Nontaxable Exchanges Certain exchanges of property are not taxable. This means that anygain from the exchange is not taxed, and any loss cannot be deducted.Your gain or loss will not be recognized until you sell or otherwisedispose of the property you receive. Like-Kind Exchanges The exchange of property for the same kind of property is the mostcommon type of nontaxable exchange. To be a like-kind exchange, theproperty traded and the property received must be both of thefollowing. Qualifying property, and Like property. These two requirements are discussed later. Additional requirements apply to exchanges in which the propertyreceived is not received immediately upon the transfer of the propertygiven up. See Deferred Exchanges, later. If the like-kind exchange involves the receipt of money or unlikeproperty or the assumption of your liabilities, you may have a taxablegain. See discount hotels in LinzPartially Nontaxable Exchanges, later. Multiple-party transactions.The like-kind exchange rules also apply to property exchanges thatinvolve three- and four-party transactions. Any part ofthese multiple-party transactions can qualify as a like-kind exchangeif it meets all of the requirements described in this section. Receipt of title from third party.If you receive property in a like-kind exchange and the other partywho transfers the property to you does not give you the title but athird party does, you may still treat this transaction as a like-kindexchange if it meets all the requirements. Basis of property received.If you acquire property in a like-kind exchange, the basis of thatproperty is the same as the basis of the property you transferred. For the basis of property received in an exchange that is onlypartially nontaxable, see Partially Nontaxable Exchanges,later. Example.You exchanged real estate held for investment with an adjustedbasis of $25,000 for other real estate held for investment. The FMV ofboth 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 like property, you pay money in alike-kind exchange, you still have no taxable gain or deductible loss.The basis of the property received is the basis of the property givenup, increased by the money paid. Example.Bill Smith trades an old cab for a new one. The new cab costs$10,800. He is allowed $2,000 for the old cab and pays $8,800 cash. Hehas no taxable gain or deductible loss on the transaction regardlessof the adjusted basis of his old cab. If Bill sold the old cab to athird party for $2,000 and bought a new one, he would have arecognized gain or loss on the sale of his old cab equal to thedifference between the amount realized and the adjusted basis of theold cab. Sale and purchase.If you sell property and buy similar property in two mutuallydependent transactions, you may have to treat the sale and purchase asa single nontaxable exchange. Example.You used your car in your business for 2 years. Its adjusted basisis $3,500 and its trade-in value is $4,500. You are interested in anew car that costs $10,500. Ordinarily, you would trade your old carfor the new one and pay the dealer $6,000. Your basis for depreciationof the new car would then be $9,500 ($6,000 plus $3,500 adjusted basisof the old car). Because you want your new car to have a larger basis fordepreciation, you arrange to sell your old car to the dealer for$4,500. You then buy the new one for $10,500 from the same dealer.However, you are treated as having exchanged your old car for the newone because the sale and purchase are reciprocal and mutuallydependent. Your basis for depreciation for the new car is $9,500, thesame as if you traded the old car. Reporting the exchange.Report the exchange of like-kind property onForm 8824. The instructionsfor the form explain how to report the details of the exchange. Reportthe exchange even though no gain or loss is recognized. If you have any taxable gain because you received money or unlikeproperty, report it on Schedule D (Form 1040) or Form 4797, whicheverapplies. See chapter 4.You may have to report the taxable gain asordinary income from depreciation. See Like-Kind Exchanges andInvoluntary Conversions in chapter 3. Exchange expenses.Exchange expenses are generally the closing costs that you pay.They include such items as brokerage commissions, attorney fees, anddeed preparation fees. Subtract these expenses from the considerationreceived to figure the amount realized on the exchange. Also add themto the basis of the like-kind property received. If you receive cashor unlike property in addition to the like-kind property and realize again on the exchange, subtract the expenses from the cash or fairmarket value of the unlike property. Then use the net amount to figurethe recognized gain. See Partially Nontaxable Exchanges,later. Qualifying Property In a like-kind exchange, both the property you give up and theproperty you receive must be held by you for investment or forproductive use in your trade or business. Machinery, buildings, land,trucks, and rental houses are examples of property that may qualify. The rules for like-kind exchanges do not apply to exchanges of thefollowing property. Property you use for