetweenRelated Partiesin chapter 2.

Rollover of gain from the sale of qualifiedsmall business stock. For sales after Au-gust 5, 1997, you may be able to roll over acapital gain from the sale of qualified smallbusiness stock into other qualified small

business stock. For more information, seeRollover of Capital Gain in chapter 1.

Nonqualified preferred stock received in anontaxable exchange. For exchanges afterJune 8, 1997, nonqualified preferred stockreceived in an exchange of stock for stock,or of property for stock in a controlled corpo-ration, is treated as other property rather thanstock. See Corporate Stock, under OtherNontaxable Exchangesin chapter 1.

Exclusion of gain from DC Zone assets.Beginning in 1998, if you acquire a District ofColumbia Enterprise Zone (DC Zone) assetand hold it more than 5 years, you will not

have to include any qualified capital gain fromits sale or exchange in your gross income.This exclusion applies to an interest in, orproperty of, certain businesses operating inthe District of Columbia. For more informa-tion, see Publication 553, Highlights of 1997Tax Changes.

Important Reminders

Investing in small business stock. Begin-ning in 1998, investments in certain smallbusiness stock held more than 5 years willqualify for a special tax benefit. If you sell or

exchange the stock at a gain, only one-halfof the gain will be subject to federal incometax. For information on qualifying stock, seechapter 4 of Publication 550, Investment In-come and Expenses.

Dispositions of U.S. real property interestsby foreign persons. If you are a foreignperson or firm and you sell or otherwise dis-pose of a U.S. real property interest, thebuyer (or other transferee) may have to with-hold income tax on the amount you receivefor the property (including cash, fair marketvalue of other property, and any assumed li-ability). Corporations, partnerships, trusts,and estates may also have to withhold oncertain U.S. real property interests they dis-

tribute to you. You must report these dispo-sitions and distributions and any income taxwithheld on your U.S. income tax return.

For more information on dispositions ofU.S. real property interests, get Publication519, U.S. Tax Guide for Aliens.

Foreign source income. If you are a U.S.citizen with income from dispositions of prop-erty outside the United States (foreign in-come), you must report all such income onyour tax return unless it is exempt by U.S.law. This is true whether you reside inside oroutside the United States and whether or notyou receive a Form 1099 from the foreignpayor.

IntroductionThis publication explains the tax rules thatapply when you dispose of property. It covers:

How to figure a gain or loss,

Whether your gain or loss is ordinary orcapital,

How to treat a capital gain and or loss,

How to treat your gain or loss when you

dispose of business property, and How to report a gain or loss.

This publication also explains whether yourgain is taxable or your loss is deductible.

This publication does notdiscuss certaintransactions covered in other IRS publica-tions. These include:

Most transactions involving stocks,bonds, options, forward and futures con-tracts, and similar investments, discussedin chapter 4 of Publication 550, Invest-ment Income and Expenses,

Sale of your main home, discussed inPublication 523, Selling Your Home,

Installment sales, discussed in Publica-tion 537, Installment Sales, and

Transfers of property at death, discussedin Publication 559, Survivors, Executors,and Administrators.

Disposing of property. You dispose ofproperty when:

You sell property,

You exchange property for other prop-erty,

Your property is condemned, or disposedof under threat of condemnation,

Your property is repossessed,

You abandon property, or

You give property away.

Forms to file. When you dispose of property,you will usually have to file one or more of thefollowing forms:

Schedule D (Form 1040), Capital Gainsand Losses.

Form 4797, Sales of Business Property.

Form 8824, Like-Kind Exchanges.

Chapter 5 illustrates how to fill out Form 4797and Form 8824.

1.

Gain or Loss

TopicsThis chapter discusses:

Sales and exchanges

Abandonments

Foreclosures and repossessions

Involuntary conversions

Nontaxable exchanges

Transfers between spouses

Rollover of capital gain

Useful ItemsYou may want to see:

Publication

523 Selling Your Home 537 Installment Sales

547 Casualties, Disasters, and Thefts(Business and Nonbusiness)

550 Investment Income and Expenses

551 Basis of Assets

908 Bankruptcy Tax Guide

Form (and Instructions)

Schedule D (Form 1040) Capital Gainsand Losses

4797 Sales of Business Property

8824 Like-Kind Exchanges

See chapter 6 for information about get-ting these publications and forms.

Sales and ExchangesThe following discussions describe the kindsof transactions that are treated as sales orexchanges and explain how to figure gain orloss. A sale is a transfer of property formoney or a mortgage, note, or other promiseto pay money. An exchange is a transfer ofproperty for other property or services.

Sale of home. Report the sale, exchange,or other disposition of your main home on

Form 2119, Sale of Your Home. If you havea gain, you may be able to postpone payingtax on all or part of it, or you may be able toexclude all or part of it. For information, getPublication 523, Selling Your Home.

If your home was used partly for rental,see Property Used Partly for Business orRental, later in this chapter.

Sale or lease. Some agreements that seemto be leases may really be conditional salescontracts. The intention of the parties to theagreement can help you distinguish betweena sale or lease.

There is no test or group of tests to provewhat the parties intended when they madethe agreement. You should consider eachagreement based on its own facts and cir-cumstances. For more information on leases,see chapter 7 in Publication 535, BusinessExpenses.

Cancellation of a lease. Payments receivedby a tenant for the cancellation of a lease aretreated as an amount realized from the saleof property. Payments received by a landlord(lessor) for the cancellation of a lease areessentially a substitute for rental paymentsand are taxed as ordinary income.

Copyrights. Payments you receive forgranting the exclusive use or right to exploita copyright throughout its life in a particularmedium are treated as received from the sale

Page 2 Chapter 1 Gain or Loss


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of property. It does not matter if the paymentsare a fixed amount or a percentage of receiptsfrom the sale, performance, exhibition, orpublication of the copyrighted work, or anamount based on the number of copies sold,performances given, or exhibitions made. Nordoes it matter if they are paid over the sameperiod as that covering the grantee's use ofthe copyrighted work.

If the copyright was used in your trade orbusiness and you held it for more than a year,the gain or loss is a section 1231 gain or loss.For more information, see Section 1231Gains and Lossesin chapter 4.

Easements. Granting or selling an easementis usually not a sale of property. Instead, theamount received for the easement is sub-tracted from the basis of the property. If onlya part of the entire tract of property is per-manently affected by the easement, only thebasis of that part is reduced by the amountreceived. If it is impossible or impractical toseparate the basis of the part of the propertyon which the easement is granted, the basisof the whole property is reduced by theamount received.

Any amount received that is more than thebasis to be reduced is a taxable gain. The

transaction is reported as a sale of property.If you transfer a perpetual easement for

consideration and do not keep any beneficialinterest in the part of the property affected bythe easement, the transaction will be treatedas a sale of property. However, if you makea qualified conservation contribution of a re-striction or easement granted in perpetuity, itis treated as a charitable contribution and nota sale or exchange even though you keep abeneficial interest in the property affected bythe easement.

If you grant an easement on your property(for example, a right-of-way over it) undercondemnation or threat of condemnation, youare considered to have made a forced sale,even though you keep the legal title. Al-

though you figure gain or loss on the ease-ment in the same way as a sale of property,the gain or loss is treated as a gain or lossfrom a condemnation. See Gain or Loss FromCondemnations, later.

Transferred property to satisfy debt. Atransfer of property to satisfy a debt is anexchange.

Extended note maturity date. The exten-sion of a note's maturity date is not treatedas an exchange of an outstanding note for anew and different note. Nor is it a closed andcompleted transaction on which gain or lossis figured. This treatment will not apply when

changes in the term of the note are so sig-nificant as to amount virtually to the issuanceof a new security. Also, each case must bedetermined by its own facts.

Transfers on death. The transfer of propertyto an executor or administrator on the deathof an individual is not a sale or exchange.

Bankruptcy. Generally, a transfer of prop-erty from a debtor to a bankruptcy estate isnot treated as a sale or exchange. For moreinformation, see The Bankruptcy Estate inPublication 908.

Gain or Loss FromSales and ExchangesGain or loss is usually realized when propertyis sold or exchanged. A gain is the excessof the amount you realize from a sale or ex-change of property over its adjusted basis. Alossis the excess of the adjusted basis of theproperty over the amount you realize.

