us internal revenue service: p544--2000

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ContentsImportant Changes for 2000 ............. 1

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

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

1. Gain or Loss ................................... 2Sales and Exchanges ..................... 2Abandonments ................................ 4Foreclosures and Repossessions .. 4Involuntary Conversions ................. 5Nontaxable Exchanges ................... 10Transfers to Spouse ....................... 17Rollover of Gain From Publicly

Traded Securities ..................... 17Sales of Small Business Stock ....... 17

2. Ordinary or Capital Gain or Loss . 18Capital Assets ................................. 18Noncapital Assets ........................... 18Sales and Exchanges Between

Related Persons ...................... 19Other Dispositions .......................... 20

3. Ordinary or Capital Gain or Lossfor Business Property ................ 23

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

4. Reporting Gains and Losses ........ 30Information Returns ........................ 31Schedule D (Form 1040) ................ 31Form 4797 ...................................... 33Example .......................................... 33

5. How To Get Tax Help .................... 38

Index .................................................... 39

Important Changes

for 2000Like-kind exchanges using qualified ex-change accommodation arrangements(QEAAs). The like-kind exchange rules gen-erally do not apply to an exchange in whichyou acquire replacement property (new prop-erty) before you transfer relinquished prop-erty (property you give up). However, if youuse a qualified exchange accommodation ar-rangement (QEAA), the exchange may qual-ify as a like-kind exchange. For more infor-mation, see Like-Kind Exchanges Using Qualified Exchanges Accommodation Ar- rangements (QEAAs) in chapter 1.

Paid preparer authorization. Beginning withyour return for 2000, you can check a box andauthorize the IRS to discuss your tax returnwith your paid preparer who signed it. If youcheck the Yes box in the signature area ofyour return, the IRS can call your paidpreparer to answer any questions that mayarise during the processing of your return.Also, you are authorizing your paid preparerto perform certain actions. See your incometax package for details.

Photographs of missing children. TheInternal Revenue Service is a proud partnerwith the National Center for Missing and Ex-ploited Children. Photographs of missingchildren selected by the Center may appearin this publication on pages that would other-

Departmentof theTreasury

InternalRevenueService

Publica tion 54 4Cat. No. 15074K

Sales and OtherDispositions ofAssetsFor use in preparing

2000 Returns


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wise be blank. You can help bring thesechildren home by looking at the photographsand calling 1800THELOST (18008435678) if you recognize a child.

Important RemindersInvesting in DC Zone assets. Beginning in2003, investments in District of Columbia

Enterprise Zone (DC Zone) assets held morethan 5 years will qualify for a special taxbenefit. If you sell or exchange a DC Zoneasset at a gain, you will not have to includeany qualified capital gain in your gross in-come. This exclusion applies to an interest in,or property of, certain businesses operatingin the District of Columbia. For more infor-mation, see Publication 954, Tax Incentives for Empowerment Zones and Other Dis- tressed Communities.

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, see 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 on

your 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 coversthe following topics.

How to figure a gain or loss. Whether your gain or loss is ordinary or

capital.

How to treat your gain or loss when youdispose of business property.

How to report a gain or loss.

This publication also explains whetheryour gain is taxable or your loss is deductible.

This publication does not discuss certaintransactions covered in other IRS publica-tions. These include the following.

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.

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

Disposing of property. You dispose ofproperty when any of the following occur.

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. 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 Gains and Losses.

Form 4797, Sales of Business Property. Form 8824, Like-Kind Exchanges.

Chapter 4 illustrates how to fill out Form4797 and Form 8824.

Comments and suggestions. We welcomeyour comments about this publication andyour suggestions for future editions.

You can e-mail us while visiting our website at www.irs.gov/help/email2.html .

You can write to us at the following ad-dress:

Internal Revenue ServiceTechnical Publications BranchW:CAR:MP:FP:P1111 Constitution Ave. NWWashington, DC 20224

We respond to many letters by telephone.Therefore, it would be helpful if you wouldinclude your daytime phone number, includ-ing the area code, in your correspondence.

1 .Gain or Loss

TopicsThis chapter discusses:

Sales and exchanges Abandonments Foreclosures and repossessions Involuntary conversions Nontaxable exchanges Transfers to spouse Rollovers and exclusions for certain cap-

ital gains

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 Assets908 Bankruptcy Tax Guide

Form (and Instructions)

Schedule D (Form 1040) Capital Gainsand Losses

1040 U.S. Individual Income Tax Return

1040X Amended U.S. Individual IncomeTax Return

1099A Acquisition or Abandonment ofSecured Property

1099C Cancellation of Debt

4797 Sales of Business Property

8824 Like-Kind ExchangesSee chapter 5 for information about get-

ting 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 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 and a 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 4 in Publication 535, Business Expenses.