personal purposes, such as your homeand your family car. Stock in trade or other property held primarily for sale,such as inventories, raw materials, and real estate held bydealers. Stocks, bonds, notes, or other securities or evidences ofindebtedness, such as accounts receivable. Partnership interests. Certificates of trust or beneficial interest. Choses in action. However, you might have a nontaxable exchange under otherrules. See Other Nontaxable Exchanges, later. An exchange of the assets of a business for the assets of a similarbusiness cannot be treated as an exchange of one property for anotherproperty. Whether you engaged in a like-kind exchange depends on ananalysis of each asset involved in the exchange. However, seeMultiple Property Exchanges, later. Like Property There must be an exchange of like property. The exchange of realestate for real estate and the exchange of personal property forsimilar personal property are exchanges of like property. For example,the trade of land improved with an apartment house for land improvedwith a store building, or a panel truck for a pickup truck, is alike-kind exchange. An exchange of personal property for real property does not qualifyas a like-kind exchange. For example, an exchange of a piece ofmachinery for a store building does not qualify. Nor does the exchangeof livestock of different sexes qualify. Real property.An exchange of city property for farm property, or improvedproperty for unimproved property is a like-kind exchange. The exchange of real estate you own for a real estate lease thatruns 30 years or longer is a like-kind exchange. However, not allexchanges of interests in real property qualify. The exchange of alife estate expected to last less than 30 years for a remainderinterest is not a like-kind exchange. An exchange of a remainder interest in real estate for a remainderinterest in other real estate is a like-kind exchange if the natureand character of the two property interests are the same. Foreign real property exchanges.Real property located in the United States and real propertylocated outside the United States are not considered like-kindproperty under the like-kind exchange rules. If you exchange foreignreal property for property located in the United States, your gain orloss on the exchange is recognized. Foreign real property is realproperty not located in a state or the District of Columbia. This foreign real property exchange rule does not apply to thereplacement of condemned real property. Foreign and U.S. real propertycan still be considered like-kind property under the rules forreplacing condemned property to postpone reporting gain on thecondemnation. See Postponement of Gain underInvoluntary Conversions, earlier. Personal property.Depreciable tangible personal property can be either "like kind"or "like class" to qualify for nonrecognition treatment.Like-class properties are depreciable tangible personal propertieswithin the same General Asset Class or Product Class. Propertyclassified in any General Asset Class may not be classified within aProduct Class. General Asset Classes.General Asset Classes describe the types of property frequentlyused in many businesses. They include the following property. Office furniture, fixtures, and equipment (asset class00.11). Information systems, such as computers and peripheralequipment (asset class 00.12). Data handling equipment except computers (asset class00.13). Airplanes (airframes and engines), except planes used incommercial or contract carrying of passengers or freight, and allhelicopters (airframes and engines) (asset class 00.21). Automobiles and taxis (asset class 00.22). Buses (asset class 00.23). Light general purpose trucks (asset class 00.241). Heavy general purpose trucks (asset class 00.242). Railroad cars and locomotives except those owned by railroadtransportation companies (asset class 00.25). Tractor units for use over the road (asset class00.26). Trailers and trailer-mounted containers (asset class00.27). Vessels, barges, tugs, and similar water-transportationequipment, except those used in marine construction (asset class00.28). Industrial steam and electric generation or distributionsystems (asset class 00.4). Product Classes.Product Classes include property listed in a 4-digit product class(except any ending in "9," a miscellaneous category) in DivisionD of the Standard Industrial Classification codes of the ExecutiveOffice of the President, Office of Management and Budget, IndustrialClassification Manual (Manual). Copies of the Manual may be obtainedfrom the National Technical Information Service, an agency of the U.S.Department of Commerce. To order the manual, call the NationalTechnical Information Service at1-800-553-6847. Example 1.You transfer a personal computer used in your business for aprinter to be used in your business. The properties exchanged arewithin the same General Asset Class and are of a like class. Example 2.Trena transfers a grader to Ron in exchange for a scraper. Both areused in a business. Neither property is within any of the GeneralAsset Classes. Both properties, however, are within the same ProductClass and