Table 1-1. How To Figure a Gain orLoss

If: Then:

Adjusted basis ismore than amountrealized

Amount realized ismore thanadjusted basis

You have a loss

You have a gain

Basis. The cost or purchase price of propertyis usually its basis for figuring the gain or lossfrom its sale or other disposition. However, if

you got the property by gift, inheritance, or insome way other than buying it, you must usea basis other than its cost. See Other Basisin Publication 551.

Adjusted basis. The adjusted basis ofproperty is your original cost or other basisplus certain additions, and minus certain de-ductions such as depreciation and casualtylosses. See Adjusted Basis in Publication551. In determining gain or loss, the cost oftransferring property to a new owner, suchas selling expenses, is added to the adjustedbasis of the property.

Amount realized. The amount you realizefrom a sale or exchange is the total of allmoney you receive plus the fair market valueof all property or services you receive. Theamount you realize also includes any of yourliabilities that were assumed by the buyer andany liabilities to which the property youtransferred is subject, such as real estatetaxes or a mortgage.

If the liabilities relate to an exchange ofmultiple properties, see Multiple Property Ex-changes, and its discussion Treatment of li-abilities, later.

Fair market value. Fair market value(FMV) is the price at which the propertywould change hands between a buyer and aseller when both have reasonable knowledgeof all the necessary facts and neither has tobuy or sell. If parties with adverse interestsplace a value on property in an arm's-length

transaction, that is strong evidence of FMV.If there is a stated price for services, this priceis treated as the FMV, unless there is evi-dence to the contrary.

Example. In your business, you used abuilding that cost you $70,000. You madecertain permanent improvements at a cost of$20,000 and deducted depreciation totaling$10,000. You sold the building for $100,000,plus property having a fair market value of$20,000. The buyer assumed your real estatetaxes of $3,000 and a mortgage of $17,000on the building. The selling expenses were$4,000. Your gain on the sale is figured asfollows:

Amount recognized. Your gain or loss re-alized from a sale or exchange of property isusually a recognized gain or loss for tax pur-poses. Recognized gains must be included ingross income. Recognized losses aredeductible from gross income. However, yourgain or loss realized from certain exchangesof property is not recognized for tax purposes.See Nontaxable Exchangeslater. Also, a lossfrom the disposition of property held for per-sonal use is not deductible.

Life estates, etc. The amount you realizefrom the disposition of a life interest in prop-erty, an interest in property for a set numberof years, or an income interest in a trust is ataxable gain if you got the interest as a gift,inheritance, or in a transfer from a spouse orformer spouse if incident to a divorce. Yourbasis in the property is disregarded. This ruledoes not apply if all interests in the propertyare disposed of at the same time.

Example 1. Your father dies, and leaveshis farm to you for life with a remainder in-terest to your younger brother. You decide tosell your life interest in the farm. The entireamount you receive is a taxable gain. Yourbasis in the farm is disregarded.

Example 2. The facts are the same as inExample 1, except that your brother joins youin selling the farm. Because the entire interestin the property is sold, your basis in the farmis not disregarded. Your gain or loss is thedifference between your share of the salesprice and your adjusted basis in the farm.

Canceling a sale of real property. If yousell real property under a sales contract thatallows the buyer to return the property for afull refund and the buyer does so, you maynot have to recognize gain or loss on the sale.If the buyer returns the property in the yearof sale, no gain or loss is recognized. Thiscancellation of the sale in the same year itoccurred places both you and the buyer in the

same positions you were in before the sale.If the buyer returns the property in a later taxyear, however, you must recognize gain (orloss, if allowed) in the year of the sale. Whenthe property is returned in a later year, youacquire a new basis in the property. That ba-sis is equal to the amount you pay to thebuyer.

Bargain Sales as GiftsIf you sell or exchange property for less thanits fair market value with the intent of makinga gift, the transaction is partly a sale or ex-change and partly a gift. You have a gain ifthe amount realized is more than your ad-

justed basis in the property. However, you do

Amount realized:Cash .................................... $100,000FMV of propertyreceived 20,000Real estate taxes (assumedbybuyer) 3,000Mortgage (assumed bybuyer) 17,000Amount realized . ................. $140,000

Adjusted basis:Cost of building ................... $70,000Improvements ...................... 20,000Total $90,000Minus: Depreciation ............ 10,000Adjusted basis ..................... $80,000Plus: Sell ing expenses .. .. .. .. 4,000 84,000

Gain on sale $56,000

Chapter 1 Gain or Loss Page 3


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not have a loss if the amount realized is lessthan the adjusted basis of the property.

Bargain sales to charity. A bargain saleof property to a charitable organization ispartly a sale or exchange and partly a chari-table contribution. If a deduction for the con-tribution is allowable, you must allocate youradjusted basis in the property between thepart sold and the part contributed, based onthe fair market value of each. The adjustedbasis of the part sold is an amount equal to:

Adjusted basisof entireproperty

Amount realized(fair market value of part sold)

Fair market value of entireproperty

Because of this allocation rule, you willhave a gain even if the amount realized is notmore than your adjusted basis in the property.This allocation rule does not apply if a de-duction for the contribution is not allowable.

See Publication 526, Charitable Contribu-tions, for information on figuring the amountof your charitable contribution.

Example. You sold property with a fairmarket value of $10,000 to a charitable or-ganization for $2,000 and are allowed a de-

duction for your contribution. Your adjustedbasis in the property is $4,000. Your gain onthe sale is $1,200, figured as follows:

Property Used Partly for Businessor RentalIf you sell or exchange property that you usedin part for business or rental purposes and inpart for personal purposes, you must figurethe gain or loss on the sale or exchange asthough you had sold two separate pieces of

property. You must divide the selling price,selling expenses, and the basis of the prop-erty between the business or rental part andthe personal part. You must subtract depre-ciation you took or could have taken from thebasis of the business or rental part.

Gain or loss on the business or rental partof the property may be a capital gain or lossor an ordinary gain or loss, as discussed inchapter 4 under Section 1231 Gains andLosses. Any gain on the personal part of theproperty is a capital gain. You cannot deducta loss on the personal part.

Example. You sold a condominium in1997 for $57,000. You bought the property in1988 for $30,000. You used two-thirds of itas your home and rented out the other third.You claimed depreciation of $3,272 for therented part during the time you owned theproperty. You made no improvements to theproperty. Your expenses of selling the con-dominium were $3,600. You figure your gainor loss as follows:

Loss Limit on Sale of PropertyChanged to Business or RentalUseYou cannot deduct a loss on the sale ofproperty you acquired for use as your homeand used as your home until the time ofsale.

You can deduct a loss on the sale ofproperty you acquired for use as your homebut converted to business or rental propertyand used as business or rental property at thetime of sale. However, if the adjusted basisof the property at the time of conversion wasmore than its fair market value, the amountof loss you can deduct is limited.

Determine the amount of loss you candeduct as follows:

1) Choose the smaller of the property'sadjusted basis or fair market value at thetime of conversion.

2) Add to (1) the cost of any improvementsand other increases to basis since thetime of conversion.

3) Subtract from (2) depreciation and anyother decreases to basis since the timeof conversion.

4) Subtract the amount you realized on thesale from the result in (3). If the amountyou realized is more than the result in(3), treat this result as zero.

The result in (4) is the amount of loss you candeduct.

Example. Five years ago, you convertedyour main home to rental property. At the timeof conversion, the adjusted basis of yourhome was $75,000 and the fair market valuewas $70,000. This year, you sold the propertyfor $55,000. You made no improvements tothe property but you have depreciation ex-pense of $12,620 over the five prior years.Your loss on the sale is $7,380

(($75,000$12,620)$55,000). The amountyou can deduct as a loss is limited to $2,380,figured as follows:

AbandonmentsThe abandonment of property is a dispositionof property. Loss from abandonment of busi-ness or investment property is deductible asan ordinary loss, even if the property is acapital asset. The loss is the amount of theproperty's adjusted basis when abandoned.This rule also applies to leasehold improve-ments the lessor made for the lessee thatwere abandoned after June 12, 1996. How-ever, if the property is later foreclosed on orrepossessed, gain or loss is figured as dis-cussed later. The abandonment loss is takenin the tax year in which the loss is sustained.

You may not deduct any loss from aban-donment of your home or other property heldfor personal use.

Example. Ann abandoned her home thatshe purchased for $200,000. At the time sheabandoned the house, her mortgage balancewas $185,000. She has a nondeductible lossof $200,000 (the adjusted basis). If the banklater forecloses on the loan or repossessesthe house, she will have to figure her gain orloss as discussed later under Foreclosuresand Repossessions.