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.

Copyright. Payments you receive for grant-ing the exclusive use of (or right to exploit) acopyright throughout its life in a particularmedium are treated as received from the saleof 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.

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If the copyright was used in your trade orbusiness and you held it longer than a year,the gain or loss is a section 1231 gain or loss.For more information, see Section 1231Gains and Losses in chapter 3.

Easement. The amount received for grantingan easement is subtracted from the basis ofthe property. If only a specific part of the en-tire tract of property is affected by the ease-ment, only the basis of that part is reducedby the amount received. If it is impossible orimpractical to separate the basis of the partof the property on which the easement isgranted, the basis of the whole property isreduced by the amount received.

Any amount received that is more than thebasis to be reduced is a taxable gain. Thetransaction is reported as a sale of property.

If you transfer a perpetual easement forconsideration 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 by

the 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. Althoughyou figure gain or loss on the easement in thesame way as a sale of property, the gain orloss is treated as a gain or loss from a con-demnation. See Gain or Loss From Con- demnations, later.

Property transferred to satisfy debt. Atransfer of property to satisfy a debt is anexchange.

Note's maturity date extended. 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 whenchanges 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.

Transfer 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 amountyou realize from a sale or exchange of prop-erty that is more than its adjusted basis. Aloss is the adjusted basis of the property thatis more than 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 acquired the property by gift, inher-itance, or in some way other than buying it,you must use a basis other than its cost. SeeBasis Other Than Cost in 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 costs oftransferring property to a new owner, such

as selling expenses, are added to the adjusted basis 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 Treatment of liabilities under Multiple Property Exchanges, later.

Fair market value. Fair market value(FMV) is the price at which the property would

change hands between a buyer and a sellerwhen both have reasonable knowledge of allthe necessary facts and neither has to buyor sell. If parties with adverse interests placea value on property in an arm's-length trans-action, that is strong evidence of FMV. If thereis a stated price for services, this price istreated as the FMV unless there is evidenceto 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 $100,000plus property having an FMV of $20,000. Thebuyer assumed your real estate taxes of$3,000 and a mortgage of $17,000 on thebuilding. The selling expenses were $4,000.Your gain on the sale is figured as follows.

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 Exchanges, later. Also, aloss from the disposition of property held forpersonal use is not deductible.

Interest in property. 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 arecognized gain under certain circumstances.If you received the interest as a gift, inher-itance, or in a transfer from a spouse or for-mer spouse incident to a divorce, the amountrealized is a recognized gain. Your basis inthe property is disregarded. This rule doesnot apply if all interests in the property aredisposed 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 entire

amount you receive is a recognized gain.Your basis 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 thesame 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 SaleIf you sell or exchange property for less thanfair market value with the intent of making a

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 donot have a loss if the amount realized is lessthan the adjusted basis of the property.

Bargain sales to charity. A bargain sale ofproperty to a charitable organization is partlya sale or exchange and partly a charitablecontribution. If a deduction for the contribu-tion is allowable, you must allocate your ad-

justed basis in the property between the partsold and the part contributed based on the fairmarket value of each. The adjusted basis ofthe part sold is figured as follows.

Amount realized:Cash .................................... $100,000FMV of property received ... 20,000Real estate taxes assumedby buyer .............................. 3,000Mortgage assumed bybuyer ................................... 17,000 $140,000

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

Gain on sale ........................................... $ 56,000

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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 your charita-

ble contribution.Example. You sold property with a fair

market 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 Partlyfor Business or Rental

If you sell or exchange property you usedpartly for business or rental purposes andpartly for personal purposes, you must figurethe gain or loss on the sale or exchange asthough you had sold two separate pieces ofproperty. 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 3 under Section 1231 Gains and Losses. 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 for$57,000. You had bought the property 9 yearsearlier 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.

Property Changed toBusiness or Rental UseYou cannot deduct a loss on the sale ofproperty you acquired for use as your homeand used as your home until the time of sale.

You can deduct a loss on the sale ofproperty you acquired for use as your homebut changed to business or rental propertyand used as business or rental property at thetime of sale. However, if the adjusted basis

of the property at the time of the change wasmore than its fair market value, the loss youcan deduct is limited.

Figure the loss you can deduct as follows.

1) Use the lesser of the property's adjustedbasis or fair market value at the time ofthe change.

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

3) Subtract from (2) depreciation and anyother decreases to basis since thechange.