are of a like class. Intangible personal property and nondepreciable personalproperty.If you exchange intangible personal property or nondepreciablepersonal property for like-kind property, no gain or loss isrecognized on the exchange. (There are no like classes for theseproperties.) Whether intangible personal property, such as a patent orcopyright, is of a like kind to other intangible personal propertygenerally depends on the nature or character of the rights involved.It also depends on the nature or character of the underlying propertyto which those rights relate. Example.The exchange of a copyright on a novel for a copyright on adifferent novel can qualify as a like-kind exchange. However, theexchange of a copyright on a novel for a copyright on a song is not alike-kind exchange. Goodwill.The exchange of the goodwill or going concern value of a businessfor the goodwill or going concern value of another business is not alike-kind exchange. Foreign personal property exchanges.Personal property used predominantly in the United States andpersonal property used predominantly outside the United States are notlike-kind property under the like-kind exchange rules. If you exchangeproperty used predominantly in the United States for property usedpredominantly outside the United States, your gain or loss on theexchange is recognized. Caution: This rule does not apply to any transfer under a written bindingcontract in effect on June 8, 1997, and at all times thereafter beforethe disposition of property. A contract will not fail to be bindingsolely because it provides for a sale in lieu of an exchange or theproperty to be acquired as replacement property was not identifiedunder that contract before June 9, 1997. You determine the predominant use of property you gave up based onwhere that property was used during the 2-year period ending on thedate you gave it up. You determine the predominant use of the propertyyou acquired based on where that property was used during the 2-yearperiod beginning on the date you acquired it. But if you held either property less than 2 years, determine itspredominant use based on where that property was used only during theperiod of time you (or a related person) held it. This does not applyif the exchange is part of a transaction (or series of transactions)structured to avoid having to treat property as unlike property underthis rule. However, you must treat property as used predominantly in theUnited States if it is used outside the United States but, undersection 168(g)(4) of the Internal Revenue Code, is eligible foraccelerated depreciation as though used in the United States. Deferred Exchanges A deferred exchange is one in which you transfer property you usein business or hold for investment and, at a later time, you receivelike-kind property you will use in business or hold for investment.(The property you 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 buyreplacement property. If, before you receive the replacement property, you actually orconstructively receive money or unlike property in full payment forthe property you transfer, the transaction will be treated as a salerather than a deferred exchange. In that case, you must recognize gainor loss on the transaction, even if you later receive the replacementproperty. (It would be treated as if you bought it.) You constructively receive money or unlike property whenthe money or property is credited to your account or made available toyou. You also constructively receive money or unlike property when anylimits or restrictions on it expire or are waived. Whether you actually or constructively receive money or unlikeproperty, however, is determined without regard to certainarrangements you make to ensure that the other party carries out itsobligation to transfer the replacement property to you. For example,if you have that obligation secured by a mortgage or by cash or itsequivalent held in a qualified escrow account or qualified trust, thatarrangement will be disregarded in determining whether you actually orconstructively receive money or unlike property. For more information,see section 1.1031(k)-1(g) of the regulations. Also, seeLike-Kind Exchanges Using Qualified Intermediaries, later. Identification requirement.You must identify the property to be received within 45 days afterthe date you transfer the property given up in the exchange. Anyproperty received during that time is considered to have beenidentified. If you transfer more than one property (as part of the sametransaction) and the properties are transferred on different dates,the identification period and the receipt period begin on the date ofthe earliest transfer. Identifying replacement property.You must identify the replacement property in a signed writtendocument and deliver it to the other person involved in the exchange.You must clearly describe the replacement property in the writtendocument. For example, use the legal description or street address forreal property and the make, model, and year for a car. In the samemanner, you can cancel an identification of replacement property atany time before the end of the identification