Cancellation of debt. If the abandonedproperty secures a debt for which you arepersonally liable and the debt is canceled,you will realize ordinary income equal to theamount of canceled debt. This income isseparate from any loss realized from aban-donment of the property. Report income fromcancellation of a debt related to a businessor rental activity as business or rental income.Report income from cancellation of a non-business debt as miscellaneous income online 21, Form 1040.

However, income from cancellation ofdebt is not taxed if:

The cancellation is intended as a gift,

The debt is qualified farm indebtedness(see chapter 4 of Publication 225, Farm-er's Tax Guide),

The debt is qualified real propertyindebtedness (see chapter 5 of Publica-tion 334,Tax Guide for Small Business),or

You are insolvent or bankrupt (see Pub-lication 908, Bankruptcy Tax Guide).

Forms 1099A and 1099C. If your aban-doned property secures a loan and the lenderknows the property has been abandoned, thelender should send you Form 1099A show-ing information you need to figure your lossfrom the abandonment. However, if your debt

is canceled and the lender must file Form1099C, the lender may include the informa-tion about the abandonment on that form in-stead of on Form 1099-A. The lender must fileForm 1099-C and send you a copy if theamount of debt canceled is $600 or more andthe lender is a financial institution, credit un-ion, or federal government agency. Forabandonments of property and debt cancel-lations occurring in 1997, these forms shouldbe sent to you by February 2, 1998.

Foreclosures andRepossessionsIf the borrower (buyer) does not make pay-ments due on a loan secured by property, thelender (mortgagee or creditor) may forecloseon the mortgage or repossess the property.The foreclosure or repossession is treated asa sale or exchange from which the borrowermay realize gain or loss. This is true even ifthe property is voluntarily returned to thelender. The borrower may also realize ordi-nary income from cancellation of debt, if theloan balance is more than the property's fairmarket value.

Gain or loss on foreclosure or repos-session. The borrower's gain or loss fromthe foreclosure or repossession described

Sales price ................................................... $2,000Minus: Adjusted basis of part sold ($4,000 ($2,000 $10,000)) .................................. 800Gain on the sale ......................................... $1,200

Smaller of adjusted basis or fair marketvalue at time of conversion ..................... $70,000Plus: Cost of any improvements and anyother additions to basis after the conver-sion .......................................................... 0

$70,000Minus: Depreciation and any other de-creases to basis after the conversion ..... 12,620

$57,380Minus: Amount you realized from the sale.................................................................. 55,000Deductible loss ...................................... $2,380

Rental Personal(1/3) (2/3)

1) Selling price ............................ $19,000 $38,0002) Less selling expenses ............ 1,200 2,4003) Amount realized (adjusted

sales price) ............................. $17,800 $35,6004) Basis ....................................... $10,000 $20,0005) Less depreciation ................... 3,2726) Adjusted basis ........................ $6,728 $20,0007) Gain (line 3 minus line 6) ....... $11,072 $15,600



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earlier is generally figured and reported in thesame way as gain or loss from a sale or ex-change. The gain or loss is the differencebetween the borrower's adjusted basis in thetransferred property and the amount realized.See Gain or Loss From Sales and Ex-changes, earlier.

TIP

You can use Table 12 to figure yourgain or loss from a foreclosure or re-possession.

Amount realized on a nonrecoursedebt. If the borrower is not personally liablefor repaying the debt (nonrecourse debt) se-cured by the transferred property, the amountrealized by the borrower includes the fullamount of the debt canceled by the transfer.The full amount of the canceled debt is in-cluded even if the property's fair market valueis less than the canceled debt.

Example 1. In 1994, Chris purchased anew car for $15,000. He paid $2,000 downand borrowed the remaining $13,000 from thedealer's credit company. Chris is not per-sonally liable on the loan (nonrecourse), butpledges the new car as security. In 1997, thecredit company repossessed the car becausehe stopped making loan payments. The bal-ance due after taking into account the pay-ments Chris made was $10,000. The car's fairmarket value when repossessed was $9,000.The amount Chris realized on the repos-session is $10,000. That amount is the debtcanceled by the repossession, even thoughhe is not personally liable for the loan and thecar's fair market value is less than $10,000.Chris figures his gain or loss on the repos-session by comparing the amount realized($10,000) with his adjusted basis ($15,000).He has a $5,000 nondeductible loss.

Example 2. In 1992, Ann paid $200,000for her home. She paid $15,000 down andborrowed the remaining $185,000 from a

bank. Ann is not personally liable on the loan(nonrecourse debt), but pledges the houseas security. In 1997, the bank foreclosed onthe loan because Ann stopped making pay-ments. When the bank foreclosed on the loan,the balance due was $180,000 and the fairmarket value of the house was $170,000. Theamount Ann realized on the foreclosure is$180,000, the debt canceled by the foreclo-sure. She figures her gain or loss by com-paring the amount realized ($180,000) withher adjusted basis ($200,000). She has a$20,000 nondeductible loss.

Amount realized on a recourse debt.If the borrower is personally liable for the debt(recourse debt), the amount realized on the

foreclosure or repossession does not includethe amount of the canceled debt that is in-come to the borrower from cancellation ofdebt. However, if the fair market value of thetransferred property is less than the canceleddebt, the amount realized by the borrowerincludes the canceled debt up to the fairmarket value of the property. The borrower istreated as receiving ordinary income from thecanceled debt for that part of the debt not in-cluded in the amount realized. See Cancella-tion of debt.

Example 1. Assume the same facts asin the previous Example 1 except that Chrisis personally liable for the car loan (recoursedebt). In this case, the amount he realizes is

Table 1-2. Worksheet for Foreclosures and Repossessions(Keep for your records)

Part 1. Figure your income from cancellation of debt. (Note: If you arenot personally liable for the debt, you do not have incomefrom cancellation of debt. Skip Part 1 and go to Part 2. )

1.

2.

3.

4.

5.

6.

Enter the amount of debt cancelled by the transfer of property

Enter the fair market value of the transferred property

Income from cancellation of debt.* Subtract line 2 from line 1. Ifless than zero, enter zero

Part 2. Figure your gain or loss from foreclosure or repossession.

Enter the smaller of line 1 or line 2. (If you are not personally liablefor the debt, enter the amount of debt cancelled by the transfer ofproperty.)

Enter the adjusted basis of the transferred property

Gain or loss from foreclosure or repossession. Subtract line 5from line 4

* The income may not be taxable. See Cancellation of debt.

$9,000. This is the amount of the canceled

debt ($10,000) up to the car's fair marketvalue ($9,000). Chris figures his gain or losson the repossession by comparing theamount realized ($9,000) with his adjustedbasis ($15,000). He has a $6,000 non-deductible loss. He is also treated as re-ceiving ordinary income from cancellation ofdebt. That income is $1,000($10,000$9,000). This is the part of thecanceled debt not included in the amount re-alized.

Example 2. Assume the same facts asin Example 2 above except that Ann is per-sonally liable for the loan (recourse debt). Inthis case, the amount she realizes is$170,000. This is the amount of the canceled

debt ($180,000) up to the house's fair marketvalue ($170,000). Ann figures her gain or losson the foreclosure by comparing the amountrealized ($170,000) with her adjusted basis($200,000). She has a $30,000 nondeductibleloss. She is also treated as receiving ordinaryincome from cancellation of debt. That in-come is $10,000 ($180,000 $170,000). Thisis the part of the canceled debt not includedin the amount realized.

Seller's (lender's) gain or loss on repos-session. If you finance a buyer's purchaseof property and later acquire an interest in itthrough foreclosure or repossession, you mayhave a gain or loss on the acquisition. Formore information, see Repossessionin Pub-

lication 537.

Cancellation of debt. If property that is re-possessed or foreclosed upon secures a debtfor which you are personally liable (recoursedebt), you generally must report, as ordinaryincome, the amount by which the canceleddebt exceeds the fair market value of theproperty. This income is separate from anygain or loss realized from the foreclosure orrepossession. Report the income from can-cellation of a debt related to a business orrental activity as business or rental income.Report the income from cancellation of anonbusiness debt as miscellaneous incomeon line 21, Form 1040.

TIP

You can use Table 12 to figure your

income from cancellation of debt.