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 loss you can deduct.

Example. You changed your main hometo rental property 5 years ago. At the timeof the change, 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 5 prior years. Yourloss on the sale is $7,380 [($75,000 $12,620) $55,000)]. The amount you candeduct as a loss is limited to $2,380, figuredas follows.

AbandonmentsThe abandonment of property is a dispositionof property. You abandon property when youvoluntarily give up possession of the propertywith the intention of ending your ownershipbut without passing it on to anyone else.

Loss from abandonment of business orinvestment property is deductible as an ordi-nary loss, even if the property is a capitalasset. The loss is the property's adjusted ba-sis when abandoned. This rule also appliesto leasehold improvements the lessor madefor the lessee that were abandoned. How-ever, if the property is later foreclosed on or

repossessed, gain or loss is figured as dis-cussed later. The abandonment loss is de-ducted in the tax year in which the loss issustained.

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

Example. Ann abandoned her home thatshe bought 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 Foreclosures and 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 thecanceled debt. This income is separate fromany loss realized from abandonment of theproperty. Report income from cancellation ofa debt related to a business or rental activityas business or rental income. Report incomefrom cancellation of a nonbusiness debt asother income on line 21, Form 1040.

However, income from cancellation ofdebt is not taxed if any of the following con-ditions apply.

The cancellation is intended as a gift. The debt is qualified farm debt (see

chapter 4 of Publication 225, Farmer's Tax Guide ).

The debt is qualified real property busi-ness debt (see chapter 5 of Publication334, Tax Guide for Small Business ).

You are insolvent or bankrupt (see Pub-lication 908).

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 debtis 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 1099A. The lender mustfile Form 1099C and send you a copy if theamount of debt canceled is $600 or more andthe lender is a financial institution, credit un-ion, federal government agency, or any or-ganization that has a significant trade orbusiness of lending money. For abandon-ments of property and debt cancellations oc-curring in 2000, these forms should be sentto you by January 31, 2001.

Foreclosuresand RepossessionsIf you do not make payments you owe on aloan secured by property, the lender mayforeclose on the loan or repossess the prop-erty. The foreclosure or repossession istreated as a sale or exchange from which youmay realize gain or loss. This is true even ifyou voluntarily return the property to thelender. You may also realize ordinary incomefrom cancellation of debt if the loan balanceis more than the fair market value of theproperty.

Buyer's (borrower's) gain or loss. You

figure and report gain or loss from a foreclo-sure or repossession in the same way as gainor loss from a sale or exchange. The gain orloss is the difference between your adjustedbasis in the transferred property and theamount realized. See Gain or Loss From Sales and Exchanges, earlier.

TIPYou can use Table 12 to figure your gain or loss from a foreclosure or repossession.

Amount realized on a nonrecourse debt. If you are not personally liable for re-paying the debt (nonrecourse debt) securedby the transferred property, the amount you

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

Lesser of adjusted basis or fair marketvalue at time of the change ..................... $70,000Plus: Cost of any improvements and anyother additions to basis af ter the change . -0-

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

57,380

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

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

1) Selling price ......................... $19,000 $38,0002) Minus sel ling expenses ... ... . 1,200 2,4003) Amount realized (adjusted

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



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realize includes the full debt canceled by thetransfer. The full canceled debt is includedeven if the fair market value of the propertyis less than the canceled debt.

Example 1. Chris bought a new car for$15,000. He paid $2,000 down and borrowedthe remaining $13,000 from the dealer's creditcompany. Chris is not personally liable for theloan (nonrecourse), but pledges the new caras security. The credit company repossessedthe car because he stopped making loanpayments. The balance due after taking intoaccount the payments Chris made was$10,000. The fair market value of the carwhen repossessed was $9,000. The amountChris realized on the repossession is$10,000. That is the debt canceled by therepossession, even though the car's fairmarket value is less than $10,000. Chris fig-ures his gain or loss on the repossession bycomparing the amount realized ($10,000) withhis adjusted basis ($15,000). He has a $5,000nondeductible loss.

Example 2. Ann paid $200,000 for herhome. She paid $15,000 down and borrowedthe remaining $185,000 from a bank. Ann isnot personally liable for the loan (nonrecoursedebt), but pledges the house as security. Thebank foreclosed on the loan because Annstopped making payments. When the bankforeclosed on the loan, the balance due was$180,000, the fair market value of the housewas $170,000, and Ann's adjusted basis was$175,000 due to a casualty loss she had de-ducted. The amount Ann realized on theforeclosure is $180,000, the debt canceledby the foreclosure. She figures her gain orloss by comparing the amount realized($180,000) with her adjusted basis($175,000). She has a $5,000 realized gain.