period. Identifying alternative and multiple properties.You can identify more than one replacement property. Regardless ofthe number of properties you give up, the maximum number ofreplacement properties you can identify is the larger of thefollowing. Three. Any number of properties whose total fair market value (FMV)at the end of the identification period is not more than double thetotal FMV, on the date of transfer, of all properties you giveup. If, as of the end of the identification period, you haveidentified more properties than permitted under this rule, the onlyproperty that will be considered identified is: Any replacement property you received before the end of theidentification period, and Any replacement property identified before the end of theidentification period and received before the end of the receiptperiod, but only if the FMV of the property is at least 95% of thetotal FMV of all identified replacement properties. (Do not includeany you canceled.) FMV is determined on the earlier of the date youreceived the property or the last day of the receipt period. Disregard incidental property.Do not treat property that is incidental to a larger item ofproperty as separate from the larger item when you identifyreplacement property. Property is incidental to a larger item ofproperty if it meets both the following tests. It is typically transferred with the larger item. The total FMV of all the incidental property is not morethan 15% of the total FMV of the larger item of property. Replacement property to be produced.Gain or loss from a deferred exchange can qualify fornonrecognition even if the replacement property is not in existence oris being produced at the time you identify it as replacement property.If you need to know the FMV of the replacement property to identifyit, estimate its FMV as of the date you expect to receive it. To determine whether the replacement property you receivedqualifies as like-kind by being substantially the same as the propertyyou identified, do not take into account any variations due to usualproduction changes. Substantial changes in the property to beproduced, however, will disqualify it as like-kind property. If your identified replacement property is personal property to beproduced, it must be completed by the date you receive it to qualifyas like-kind property. If your identified replacement property is real property to beproduced and it is not completed by the date you receive the property,it may still qualify as like-kind property. It will qualify aslike-kind property only if, had it been completed on time, theproperty you received would have been considered to be substantiallythe same as the property you identified. It is considered to besubstantially the same only to the extent the property received isconsidered real property under local law. However, any additionalproduction on the replacement property after you receive it does notqualify as like-kind property. (To this extent, the transaction istreated as a taxable exchange of property for services.) Receipt requirement.The property must be received by the earlier of the followingdates. The 180th day after the date on which you transfer theproperty given up in the exchange. The due date, including extensions, for your tax return forthe tax year in which the transfer of the property given upoccurs. You must receive substantially the same property that met theidentification requirement, discussed earlier. Like-Kind ExchangesUsing Qualified Intermediaries If you transfer property through a qualified intermediary, thetransfer of the property given up and receipt of like-kind replacementproperty is treated as an exchange. This rule applies even if youreceive money or other property directly from a party to thetransaction other than the qualified intermediary. A qualified intermediary is a person who enters into awritten exchange agreement with you to acquire and transfer theproperty you give up and to acquire the replacement property andtransfer it to you. This agreement must expressly limit your rights toreceive, pledge, borrow, or otherwise obtain the benefits of money orother property held by the qualified intermediary. A qualified intermediary cannot be either of the following. Your agent at the time of the transaction. This includes aperson who has been your employee, attorney, accountant, investmentbanker or broker, or real estate agent or broker within the 2-yearperiod before the transfer of property you give up. A person who is related to you or your agent under the rulesdiscussed in chapter 2under Nondeductible Loss,substituting "10%" for "50%." An intermediary is treated as acquiring and transferring propertyif all the following requirements are met. The intermediary acquires and transfers legal title to theproperty. The intermediary enters into an agreement with a personother than you for the transfer to that person of the property yougive up and that property is transferred to that person. The intermediary enters into an agreement with the owner ofthe replacement property for the transfer of that property and thereplacement property is transferred to you. An intermediary