However, income from cancellation ofdebt is not taxed if:

The cancellation is intended as a gift,

The debt is qualified farm indebtedness(see chapter 4 of Publication 225, Farm-er's Tax Guide),

The debt is qualified real propertyindebtedness (see chapter 5 of Publica-tion 334, Tax Guide for Small Business),or

You are insolvent or bankrupt (see Pub-lication 908, Bankruptcy Tax Guide).

Forms 1099A and 1099C. A lender whoacquires an interest in your property in aforeclosure or repossession should send youForm 1099A showing information you needto figure your gain or loss. However, if thelender also cancels part of your debt andmust file Form 1099-C, the lender may in-clude the information about the foreclosureor repossession on that form instead of onForm 1099-A. The lender must file Form1099-C and send you a copy if the amountof debt canceled is $600 or more and thelender is a financial institution, credit union,or federal government agency. For foreclo-sures or repossessions occurring in 1997,these forms should be sent to you by Febru-

ary 2, 1998.

InvoluntaryConversionsAn involuntary conversion occurs when yourproperty is destroyed, stolen, condemned, ordisposed of under the threat of condemnation,and you receive other property or money inpayment, such as insurance or a condemna-tion award. Involuntary conversions are alsocalled involuntary exchanges.

Gain or loss from an involuntary conver-sion of your property is usually recognized, for



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tax purposes. You report the gain or deductthe loss on your tax return for the year yourealize it. (You cannot deduct a loss from aninvoluntary conversion of property you heldfor personal use, unless it resulted from acasualty or theft.)

However, depending on the type of prop-erty you receive, you may not have to reporta gain on an involuntary conversion. You donot report the gain if you receive property thatis similar or related in service or use to theconverted property. Your basis for the newproperty is the same as your basis for theconverted property. The gain on the involun-tary conversion is deferred until a taxable saleor exchange occurs.

If you receive money or property that isnot similar or related in service or use to theinvoluntarily converted property and you buyqualifying replacement property within aspecified period of time, you can choose topostpone reporting the gain.

This publication explains the treatment ofa gain or loss from a condemnation or dispo-sition under the threat of condemnation. If youhave a gain or loss from the destruction ortheft of property, see Publication 547.

CondemnationsCondemnation is the process by which privateproperty is legally taken for public use withoutthe owner's consent. The property may betaken by the federal government, a stategovernment, a political subdivision, or a pri-vate organization that has the power to legallytake it. The owner receives a condemnationaward (money or property) in exchange forthe property taken. A condemnation is like aforced sale, the owner being the seller andthe condemning authority being the buyer.

Example. A local government authorizedto acquire land for public parks told you thatit wished to acquire your property. After thelocal government took action to condemnyour property, you went to court to keep it.But the court decided in favor of the localgovernment, which took your property andpaid you an amount fixed by the court. Thisis a condemnation of private property forpublic use.

Threat of condemnation. A threat of con-demnation exists if a representative of agovernment body or a public official author-ized to acquire property for public use tellsyou that the government body or official hasdecided to acquire your property. You musthave reasonable grounds to believe that, ifyou do not sell voluntarily, your property willbe condemned.

The sale of your property to someoneother than the condemning authority qualifiesas an involuntary conversion, provided youhave reasonable grounds to believe that yourproperty will be condemned. If the buyer ofthis property knows at the time of purchasethat it will be condemned and sells it to thecondemning authority, this sale also qualifiesas an involuntary conversion.

Reports of condemnation. A threat ofcondemnation exists if you learn of a decisionto acquire your property for public usethrough a report in a newspaper or othernews medium, and this report is confirmedby a representative of the government bodyor public official involved. You must havereasonable grounds to believe that they willtake necessary steps to condemn your prop-

erty if you do not sell voluntarily. If you reliedon oral statements made by a governmentrepresentative or public official, the InternalRevenue Service may ask you to get writtenconfirmation of the statements.

Example. Your property lies along publicutility lines. The utility company has the au-thority to condemn your property. They notifyyou that they intend to acquire your propertyby negotiation or condemnation. A threat ofcondemnation exists when you receive theirnotice.

Related property voluntarily sold. A vol-untary sale of your property may be treatedas a forced sale that qualifies as an involun-tary conversion if the property had a sub-stantial economic relationship to propertyof yours that was condemned. A substantialeconomic relationship exists if together theproperties were one economic unit. You mustalso show that the condemned property couldnot reasonably or adequately be replaced.You can choose to postpone reporting thegain by buying replacement property. SeePostponement of Gain, later.

Gain or Loss From

CondemnationsIf your property was condemned or disposedof under the threat of condemnation, figureyour gain or loss by comparing the adjustedbasis of your condemned property with yournet condemnation award.

If your net condemnation award is morethan the adjusted basis of the condemnedproperty, you have a gain. You can postponereporting gain from a condemnation if you buyreplacement property. If only part of yourproperty is condemned, you can treat the costof restoring the remaining part to its formerusefulness as the cost of replacement prop-erty. See Postponement of Gain, later.

If your net condemnation award is lessthan your adjusted basis, you have a loss. If

your loss is from property you held for per-sonal use, you cannot deduct it. You mustreport any deductible loss in the tax year ithappened.

TIP

You can use Part 2 of Table13 tofigure your gain or loss from a con-demnation award.

Condemnation award. A condemnationaward is the money you are paid or the valueof other property you receive for your con-demned property. The award is also theamount you are paid for the sale of your

property under threat of condemnation.Payment of your debts. Amounts takenout of the award to pay your debts are con-sidered paid to you. Amounts paid directly tothe holder of a mortgage or other lien (claim)against your property are part of your award,even if the debt attaches to the property andis not your personal liability.

Example. The state condemned yourproperty for public use. The award was setat $200,000. The state paid you only$148,000 because it paid $50,000 to yourmortgage holder and $2,000 accrued realestate taxes. You are considered to have re-ceived the entire $200,000 as a condemna-tion award.

Interest on award. If the condemningauthority pays you interest for its delay inpaying your award, it is not part of the con-demnation award. You must report the inter-est separately as ordinary income.

Payments to relocate. Payments youreceive to relocate and replace housing be-cause you have been displaced from yourhome, business, or farm as a result of federalor federally assisted programs are not partof the condemnation award. Do not includethem in your income. Replacement housingpayments used to buy new property are in-cluded in the property's basis as part of yourcost.

Net condemnation award. A net con-demnation award is the total award you re-ceived, or are considered to have received,for the condemned property minus your ex-penses of obtaining the award. If only a partof your property was condemned, you mustalso reduce the award by any special as-sessment levied against the part of the prop-erty you retain. This is discussed later underSpecial assessment taken out of award.

Severance damages. Severance damagesare not part of the award paid for the propertycondemned. They are paid to you if part ofyour property is condemned and the value ofthe part you keep is decreased because ofthe condemnation.

For example, you may receive severancedamages if your property is subject to floodingbecause you sell flowage easement rights(the condemned property) under threat ofcondemnation. Severance damages may alsobe given to you if, because part of yourproperty is condemned for a highway, youmust replace fences, dig new wells or ditches,or plant trees to restore your remaining prop-erty to the same usefulness it had before thecondemnation.

The contracting parties should agree onthe amount of the severance damages andput that in writing. If this is not done, all pro-ceeds from the condemning authority are

considered awarded for your condemnedproperty.

You may not make a completely new al-location of the total award after the trans-action is completed. However, you may showhow much of the award both parties intendedfor severance damages. The severancedamages part of the award is determinedfrom all the facts and circumstances.

Example. You sold part of your propertyto the state under threat of condemnation.The contract you and the condemning au-thority signed showed only the total purchaseprice. It did not specify a fixed sum forseverance damages. However, at settlement,the condemning authority gave you closing

papers showing clearly the part of the pur-chase price that was for severance damages.You may treat this part as severance dam-ages.

Treatment of severance damages. Yournet severance damages are treated as theamount realized from an involuntary conver-sion of the remaining part of your property.Use them to reduce the basis of the remainingproperty. If the amount of severance dam-ages is based on damage to a specific partof the property you kept, reduce the basis ofonly that part by the net severance damages.

If your net severance damages are morethan the basis of your retained property, youhave a gain. You may be able to postpone



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Table 1-3. Worksheet for Condemnations(Keep for your records)

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.15.

16.

17.

18.

19.

20.

21.

22.

23.

24.

Part 1. Gain from severance damages.(If you did not receive severance damages, skip Part 1 and go to Part 2.)