Amount realized on a recourse debt.If you are personally liable for the debt (re-course debt), the amount realized on theforeclosure or repossession does not include

the canceled debt that is your income fromcancellation of debt. However, if the fair mar-ket value of the transferred property is lessthan the canceled debt, the amount realizedincludes the canceled debt up to the fairmarket value of the property. You are treatedas receiving ordinary income from the can-celed debt for the part of the debt that is morethan the fair market value. See Cancellation of debt, later.

Example 1. Assume the same facts asin the previous Example 1 except Chris ispersonally liable for the car loan (recoursedebt). In this case, the amount he realizes is$9,000. This is the canceled debt ($10,000)up to the car's fair market value ($9,000).Chris figures his gain or loss on the repos-session by comparing the amount realized($9,000) with his adjusted basis ($15,000).He has a $6,000 nondeductible loss. He isalso treated as receiving ordinary incomefrom cancellation of debt. That income is$1,000 ($10,000 $9,000). This is the partof the canceled debt not included in theamount realized.

Example 2. Assume the same facts asin the previous Example 2 except Ann ispersonally liable for the loan (recourse debt).In this case, the amount she realizes is$170,000. This is the canceled debt($180,000) up to the fair market value of thehouse ($170,000). Ann figures her gain or

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

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

1.2.3.

4.

5.6.

Enter the amount of debt canceled by the transfer of propertyEnter the fair market value of the transferred propertyIncome 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. Also include any proceeds youreceived from the foreclosure sale. (If you are not personally liablefor the debt, enter the amount of debt canceled by the transfer ofproperty.)Enter the adjusted basis of the transferred propertyGain or loss from foreclosure or repossession. Subtract line 5from line 4

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

loss on the foreclosure by comparing theamount realized ($170,000) with her adjustedbasis ($175,000). She has a $5,000 non-deductible loss. She is also treated as re-ceiving ordinary income from cancellation ofdebt. That income is $10,000 ($180,000 $170,000). This is the part of the canceleddebt not included in 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 Repossession in Pub-lication 537.

Cancellation of debt. If property that is re-possessed or foreclosed on secures a debtfor which you are personally liable (recoursedebt), you generally must report as ordinaryincome the amount by which the canceleddebt is more than 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 other income on line 21,Form 1040.

TI PYou can use Table 12 to figure your income from cancellation of debt.

However, income from cancellation ofdebt is not taxed if any of the following con-ditions apply.

The cancellation is intended as a gift. The debt is qualified farm debt (see

chapter 4 of Publication 225, Farmer's Tax Guide).

The debt is qualified real property busi-ness debt (see chapter 5 of Publication334, Tax Guide for Small Business).

You are insolvent or bankrupt (see Pub-lication 908).

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 1099C, the lender may in-clude the information about the foreclosureor repossession on that form instead of onForm 1099A. The lender must file Form1099C and send you a copy if the amountof debt canceled is $600 or more and thelender is a financial institution, credit union,federal government agency, or any organiza-tion that has a significant trade or businessof lending money. For foreclosures or repos-sessions occurring in 2000, these formsshould be sent to you by January 31, 2001.

InvoluntaryConversionsAn involuntary conversion occurs when yourproperty is destroyed, stolen, condemned, ordisposed of under the threat of condemnationand 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 fortax purposes unless the property is your mainhome. You report the gain or deduct the losson your tax return for the year you realize it.(You cannot deduct a loss from an involuntaryconversion of property you held for personaluse unless the loss resulted from a casualtyor 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.



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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 a cer-tain period of time, you can choose to post-pone reporting the gain.

This publication explains the treatment ofa gain or loss from a condemnation or dispo-sition under the threat of condemnation. Ifyou have a gain or loss from the destructionor theft 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 someone

other 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. The com-pany notifies you it intends to acquire yourproperty by negotiation or condemnation. Athreat of condemnation exists when you re-ceive the notice.

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 property ofyours that was condemned. A substantial economic 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 LossFrom 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. Ifyour loss is from property you held for per-sonal use, you cannot deduct it. You mustreport any deductible loss in the tax year ithappened.

TIPYou can use Part 2 of Table 13 to figure your gain or loss from a condemnation award.

Main home condemned. If you have a gainbecause your main home is condemned, yougenerally can exclude the gain from your in-come as if you had sold or exchanged yourhome. You may be able to exclude up to$250,000 of the gain (up to $500,000 if mar-ried filing jointly). For information on this ex-

clusion, see Publication 523. If your gain ismore than you can exclude but you buy re-placement property, you may be able topostpone reporting the rest of the gain. SeePostponement of Gain, later.