is treated as entering into an agreement if therights of a party to the agreement are assigned to the intermediaryand all parties to that agreement are notified in writing of theassignment by the date of the relevant transfer of property. Partially Nontaxable Exchanges If, in addition to like property, you receive money or unlikeproperty in an exchange in which you realize a gain, you have apartially nontaxable exchange. You are taxed on the gain you realize,but only to the extent of the money and the fair market value of theunlike property you receive. TaxTip: A loss is never deductible in a nontaxable exchange in which youreceive unlike property or cash. To figure the amount of taxable gain, first determine the fairmarket value of any unlike property you receive and add it to theamount of any money you receive. The total is the maximum amount ofgain that can be taxed. Next, figure the amount of gain on the wholeexchange as discussed earlier under Gain or Loss From Sales andExchanges. Your recognized (taxable) gain is the lesser of thesetwo amounts. Example.You exchange real estate held for investment with an adjusted basisof $8,000 for other real estate that you want to hold for investment.The fair market value of the real estate you receive is $10,000. Youalso receive $1,000 in cash. You paid $500 in exchange expenses.Although the total gain realized on the transaction is $2,500, only$500 ($1,000 cash received minus the $500 exchange expenses) isrecognized (included in your income). Assumption of liabilities.If the other party to a nontaxable exchange assumes any of yourliabilities, you will be treated as if you received cash in the amountof the liability. For more information on the assumption ofliabilities, see section 357(d) of the Internal Revenue Code. Example.The facts are the same as in the previous example, except theproperty you give up is subject to a $3,000 mortgage for which youwere personally liable. The other party in the trade has agreed to payoff the mortgage. Figure the gain realized as follows. FMV of like property received $10,000 Cash 1,000 Mortgage treated as assumed by other party      3,000 Total received $14,000 Minus: Exchange expenses      (500) Amount realized $13,500 Minus: Adjusted basis of property youtransferred    (8,000) Realized gain $ 5,500 The realized gain is taxed only up to $3,500, the sum of the cashreceived ($1,000 - $500 exchange expenses) and the mortgage($3,000). Unlike property given up.If, in addition to like property, you give up unlike property, youmust recognize gain or loss on the unlike property you give up. Thegain or loss is equal to the difference between the fair market valueof the unlike property and its adjusted basis. Example.You exchange stock and real estate that you held for investment forreal estate that you also intend to hold for investment. The stock youtransfer has a fair market value of $1,000 and an adjusted basis of$4,000. The real estate you exchange has a fair market value of$19,000 and an adjusted basis of $15,000. The real estate you receivehas a fair market value of $20,000. You do not have a taxable gain onthe exchange of the real estate because it qualifies as a nontaxableexchange. However, you must recognize (report on your return) a $3,000loss on the stock because it is unlike property. Basis of property received.The total basis for all properties (other than money) you receivein a partially nontaxable exchange is the total adjusted basis of theproperties you give up, with the following adjustments. Add-- Any additional costs you incur, and Any gain you recognize on the exchange. Subtract-- Any money you receive, and Any loss you recognize on the exchange. Allocate this basis first to the unlike property, other thanmoney, up to its fair market value on the date of the exchange. Therest is the basis of the like property. For more information, see Publication 551. Multiple Property Exchanges Under the like-kind exchange rules, you must generally make aproperty-by-property comparison to figure your recognized gain and thebasis of the property you receive in the exchange. However, forexchanges of multiple properties, you do not make aproperty-by-property comparison if you do either of the following. Transfer and receive properties in two or more exchangegroups. Transfer or receive more than one property within a singleexchange group. In this situation, you figure your recognized gain and thebasis of the property you receive by comparing the properties withineach exchange group. Exchange groups.Each exchange group consists of properties transferred and receivedin the exchange that are of like kind or like classes. (See LikeProperty, earlier.) If property could be included in more thanone exchange group, you can include it in any one of those groups.However, the following may not be included in an exchange group. Money. Stock in trade or other property held primarily forsale. Stocks, bonds, notes, or other securities or evidences ofdebt or interest. Interests in a partnership. Certificates of trust or beneficial interests. Choses in action. Example.Ben exchanges computer A (asset class 00.12), automobile