Enter the amount of severance damages received

Enter the amount of your expenses in getting severance damages

Subtract line 2 from line 1. If less than zero, enter -0-

Enter the amount of any special assessment on remaining property taken out of your award

Net severance damages. Subtract line 4 from line 3. If less than zero, enter -0-

Enter the adjusted basis of the remaining property

Gain from severance damages. Subtract line 6 from line 5. If less than zero, enter -0-

Refigured adjusted basis of the remaining property. Subtract line 5 from line 6. If less than zero, enter -0-

Part 2. Gain or loss from condemnation award.

Enter the amount of the condemnation award received

Enter the amount of your expenses in getting the condemnation award

If you completed Part 1 and line 4 is more than line 3, subtract line 3 from line 4. Otherwise, enter -0-

Add lines 10 and 11

Net condemnation award. Subtract line 12 from line 9

Enter the adjusted basis of the condemned propertyGain from condemnation award. If line 14 is more than line 13, enter -0-. Otherwise, subtract line 14 fromline 13 and skip line 16

Loss from condemnation award. Subtract line 13 from line 14

(Note:You cannot deduct the amount on line 16 if the condemned property was held for personal use. )

Part 3. Postponed gain from condemnation.(Complete only if line 7 or line 15 is more than zero and you bought qualifying replacement property or madeexpenditures to restore the usefulness of your remaining property.)

If you completed Part 1 and line 7 is more than zero, enter the amount from line 5. Otherwise, enter -0-

Add lines 17 and 18

Enter the total cost of replacement property and any expenditures to restore the usefulness of your remaining

propertySubtract line 20 from line 19. If less than zero, enter -0-

If you completed Part 1, add lines 7 and 15. Otherwise, enter the amount from line 15

Recognized gain. Enter the smaller of line 21 or line 22

Postponed gain. Subtract lne 23 from line 22. If less than zero, enter -0-

If line 15 is more than zero, enter the amount from line line 13. Otherwise, enter -0-

reporting the gain. See the later discussion,Postponement of Gain.

TIP

You can use Part I of Table 13 tofigure any gain from severance dam-ages and to refigure the adjusted ba-

sis of the remaining part of your property.

Net severance damages. To figure yournet severance damages, you must first re-duce your severance damages by your ex-penses in obtaining the damages. You thenreduce them by any special assessmentlevied against the remaining part of the prop-erty if the assessment was taken out of theaward by the condemning authority. The bal-ance is your net severance damages.

Expenses of obtaining a condemnationaward and severance damages. Subtractthe expenses of obtaining a condemnationaward, such as legal, engineering, and ap-praisal fees, from the amount of the totalaward. Also subtract the expenses of obtain-ing severance damages from the severance

damages paid to you. If you cannot determinewhich part of your expenses is for each partof the condemnation proceeds, you mustmake a proportionate allocation.

Example. You receive a condemnationaward and severance damages. One-fourthof the total was designated as severancedamages in your agreement with the con-demning authority. You had legal expenses

for the entire condemnation proceeding. Youcannot determine how much of your legalexpenses is for each part of the condemna-tion proceeds. You must allocate one-fourthof your legal expenses to the severancedamages and the other three-fourths to thecondemnation award.

Special assessment taken out of award.When only part of your property is con-demned, a special assessment levied againstthe remaining property may be taken out ofyour condemnation award. An assessmentmay be levied if the remaining part of yourproperty benefited by the improvement re-sulting from the condemnation. Examples of

improvements that may cause a special as-sessment are widening a street and installinga sewer.

To figure your net condemnation award,you generally reduce the award by theamount of the assessment taken out of theaward. The award cannot be reduced by anyassessment levied after the award is made,even if the assessment is levied in the sameyear the award is made.

Example. To widen the street in front ofyour home, the city condemned 25 feet ofyour land. You were awarded $5,000 for thisand spent $300 to get the award. Beforepaying the award, the city levied a specialassessment of $700 for the street improve-ment against your remaining property. Thecity then paid you only $4,300. Your netaward is $4,000 ($5,000 total award minus$300 expenses in obtaining the award andminus $700 for the special assessment takenout).

If the $700 special assessment were nottaken out of the award, and you were paid$5,000, your net award would be $4,700



8/39

($5,000 minus $300). The net award wouldnot change, even if you later paid the as-sessment from the amount you received.

Severance damages received. Ifseverance damages are included in the con-demnation proceeds, the special assessmenttaken out is first used to reduce the severancedamages. Any balance of the special as-sessment is used to reduce the condemnationaward.

Example. You were awarded $4,000 for

the condemnation of your property and$1,000 for severance damages. You spent$300 to obtain the severance damages. Aspecial assessment of $800 was taken outof the award. The $1,000 severance damagesare reduced to zero by first subtracting the$300 expenses and then $700 of the specialassessment. Your $4,000 condemnationaward is reduced by the $100 balance of thespecial assessment, leaving a $3,900 netcondemnation award.

Part business or rental. If you used part ofyour condemned property as your home andpart as business or rental property, treat eachpart as a separate property. Figure your gainor loss separately, because gain or loss may

be treated differently.Some examples of this type of propertyare a building in which you live and operatea grocery, and a building in which you live onthe first floor and rent out the second floor.

Example. You sold your building for$24,000 under threat of condemnation to apublic utility company that had the authorityto condemn. You rented half the building andlived in the other half. You paid $25,000 forthe building and spent an additional $1,000for a new roof. You claimed allowable depre-ciation of $4,600 on the rental half. You spent$200 in legal expenses to obtain the con-demnation award. Figure your gain or loss asfollows:

The loss on the residential part of the propertyis not deductible.

Postponement of GainDo not report the gain on condemned prop-erty if you receive only property that is similaror related in service or use to it. Your basisfor the new property is the same as your basisfor the old.

You must ordinarily report the gain if youreceive money or unlike property. You canchoose to postpone reporting the gain if youpurchase property that is similar or related inservice or use to the condemned propertywithin a specified replacement period, dis-cussed later. You can also choose to post-

pone reporting the gain if you purchase con-trolling interest (at least 80%) in a corporationowning property that is similar or related inservice or use to the property.

To postpone all the gain, you must buyreplacement property costing at least asmuch as the amount realized for the con-demned property. If the cost of the replace-ment property is less than the amount real-ized, you must report the gain up to theamount of the unspent part of the amountrealized.

TIPYou can use Part 3 of Table 13 tofigure the gain you must report andyour postponed gain.

Reduce the basis of the replacementproperty by the amount of postponed gain.Also, if your replacement property for propertycondemned after August 20, 1996, is stock ina corporation that owns property that is simi-lar or related in service or use, the corporationwill generally reduce its basis in its assets bythe amount by which you reduce your basisin the stock. See Controlling interest in acorporation, later.

Choosing to postpone gain. Report yourelection to postpone your gain, along with allnecessary details, on your return for the taxyear in which you realize the gain.

If a partnership or a corporation owns thecondemned property, only the partnershipor corporation can choose to postpone re-porting the gain.

Changing your mind. You can changeyour mind about reporting or postponing thegain at any time before the end of the speci-fied replacement period.

Example. Your property was condemnedand you had a gain of $5,000. You reportedthe gain on your return for the year in whichyou received it, and paid the tax due. You buyreplacement property within the replacementperiod. You used all but $1,000 of theamount realized from the condemnation tobuy the replacement property. You nowchange your mind and want to postpone thetax on the $4,000 of gain equal to the amountyou spent for the replacement property. Youshould file a claim for refund on Form 1040X.Explain on Form 1040X that you previouslyreported the entire gain from the condemna-tion, but you now want to report only the partof the gain ($1,000) equal to the amount ofcondemnation proceeds not spent for re-placement property.

Postponing gain on severance damages.If you received severance damages for partof your property because another part wascondemned and you buy replacement prop-erty, you can choose to postpone reportinggain. See Treatment of severance damages,earlier. You can postpone reporting all yourgain if the replacement property costs at leastas much as your net severance damages plusyour net condemnation award (if resulting ingain).

You can also make this choice if youspend the severance damages, together withother money you received for the condemnedproperty (if resulting in gain), to acquirenearby property that will allow you to continueyour business. If suitable nearby property isnot available and you are forced to sell theremaining property and relocate in order to

continue your business, see Postponing gainon the sale of related property, next.

If you restore the remaining property to itsformer usefulness, you can treat the cost ofrestoring it as the cost of replacement prop-erty.