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 yourproperty under threat of condemnation.

Payment of your debts. Amounts takenout of the award to pay your debts are con-sidered paid to you. Amounts the governmentpays directly to the holder of a mortgage orlien against your property are part of your

award, even if the debt attaches to the prop-erty and is 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 mayalso be 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 severance damages and put that in writ-ing. If this is not done, all proceeds from thecondemning authority are consideredawarded for your condemned property.

You may not make a completely new al-location of the total award after the trans-action is completed. However, you may show

how 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 closingpapers 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 postponereporting the gain. See Postponement of Gain, later.



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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 severance damages receivedEnter your expenses in getting severance damagesSubtract line 2 from line 1. If less than zero, enter -0-Enter any special assessment on remaining property taken out of your awardNet severance damages. Subtract line 4 from line 3. If less than zero, enter -0-Enter the adjusted basis of the remaining propertyGain 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 condemnation award receivedEnter your expenses in getting the condemnation awardIf 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 11Net 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 16Loss 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 15Recognized gain. Enter the smaller of line 21 or line 22Postponed gain. Subtract line 23 from line 22. If less than zero, enter -0-

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

*If the condemned property was your main home, subtract from this total the gain you excluded from your income and enter the result.

TIPYou can use Part 1 of Table 13 to figure any gain from severance damages 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 assessment (de-scribed later) levied against the remainingpart of the property and taken out of theaward by the condemning authority. Thebalance 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 total award. Also sub-tract the expenses of obtaining severancedamages, which may include similar ex-penses, from the severance damages paid toyou. If you cannot determine which part of

your expenses is for each part of the con-demnation proceeds, you must make aproportionate 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 expensesfor 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 the as-sessment taken out of the award.

Example. To widen the street in front ofyour home, the city condemned a 25-footdeep strip of your land. You were awarded$5,000 for this and spent $300 to get theaward. Before paying the award, the citylevied a special assessment of $700 for thestreet improvement against your remainingproperty. The city then paid you only $4,300.Your net award is $4,000 ($5,000 total awardminus $300 expenses in obtaining the awardand $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($5,000 minus $300). The net award wouldnot change, even if you later paid the as-sessment from the amount you received.



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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 forthe 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 oneach part 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 youbuy property that is similar or related in ser-vice or use to the condemned property withinthe replacement period, discussed later. Youcan also choose to postpone reporting thegain if you buy a controlling interest (at least80%) in a corporation owning property that issimilar or related in service or use to the

condemned property. See Controlling interest in a corporation, later.

To postpone reporting all the gain, youmust buy replacement property costing atleast as much as the amount realized for thecondemned property. If the cost of the re-placement property is less than the amountrealized, you must report the gain up to theunspent part of the amount realized.

TIPYou can use Part 3 of Table 13 to figure the gain you must report and your postponed gain.

Reduce the basis of the replacementproperty by the postponed gain. Also, if yourreplacement property is stock in a corporationthat owns property similar or related in serviceor use, the corporation will generally reduceits basis in its assets by the amount by whichyou reduce your basis in the stock. SeeControlling interest in a corporation, later.

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 reporting

gain. 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 tocontinue your business, see Postponing gain on 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 person. Certain taxpayers cannotpostpone reporting gain from a condemnationif they buy the replacement property from arelated person. For information on relatedpersons, see Nondeductible Loss underSales and Exchanges Between Related Per- sons in chapter 2.

This rule applies to the following taxpay-ers.

1) C corporations.

2) Partnerships in which more than 50% ofthe capital or profits interest is owned byC corporations.

3) For condemnations after June 8, 1997,all others (including individuals, partner-ships (other than those in (2) above),and S corporations) if the total realizedgain for the tax year on all involuntarilyconverted properties on which there arerealized gains is more than $100,000.

For taxpayers described in (3) above,gains cannot be offset with any losses whendetermining whether the total gain is morethan $100,000. If the property is owned by apartnership, the $100,000 limit applies to thepartnership and each partner. If the propertyis owned by an S corporation, the $100,000limit applies to the S corporation and eachshareholder.

Exception. This rule does not apply if therelated person acquired the property from anunrelated person within the replacement pe-riod.

Advance payment. If you pay a contractorin advance to build your replacement prop-erty, you have not bought replacement prop-erty unless it is finished before the end of thereplacement period (discussed later).

Replacement property. To postpone re-porting gain, you must buy replacementproperty for the specific purpose of replacingyour condemned property. You do not haveto use the actual funds from the condemna-tion award to acquire the replacement prop-erty. Property you acquire by gift or inher-itance does not qualify as replacementproperty.

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 propertyis not similar or related in service or use, itwill be treated as such if it is like-kind propertyto be held for use in a trade or business or forinvestment. For a discussion of like-kindproperty, see Like Property under Like-Kind Exchanges, later.

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 all the followinginformation.

Whether the properties are of similarservice to you.

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

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

Resi-dential

Part

Busi-nessPart

1) Condemnation award re- $12,000 $12,000ceived .................................... $12,000 $12,000

2) Minus: Legal expenses,$200 .. .. ... ... ... ... ... ... ... ... ... ... ... . 100 100

3) Net condemnation award ...... $11,900 $11,9004) Adjusted basis:

1/2 of original cost, $25,000 . $12,500 $12,500Plus: 1/2 of cost of roof,

$1,000 ............................... 500 500Total .............................. $13,000 $13,000

5) Minus: Depreciation .............. 4,6006) Adjusted basis, business

par t .... .. ... ... ... ... ... ... ... ... ... ... ... . $ 8,4007) Loss on residential prop- ..

erty ........................................ ($ 1,100)8) Gain on business property ................ $ 3,500



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Example. You owned land and a buildingyou rented to a manufacturing company. Thebuilding was condemned. During the re-placement period, you had a new buildingbuilt on other land you already owned. Yourented 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 all the following areas.

Your management activities. The amount and kind of services you

provide to your tenants.

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

Leasehold replaced with fee simple property. 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.

A fee simple property interest generallyis a property interest that entitles the ownerto the entire property, with unconditionalpower to dispose of it during his or her life-time. A leasehold is property held under alease, usually for a term of years.

Outdoor advertising display replaced with real property. You can choose to treatan outdoor advertising display as real prop-erty. If you make this choice and you replacethe display with real property in which youhold a different kind of interest, your replace-ment property can qualify as like-kind prop-erty. For example, real property bought toreplace a destroyed billboard and leasedproperty on which the billboard was locatedqualifies as property of a like kind.

You can make this choice only if you did

not claim a section 179 deduction for thedisplay. You cannot cancel this choice unlessyou get the consent of the Internal RevenueService.

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.

Substituting replacement property.Once you designate certain property as re-placement property on your tax return, youcannot substitute other qualified property. Butif 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. The basis of property held by thecorporation at the time you acquired controlmust be reduced by your postponed gain, ifany. You are not required to reduce the ad-

justed bases of the corporation's propertiesbelow your adjusted basis in the corporation's

stock (determined after reduction by yourpostponed 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 the sameclass, allocate the reduction to each propertyin proportion to the adjusted bases of all theproperties in that class. The reduced basisof any single property cannot be less thanzero.

Main home replaced. If your gain from acondemnation of your main home is morethan you can exclude from your income (seeMain home condemned under Gain or Loss From Condemnations, earlier), you can post-pone reporting the rest of the gain by buyingreplacement property that is similar or relatedin service or use. To postpone reporting allthe gain, the replacement property must costat least as much as the amount realized fromthe condemnation minus the excluded gain.

You must reduce the basis of your re-placement property by the postponed gain.Also, if you postpone reporting any part ofyour gain under these rules, you are treatedas having owned and used the replacementproperty as your main home for the periodyou owned and used the condemned propertyas your main home.

Replacement period. To postpone reportingyour gain from a condemnation, you must buyreplacement property within a certain periodof time. This is the replacement period.

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

The date on which you disposed of thecondemned property. The date on which the threat of condem-

nation began.

The replacement period ends 2 years afterthe end of the first tax year in which any partof the gain on the condemnation is realized.

If real property held for use in a trade orbusiness or for investment (not includingproperty held primarily for sale) is con-demned, the replacement period ends 3 yearsafter the end of the first tax year in which anypart of the gain on the condemnation is real-ized. However, this 3-year replacement pe-riod cannot be used if you replace the con-demned property by acquiring control of acorporation owning property that is similar orrelated in service or use.

Determining when gain is realized. Ifyou are a cash basis taxpayer, you realizegain when you receive payments that aremore than your basis in the property. If thecondemning authority makes deposits withthe court, you realize gain when you withdraw(or have the right to withdraw) amounts thatare more than your basis.

This applies even if the amounts receivedare only partial or advance payments and thefull award has not yet been determined. Areplacement will be too late if you wait for afinal determination that does not take placein the applicable replacement period after youfirst realize gain.