Postponing gain on the sale of relatedproperty. If part of your property is con-demned, and you sell the related part and buyreplacement property, you can choose topostpone reporting gain on the sale. Youmust meet the requirements explained earlierunder Related property voluntarily sold. Youcan postpone reporting all your gain if thereplacement property costs at least as muchas the amount realized from the sale, plusyour net condemnation award (if resulting ingain), plus your net severance damages, ifany (if resulting in gain).

Buying replacement property from a re-lated party. You cannot postpone reportinggain from a condemnation if you buy the re-placement property from a related party. Forinformation on related parties, see Non-deductible Lossunder Sales and ExchangesBetween Related Partiesin chapter 2.

This rule applies to condemnations oc-curring:

1) After February 5, 1995, for C corpo-rations and partnerships in which morethan 50% of the capital or profits interestis owned by C corporations.

2) After June 8, 1997, for all others (in-cluding individuals, partnerships (otherthan those in (1) above), and S corpo-rations) if the total realized gain for thetax year on all involuntarily convertedproperties on which there are realizedgains is more than $100,000.

For condemnations described in (2)above, gains cannot be offset with any losseswhen determining whether the total gain ismore than $100,000. If the property is owned

by a partnership, the $100,000 limit appliesto the partnership and each partner. If theproperty is owned by an S corporation, the$100,000 limit applies to the S corporationand each shareholder.

Exception. This rule does not apply if therelated party acquired the property from anunrelated party within the period of time al-lowed for replacing the condemned property.

Advance payment. You have not purchasedreplacement property if you pay a contractorin advance to build your replacement propertyunless it is finished before the end of the re-placement period.

Replacement property. To postpone gain,you must buy replacement property for thespecific purpose of replacing your con-demned property. You do not have to use theactual funds from the condemnation award toacquire the replacement property. Propertyyou acquire by gift or inheritance does notqualify as replacement property.

Similar or related in service or use.Your replacement property must be similaror related in service or use to the property itreplaces.

If the condemned property is real propertyyou held for use in your trade or business orfor investment (other than property heldmainly for sale), but your replacement prop-erty is not similar or related in service or use,it will be treated as such if it is like-kind

Resi-dential

part

Busi-nesspart

Amount of award received $12,000 $12,000Minus: Legal expenses, $200 100 100Net condemnation award $11,900 $11,900Minus:Adjusted basis of residential part:

1/2 of original cost, $25,000 $12,5001/2 of cost of roof, $1,000 500

Adjusted basis, residential part $13,000Adjusted basis of business part:

1/2 of original cost, $25,000 $12,5001/2 of cost of roof, $1,000 500

Total $13,000Minus: Depreciation 4,600Adjusted basis, business part $8,400Loss on residential property $1,100Gain on business property $3,500



9/39

property. For a discussion of like-kind prop-erty, see Like Property under Like-Kind Ex-changes, later.

Leasehold replaced with fee simpleproperty. Fee simple property you will usein your trade or business or for investmentcan qualify as replacement property that issimilar or related in service or use to a con-demned leasehold if you use it in the samebusiness and for the identical purpose as thecondemned leasehold. If the condemnedleasehold has 30 or more years to run, the feesimple property is like-kind property. It canqualify as replacement property regardlessof how you use it.

A fee simple property interest generallyis one in which the owner is entitled to theentire property, with unconditional power todispose of it during his or her lifetime. Aleasehold is property held under a lease,usually for a term of years.

Outdoor advertising display replacedwith real property. You can make anelection to treat an outdoor advertising displayas real property. If you make this election andyou replace the display with real property inwhich you hold a different kind of interest,your replacement property can qualify aslike-kind property. For example, real propertypurchased to replace a destroyed billboard

and leased property on which the billboardwas located qualifies as property of a likekind.

You can make this election only if you didnot claim a section 179 deduction for thedisplay. You cannot revoke this election un-less you get the consent of the Internal Rev-enue Service.

An outdoor advertising display is a signor device rigidly assembled and permanentlyattached to the ground, a building, or anyother permanent structure used for commer-cial or other advertisement to the public.

Owner-user. If you are an owner-user,similar or related in service or use means thatreplacement property must function in thesame way as the property it replaces.

Example. Your home was condemned,and you invested the proceeds from the con-demnation in a grocery store. Your replace-ment property is not similar or related in ser-vice or use to the condemned property. Tobe similar or related in service or use, yourreplacement property must also be used byyou as your home.

Owner-investor. If you are an owner-investor, similar or related in service or usemeans that any replacement property musthave the same relationship of services oruses to you as the property it replaces. Youdecide this by determining:

Whether the properties are of similarservice to you,

The nature of the business risks con-nected with the properties, and

What the properties demand of you in theway of management, service, and re-lations to your tenants.

Example. You owned land and a buildingyou rented to a manufacturing company. Thebuilding was condemned. During the re-placement period, you had a new buildingconstructed on other land you already owned.You rented out the new building for use as awholesale grocery warehouse. Because thereplacement property is also rental property,

the two properties are considered similar orrelated in service or use if there is a similarityin:

1) Your management activities,

2) The amount and kind of services youprovide to your tenants, and

3) The nature of your business risks con-nected with the properties.

Substituting replacement property.Once you designate certain property as re-

placement property on your tax return, youmay not substitute other qualified property.But if your previously designated replacementproperty does not qualify, you can substitutequalified property if you acquire it within thereplacement period.

Controlling interest in a corporation. Youcan replace property by acquiring a control-ling interest in a corporation that owns prop-erty similar or related in service or use to yourcondemned property. You have controllinginterest if you own stock having at least 80%of the combined voting power of all classesof voting stock and at least 80% of the totalnumber of shares of all other classes of stock.

Basis adjustment to corporation's

property. For condemnations occurring afterAugust 20, 1996, the basis of property heldby the corporation at the time you acquiredcontrol must be reduced by the amount ofyour postponed gain, if any. You are not re-quired to reduce the adjusted bases of thecorporation's properties below your adjustedbasis in the corporation's stock (determinedafter reduction by the amount of your post-poned gain).

Allocate this reduction to the followingclasses of property in the order shown below.

1) Property that is similar or related in ser-vice or use to the condemned property.

2) Depreciable property not reduced in (1)above.

3) All other property.

If two or more properties fall in class (1), (2),or (3), you allocate the reduction to eachproperty in proportion to the adjusted basesof all the properties in that class. The re-duced basis of any single property cannot beless than zero.

Replacement period. To postpone reportingyour gain from a condemnation, you must buyreplacement property within a specified pe-riod of time. This is the replacement period.

The replacement period for a condemna-tion begins on the earlier of:

1) The date on which you disposed of the

condemned property, or

2) The date on which the threat of con-demnation began.

The replacement period ends 2 yearsaf-ter the close of the first tax year in which anypart of the gain on the condemnation is real-ized.

If real property held for use in a tradeor businessor for investment (not includingproperty held primarily for sale) is con-demned, the replacement period ends 3years after the close of the first tax year inwhich any part of the gain on the condemna-tion is realized. However, this 3-year re-placement period cannot be used if you re-

place the condemned property by acquiringcontrol of a corporation owning property thatis similar or related in service or use.

Determining when gain is realized. Thereplacement period ends 2 (or 3) years afterthe close of the first tax year in which yourealize any part of the gain. If you are a cashbasis taxpayer, you realize gain when youreceive payments that exceed your basis inthe property. If the condemning authoritymakes deposits into the court, you realizegain when you withdraw (or have the right towithdraw) amounts that exceed your basis.

This applies even though the amounts re-ceived are only partial or advance paymentsand the full amount of the award has not yetbeen determined. A replacement will be toolate if you wait for a final determination thatdoes not take place in the applicable re-placement period after you first realize gain.

For accrual basis taxpayers, gain (if any)accrues in the earliest year when:

1) All events have occurred that fix the rightto the condemnation award and theamount can be determined with reason-able accuracy, or

2) All or part of the award is actually orconstructively received.

For example, if you have an absolute right toa part of a condemnation award when it isdeposited into court, the amount depositedaccrues in the year the deposit is made eventhough the full amount of the award is stillcontested.

Replacement property purchased be-fore the condemnation. If you purchaseyour replacement property after there is athreat of condemnation but before the actualcondemnation, and you still hold the replace-ment property at the time of the condemna-tion, you have purchased your replacementproperty within the replacement period.Property you acquire before there is a threatof condemnation does not qualify as replace-ment property acquired within the replace-

ment period.

Example. On April 3, 1996, city authori-ties notified you that your property would becondemned. On June 5, 1996, you acquiredproperty to replace the property to be con-demned. You still had the new property whenthe city took possession of your old propertyon September 4, 1997. You have made a re-placement within the replacement period.

Extension. You may get an extension ofthe replacement period if you apply to theDistrict Director of the Internal Revenue Ser-vice for your area. You should apply beforethe end of the replacement period. Your ap-plication should contain all details of yourneed for an extension. You may file an appli-cation within a reasonable time after the re-placement period ends if you can show rea-sonable cause for the delay. An extension ofthe replacement period will be granted if youcan show reasonable cause for not makingthe replacement within the regular period.

Ordinarily, requests for extensions aregranted near the end of the replacement pe-riod or the extended replacement period. Ex-tensions are usually limited to a period of 1year or less. The high market value or scarcityof replacement property is not a sufficientreason for granting an extension. If your re-placement property is being constructed andyou clearly show that the replacement orrestoration cannot be made within the re-



10/39

placement period, you will be granted an ex-tension of the period.

Time for assessing a deficiency. Anydeficiency for any tax year in which part of thegain is realized may be assessed at any timebefore the expiration of 3 years from the dateyou notify the IRS District Director for yourarea that you have replaced, or intend not toreplace, the condemned property within thereplacement period.

NontaxableExchangesCertain exchanges are not taxable. Thismeans that any gain from the exchange is nottaxed, and any loss cannot be deducted. Inother words, even if you realize a gain or losson the exchange, it will not be recognized untilyou sell or otherwise dispose of the propertyyou receive.

Like-Kind ExchangesThe exchange of property for the same kindof property is the most common type of non-taxable exchange. To be a like-kind ex-

change, the property traded and the propertyreceived must be both:

1) Qualifying property, and

2) Like property.

These two requirements are discussed later.If the like-kind exchange includes the re-

ceipt of money or unlike property or the as-sumption of your liabilities, you may have ataxable gain. See Partially Nontaxable Ex-changes, later.

Additional requirements apply to ex-changes in which the property received is notreceived immediately upon the transfer of theproperty given up. See Deferred Exchanges,later.

Multiple-party transactions. The like-kindexchange rules also apply to property ex-changes that involve three- and four-partytransactions. Any part of these multiple-partytransactions can qualify as a like-kind ex-change if it meets all of the requirements de-scribed in this section.

Receipt of title from third party. If youreceive property in a like-kind exchange andthe other party who transfers the property toyou does not give you the title but a third partydoes, you may still treat this transaction as alike-kind exchange, if it meets all the require-ments.

Basis of property received. If you acquire

property in a like-kind exchange, the basis ofthat property is the same as the basis of theproperty you transferred.

For the basis of property received in anexchange that is only partially nontaxable,see Partially Nontaxable Exchanges, later.

Example. You exchanged real estateheld for investment having an adjusted basisof $25,000 for other real estate held for in-vestment. The FMV of both properties is$50,000. The basis of your new property isthe same as the basis of the old ($25,000).

Money paid. If, in addition to giving up likeproperty, you pay money in a like-kind ex-change, you still have no taxable gain or

deductible loss. The basis of the property re-ceived is the basis of the property given upincreased by the money paid.

Example. Bill Smith trades an old cab fora new one. The new cab costs $10,800. Heis allowed $2,000 for the old cab, and pays$8,800 cash. He has no taxable gain ordeductible loss on the transaction, regardlessof the adjusted basis of his old cab. If Bill soldthe old cab to a third party for $2,000 andbought a new one, he would have a recog-nized gain or loss on the sale of his old cab

equal to the difference between the amountrealized and the adjusted basis of the old cab.

Sale and purchase. If you sell property andbuy similar property in two mutually depend-ent transactions, you may have to treat thesale and purchase as a single nontaxableexchange.

Example. You used your car in yourbusiness for 2 years. Its adjusted basis is$3,500 and its trade-in value is $4,500. Youare interested in a new car that costs$10,500. Ordinarily, you would trade your oldcar for the new one and pay the dealer$6,000. Your basis for depreciation of the newcar would then be $9,500 ($6,000 plus $3,500

adjusted basis of the old car).Because you want your new car to have

a larger basis for depreciation, you arrangeto sell your old car to the dealer for $4,500.You then buy the new one for $10,500 fromthe same dealer. However, you are treatedas having exchanged your old car for the newone because the sale and purchase are re-ciprocal and mutually dependent. Your basisfor depreciation for the new car is $9,500, thesame as if you traded the old car.

Reporting the exchange. Report the ex-change of like-kind property on Form 8824.The instructions for the form explain how toreport the details of the exchange. Report theexchange even though no gain or loss is

recognized.If you have any taxable gain because you

received money or unlike property, report iton Schedule D (Form 1040) or Form 4797,whichever applies. See chapter 5. You mayhave to report the taxable gain as ordinaryincome because of depreciation. See Like-Kind Exchanges and Involuntary Conversionsin chapter 4.

Exchange expenses. Exchange expensesare generally the closing costs that you pay.They include such items as brokerage com-missions, attorney fees, and deed preparationfees. Subtract these expenses from the con-sideration received to figure the amount real-ized on the exchange. Also add them to the

basis of the like-kind property received. If youreceive cash or unlike property in addition tothe like-kind property and realize a gain onthe exchange, subtract the expenses from thecash or fair market value of the unlike prop-erty. Then use the net amount to figure therecognized gain. See Partially NontaxableExchanges, later.

Qualifying PropertyIn a like-kind exchange, both the property yougive up and the property you receive must beheld by you for investment or for productiveuse in your trade or business. Machinery,buildings, land, trucks, and rental houses areexamples of property that may qualify.

The rules for like-kind exchanges do notapply 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 pri-marily for sale, such as inventories, rawmaterials, and real estate held by deal-ers.

Stocks, bonds, notes, or other securitiesor evidences of indebtedness, such as

accounts receivable. Partnership interests.

Certificates of trust or beneficial interest.

Choses in action.

However, you might have a nontaxable ex-change under other rules. See Other Non-taxable Exchanges, later.

An exchange of the assets of a businessfor the assets of a similar business cannot betreated as an exchange of one property foranother property. Whether you engaged in alike-kind exchange depends on an analysisof each asset involved in the exchange.However, see Multiple Property Exchanges,later.

Like PropertyThere must be an exchange of like property.The exchange of real estate for real estateand the exchange of personal property forsimilar personal property are exchanges oflike property. For example, the trade of landimproved with an apartment house for landimproved with a store building, or a paneltruck for a pickup truck, is a like-kind ex-change.

An exchange of personal property for realproperty does not qualify as a like-kind ex-change. For example, an exchange of a pieceof machinery for a store building does notqualify. Nor does the exchange of livestockof different sexes qualify.

Real property. An exchange of city propertyfor farm property, or improved property forunimproved property is a like-kind exchange.

The exchange of real estate you own fora real estate lease that runs 30 years or moreis a like-kind exchange. However, not all ex-changes of interests in real property qualify.The exchange of a l ife estate expected to lastless than 30 years for a remainder interest isnot a like-kind exchange.

An exchange of a remainder interest inreal estate for a remainder interest in otherreal estate is a like-kind exchange if the na-ture and character of the two property inter-ests are the same.

Special rule for foreign real propertyexchanges. Real property located in theUnited States and real property located out-side of the United States are not consideredlike-kind property under the like-kind ex-change rules. If you exchange foreign realproperty for property located in the UnitedStates, your gain or loss on the exchange isrecognized. Foreign real property is realproperty not located in a state or the Districtof Columbia.

This foreign real property exchange ruledoes not apply to the replacement of con-demned real property. Foreign and U.S. realproperty can still be considered like-kindproperty under the rules for replacing con-demned property to postpone gain on the



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condemnation. See Postponement of Gain,under Involuntary Conversions, earlier.

Personal property. Depreciable tangiblepersonal property can be either like kind orlike class to qualify for nonrecognition treat-ment. Like-class properties are depreciabletangible personal properties within the sameGeneral Asset Class or Product Class. Prop-erty classified in any General Asset Classmay not be classified within a Product Class.