For accrual basis taxpayers, gain (if any)accrues in the earlier year when either of thefollowing occurs.

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

All or part of the award is actually orconstructively received.

For example, if you have an absolute right to

a part of a condemnation award when it isdeposited with the court, the amount depos-ited accrues in the year the deposit is madeeven though the full amount of the award isstill contested.

Replacement property bought before the condemnation. If you buy your re-placement property after there is a threat ofcondemnation but before the actual condem-nation and you still hold the replacementproperty at the time of the condemnation, youhave bought your replacement property withinthe replacement period. Property you acquirebefore there is a threat of condemnation doesnot qualify as replacement property acquiredwithin the replacement period.

Example. On April 3, 1999, city authori-ties notified you that your property would becondemned. On June 5, 1999, 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 3, 2000. You have made a re-placement within the replacement period.

Extension. You can get an extension ofthe replacement period if you apply to the IRSdirector for your area. You should apply be-fore the end of the replacement period. Yourapplication should contain all details of yourneed for an extension. You can 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

of the replacement period will be granted ifyou can show reasonable cause for notmaking the replacement within the regularperiod.

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 built and youclearly show that the replacement or restora-tion cannot be made within the replacementperiod, you will be granted an extension of theperiod.

Choosing to postpone gain. Report yourchoice to postpone reporting your gain, alongwith all necessary details, on a statement at-tached to your return for the tax year in whichyou realize the gain.

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

Replacement property acquired after return filed. If you buy the replacementproperty after you file your return reportingyour choice to postpone reporting the gain,attach a statement to your return for the yearin which you buy the property. The statementshould contain detailed information on thereplacement property.



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Amended return. If you choose to post-pone reporting gain, you must file anamended return for the year of the gain (in-dividuals file Form 1040X) in either of thefollowing situations.

You do not buy replacement propertywithin the replacement period. On youramended return, you must report the gainand pay any additional tax due.

The replacement property you buy costsless than the amount realized for thecondemned property (minus the gain youexcluded from income if the property wasyour main home). On your amended re-turn, you must report the part of the gainyou cannot postpone reporting and payany additional tax due.

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 director for your area thatyou have replaced, or intend not to replace,the condemned property within the replace-ment period.

Changing your mind. You can changeyour mind about reporting or postponing the

gain at any time before the end of the re-placement period.

Example. Your property was condemnedand you had a gain of $5,000. You reportedthe gain on your return for the year in whichyou realized it, and paid the tax due. You buyreplacement property within the replacementperiod. You used all but $1,000 of the amountrealized from the condemnation to buy thereplacement property. You now change yourmind and want to postpone reporting the$4,000 of gain equal to the amount you spentfor the replacement property. You should filea claim for refund on Form 1040X. Explainon Form 1040X that you previously reportedthe entire gain from the condemnation, but

you now want to report only the part of thegain equal to the condemnation proceeds notspent for replacement property ($1,000).

Reporting a CondemnationGain or LossGenerally, you report gain or loss from acondemnation on your return for the year yourealize the gain or loss.

Personal-use property. Report gain from acondemnation of property you held for per-sonal use (other than excluded gain from acondemnation of your main home or post-poned gain) on Schedule D (Form 1040).

Do not report loss from a condemnationof personal-use property. But if you receiveda Form 1099S, Proceeds From Real Estate Transactions, (for example, showing the pro-ceeds of a sale of real estate under threat ofcondemnation), you must show the trans-action on Schedule D even though the lossis not deductible. Complete columns (a)through (e), and enter -0- in column (f).

Business property. Report gain (other thanpostponed gain) or loss from a condemnationof property you held for business or profit onForm 4797. If you had a gain, you may haveto report all or part of it as ordinary income.See Like-Kind Exchanges and Involuntary Conversion in chapter 3.

NontaxableExchangesCertain exchanges of property are not taxa-ble. This means any gain from the exchangeis not recognized, and any loss cannot bededucted. Your gain or loss will not be rec-ognized until you sell or otherwise dispose ofthe property you 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 of the following.

Qualifying property. Like property.

These two requirements are discussed 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.

If the like-kind exchange involves the re-ceipt of money or unlike property or the as-sumption of your liabilities, you may have torecognize gain. See Partially Nontaxable Ex- changes, 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 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 thirdparty does, you can still treat this transactionas a like-kind exchange if it meets all the re-quirements.