General Asset Classes. General Asset

Classes describe the types of property fre-quently used in many businesses. They in-clude:

1) Office furniture, fixtures, and equipment(asset class 00.11),

2) Information systems, such as computersand peripheral equipment (asset class00.12),

3) Data handling equipment except com-puters (asset class 00.13),

4) Airplanes (airframes and engines), ex-cept planes used in commercial or con-tract carrying of passengers or freight,and all helicopters (airframes and en-gines) (asset class 00.21),

5) Automobiles and taxis (asset class00.22),

6) Buses (asset class 00.23),

7) Light general purpose trucks (asset class00.241),

8) Heavy general purpose trucks (assetclass 00.242),

9) Railroad cars and locomotives exceptthose owned by railroad transportationcompanies (asset class 00.25),

10) Tractor units for use over the road (assetclass 00.26),

11) Trailers and trailer-mounted containers

(asset class 00.27),

12) Vessels, barges, tugs, and similarwater-transportation equipment, exceptthose used in marine construction (assetclass 00.28), and

13) Industrial steam and electric generationor distribution systems (asset class00.4).

Product Classes. Product Classes in-clude property listed in a 4-digit product class(except any ending in 9, a miscellaneouscategory) in Division D of the Standard In-dustrial Classification codes of the ExecutiveOffice of the President, Office of Managementand Budget, Standard Industrial Classification

Manual (SIC Manual). Copies of the SICManual may be obtained from the NationalTechnical Information Service, an agency ofthe U.S. Department of Commerce.

Example 1. You transfer a personalcomputer used in your business for a printerto be used in your business. The propertiesexchanged are within the same General As-set Class and are therefore of a like class.

Example 2. Trena transfers a grader toRon in exchange for a scraper. Both are usedin a business. Neither property is within anyof the General Asset Classes. Both proper-ties, however, are within the same ProductClass and are therefore of a like class.

Intangible personal property and non-depreciable personal property. If you ex-change intangible personal property or non-depreciable personal property for like-kindproperty, no gain or loss is recognized on theexchange. (There are no like classes forthese properties.) Whether intangible per-sonal property, such as a patent or copyright,is of a like kind to other intangible personalproperty generally depends on the nature orcharacter of the rights involved. It also de-pends on the nature or character of theunderlying property to which those rights re-late.

Example. The exchange of a copyrighton a novel for a copyright on a different novelcan qualify as a like-kind exchange. However,the exchange of a copyright on a novel for acopyright on a song is not a like-kind ex-change.

Goodwill. The exchange of the goodwillor going concern value of a business for thegoodwill or going concern value of anotherbusiness is not a like-kind exchange.

Special rule for foreign personal prop-erty exchanges. For exchanges of propertyafter June 8, 1997, in tax years ending afterthat date, personal property used predomi-

nantly in the United States and personalproperty used predominantly outside theUnited States are not like-kind property underthe like-kind exchange rules. If you exchangeproperty used predominantly in the UnitedStates for property used predominantly out-side the United States, your gain or loss onthe exchange is recognized.

CAUTION

!This rule does not apply to anytransfer under a written binding con-tract in effect on June 8, 1997, and

at all times thereafter before the dispositionof property. A contract will not fail to be bind-ing solely because it provides for a sale in lieuof an exchange or the property to be acquiredas replacement property was not identified

under that contract before June 9, 1997.You determine the predominant use ofproperty you gave up based on where thatproperty was used during the 2-year periodending on the date you gave it up. You de-termine the predominant use of the propertyyou acquired based on where that propertywas used during the 2-year period beginningon the date you acquired it.

But if you held either property less than 2years, determine its predominant use basedon where that property was used only duringthe period of time you (or a related person)held it. This does not apply if the exchangeis part of a transaction (or series of trans-actions) structured to avoid having to treatproperty as unlike property under this rule.

However, you must treat property as used

predominantly in the United States if it is usedoutside the United States but, under section168(g)(4) of the Internal Revenue Code, iseligible for accelerated depreciation asthough used in the United States.

Deferred ExchangesA deferred exchange is one in which youtransfer property you use in business or holdfor investment and, at a later time, you re-ceive like-kind property you will use in busi-ness or hold for investment. (The propertyyou receive is replacement property.) Thetransaction must be an exchange (that is,property for property), rather than a transfer

of property for money that is used to purchasereplacement property.

If, before you receive the replacementproperty, you actually or constructively re-ceive money or unlike property in full paymentfor the property you transfer, the transactionwill be treated as a sale rather than a deferredexchange. In that case, you must recognizegain or loss on the transaction, even if youlater receive the replacement property. (Itwould be treated as if you purchased it.)

You are in actual or constructive receiptof money or unlike property at the time themoney or property is credited to your accountor made available to you. You are also inactual or constructive receipt of money orunlike property at the time any limits or re-strictions on it expire or are waived.

The determination of whether you are inactual or constructive receipt of money orunlike property, however, is made without re-gard to certain arrangements you make toensure that the other party carries out its ob-ligation to transfer the replacement propertyto you. For example, if you have that obli-gation secured by a mortgage or by cash orits equivalent held in a qualified escrow ac-count or qualified trust, that arrangement willbe disregarded in determining whether youare in actual or constructive receipt of money

or unlike property. For more information, seesection 1.1031(k)-1(g) of the Income TaxRegulations. Also, see Like-Kind ExchangesUsing Qualified Intermediaries, later.

Identification requirement. You must iden-tify the property to be received within 45 daysafter the date you transfer the property givenup in the exchange. Any property receivedduring that time is considered to have beenidentified.

If you transfer more than one property (aspart of the same transaction) and the proper-ties are transferred on different dates, theidentification period and the receipt period(discussed later) begin on the earliest dateof the transfers.

Identifying replacement property. Youmust identify the replacement property in asigned written document and deliver it to theother person involved in the exchange. Youmust clearly describe the replacement prop-erty in the written document. For example,use the legal description or street address forreal property and the make, model, and yearfor a car. In the same manner, you can revokean identification of replacement property atany time before the end of the identificationperiod.

Identifying alternative and multipleproperties. You can identify more than onereplacement property. Regardless of thenumber of properties you give up, the maxi-mum number of replacement properties youcan identify is:

1) Three, or

2) Any number of properties whose total fairmarket value (FMV) at the end of theidentification period is not more thandouble the total FMV, on the date oftransfer, of all properties you give up.

If, as of the end of the identification period,you have identified more properties than per-mitted under this maximum rule, the onlyproperty that will be considered identified is:

Any replacement property you receivedbefore the end of the identification period,and



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Any replacement property identified be-fore the end of the identification periodand received before the end of the receiptperiod, but only if the FMV of the propertyis at least 95% of the total FMV of allidentified replacement properties. (Do notinclude any you revoked.) FMV is deter-mined on the earlier of the date you re-ceived the property or the last day of thereceipt period.

Disregard incidental property. Do not

treat property that is incidental to a larger itemof property as separate from the larger itemwhen you identify replacement property.Property is incidental to a larger item ofproperty if:

1) It is typically transferred with the largeritem, and

2) The total FMV of all the incidental prop-erty is not more than 15% of the totalFMV of the larger item of property.

Replacement property to be produced.Gain or loss from a deferred exchange canqualify for nonrecognition even if the re-placement property is not in existence or isbeing produced at the time you identify it asreplacement property. If you need to know theFMV of the replacement property to identifyit, estimate its FMV as of the date you expectto receive it.

To determine whether the replacementproperty you received qualifies as like-kindby being substantially the same as the prop-erty you identified, do not take into accountany variations due to usual productionchanges. Substantial changes in the propertyto be produced, however, will disqualify it aslike-kind property.

If your identified replacement property ispersonal property to be produced, it must becompleted by the date you receive it to qualifyas like-kind property.

If your identified replacement property isreal property to be produced and it is notcompleted by the date you receive the prop-erty, it may still qualify as like-kind property.It will qualify as like-kind property only if, hadit been completed on time, the property youreceived would have been considered to besubstantially the same as the property youidentified. It is considered to be substantiallythe same only to the extent the property re-ceived is considered real property under locallaw. However, any additional production onthe replacement property after you receive itdoes not qualify as l ike-kind property. (To thisextent, the transaction is treated as a taxableexchange of property for services.)

Receipt requirement. The property must bereceived by the earlier of:

The 180th day after the date on whichyou transfer the property given up in theexchange, or

The due date, including extensions, foryour tax return for the tax year in whichthe transfer of the property given up oc-curs.

You must receive substantially the sameproperty that met the identification require-ment, discussed earlier.

us internal revenue service: p544--1997

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