Basis of property received. If you acquireproperty 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 with an adjusted basis of$25,000 for other real estate held for invest-ment. The FMV of both properties is $50,000.The basis of your new property is the sameas 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 recognized gain orloss. The basis of the property received is thebasis of the property given up, increased bythe 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 recognized gain orloss on the transaction regardless of the ad-

justed basis of his old cab. If Bill sold the oldcab to a third party for $2,000 and bought anew one, he would have a recognized gainor loss on the sale of his old cab equal to the

difference between the amount realized andthe 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 $3,500adjusted basis of the old car).

Because you want your new car to havea 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 isrecognized.

If you have any recognized gain becauseyou received money or unlike property, reportit on Schedule D (Form 1040) or Form 4797,whichever applies. See chapter 4. You mayhave to report the recognized gain as ordinaryincome from depreciation. See Like-Kind Exchanges and Involuntary Conversion inchapter 3.

Exchange expenses. Exchange expensesare generally the closing costs you pay. Theyinclude such items as brokerage commis-sions, 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 thebasis 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 Nontaxable Exchanges, 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 asaccounts receivable.



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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 orlonger is a like-kind exchange. However, notall exchanges of interests in real propertyqualify. The exchange of a life estate ex-pected to last less than 30 years for a re-mainder interest is not a like-kind exchange.

An exchange of a remainder interest inreal estate for a remainder interest in other

real estate is a like-kind exchange if the na-ture and character of the two property inter-ests are the same.

Foreign real property exchanges. Realproperty located in the United States and realproperty located outside the United States arenot considered like-kind property under thelike-kind exchange rules. If you exchangeforeign real property for property located inthe United States, your gain or loss on theexchange is recognized. Foreign real prop-erty is real property not located in a state orthe District of 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 reporting gainon the condemnation. See Postponement of Gain under Involuntary Conversion, 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 AssetClasses describe the types of property fre-quently used in many businesses. They in-clude the following property.

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).

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, Industrial Classification Manual(Manual). Copies of the manual may be ob-tained from the National Technical Informa-tion Service, an agency of the U.S. Depart-ment of Commerce. To order the manual, callthe National Technical Information Service at1800553NTIS (18005536847). Thecost of the manual is $30 and the ordernumber is PB87100012INQ.

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 of a like class.

Example 2. Trena transfers a grader toRon in exchange for a scraper. Both are used

in a business. Neither property is within anyof the General Asset Classes. Both proper-ties, however, are within the same ProductClass and are 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 the

underlying 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 another

business is not a like-kind exchange.Foreign personal property exchanges.Personal property used predominantly in theUnited States and personal property usedpredominantly outside the United States arenot like-kind property under the like-kind ex-change rules. If you exchange property usedpredominantly in the United States for prop-erty used predominantly outside the UnitedStates, your gain or loss on the exchange isrecognized.

CAUTION

!This rule does not apply to any transfer under a written binding contract in effect on June 8, 1997, or at

any time thereafter before the disposition of property. A contract will not fail to be binding solely because it provides for a sale in lieu of an exchange or the property to be acquired as 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 usedpredominantly 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 ExchangeA deferred exchange is one in which youtransfer property you use in business or holdfor investment and later you receive like-kindproperty you will use in business or hold forinvestment. (The property you receive is re-placement property.) The transaction must bean exchange (that is, property for property)rather than a transfer of property for moneyused to buy replacement 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 bought it.)

You constructively receive money or un-like property when the money or property iscredited to your account or made available toyou. You also constructively receive money



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or unlike property when any limits or re-strictions on it expire or are waived.

Whether you actually or constructively re-ceive money or unlike property, however, isdetermined without regard to certain ar-rangements you make to ensure that theother party carries out its obligation to transferthe replacement property to you. For exam-ple, if you have that obligation secured by amortgage or by cash or its equivalent held ina qualified escrow account or qualified trust,that arrangement will be disregarded in de-termining whether you actually or construc-tively receive money or unlike property. Formore information, see section 1.1031(k)-1(g)of the regulations. Also, see Like-Kind Ex- changes Using 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 periodbegin on the date of the earliest transfer.

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 cancelan identification of replacement property atany time before the end of the identificationperiod.

Identifying alternative and multiple properties. 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 the larger of the following.

Three. Any number of properties whose total fair

market 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 rule, the only property thatwill be considered identified is:

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

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 canceled.) FMV is de-termined on the earlier of the date youreceived the property or the last day ofthe receipt period.

Disregard incidental property. Do nottreat property incidental to a larger item ofproperty as separate from the larger itemwhen you identify replacement property.Property is incidental if it meets both the fol-lowing tests.

It is typically transferred with the largeritem.

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 the

FMV 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 prope

us internal revenue service: p544--2000

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