A (assetclass 00.22), and truck A (asset class 00.241) for computer R (assetclass 00.12), automobile R (asset class 00.22), truck R (asset class00.241), and $400. All properties transferred were used in Ben'sbusiness. Similarly, all properties received will be used in hisbusiness. The first exchange group consists of computers A and R, the secondexchange group consists of automobiles A and R, and the third exchangegroup consists of trucks A and R. Treatment of liabilities.Offset all liabilities you assume as part of the exchange againstall liabilities of which you are relieved. Offset these liabilitieswhether they are recourse or nonrecourse and regardless of whetherthey are secured by or otherwise relate to specific propertytransferred or received as part of the exchange. If you assume more liabilities than you are relieved of,allocate the difference among the exchange groups in proportion to thetotal fair market value of the properties you received in the exchangegroups. The difference allocated to each exchange group may not bemore than the total fair market value of the properties you receivedin the exchange group. The amount allocated to an exchange group reduces the total fairmarket value of the properties received in that exchange group. Thisreduction is made in determining whether the exchange group has asurplus or a deficiency. (See Exchange group surplus anddeficiency, later.) This reduction is also made in determiningwhether a residual group is created. (See Residual group,later.) If you are relieved of more liabilities than you assume,treat the difference as cash, demand deposits and like accounts, andsimilar items when making allocations to the residual group, discussedlater. The treatment of liabilities and any differences between amountsyou assume and amounts you are relieved of will be the same even ifthe like-kind exchange treatment applies to only a portion of a largertransaction. If so, determine the difference in liabilities based onall liabilities you assume or are relieved of as part of the largertransaction. Example.The facts are the same as in the preceding example. In addition,the fair market value of and liabilities secured by each property areas follows. Fair Market Value Liability Ben Transfers: Computer A $1,500 $ -0- Automobile A 2,500 500 Truck A 2,000 -0- Ben Receives: Computer R $1,600 $ -0- Automobile R 3,100 750 Truck R 1,400 250 Cash 400 All liabilities assumed by Ben ($1,000) are offset by allliabilities of which he is relieved ($500), resulting in a differenceof $500. The difference is allocated among Ben's exchange groups inproportion to the fair market value of the properties received in theexchange groups as follows. $131 ($500 $1,600 $6,100) is allocated tothe first exchange group (computers A and R). The fair market value ofcomputer R is reduced to $1,469 ($1,600 - $131). $254 ($500 $3,100 $6,100) is allocated tothe second exchange group (automobiles A and R). The fair market valueof automobile R is reduced to $2,846 ($3,100 - $254). $115 ($500 $1,400 $6,100) is allocated tothe third exchange group (trucks A and R). The fair market value oftruck R is reduced to $1,285 ($1,400 - $115). In each exchange group, Ben uses the reduced fair market valueof the properties received to figure the exchange group's surplus ordeficiency and to determine whether a residual group has been created. Residual group.A residual group is created if the total fair market value of theproperties transferred in all exchange groups differs from the totalfair market value of the properties received in all exchange groupsafter taking into account the treatment of liabilities (discussedearlier). The residual group consists of money or other property thathas a total fair market value equal to that difference. It consists ofeither money or other property transferred in the exchange or money orother property received in the exchange, but not both. Other property includes the following items. Stock in trade or other property held primarily forsale. Stocks, bonds, notes, or other securities or evidences ofdebt or interest. Interests in a partnership. Certificates of trust or beneficial interests. Choses in action. Other property also includes property transferred that is notof a like kind or like class with any property received, and propertyreceived that is not of a like kind or like class with any propertytransferred. The money and properties allocated to the residual group areconsidered to come from the following assets in the following order. Cash, demand deposits and like accounts, and similaritems. Certificates of deposit, U.S. Government securities, readilymarketable stock or securities, and foreign currency. All other assets except section 197 intangibles. Section 197 intangibles (other than goodwill and goingconcern value). See chapter 2. Section 197 intangibles in the nature of goodwill and goingconcern value. Within each category, you may choose which properties toallocate to the residual group. Example.Fran exchanges computer A (asset class 00.12) and automobile A(asset class 00.22) for printer B (asset class 00.12), automobile B(asset class 00.22), corporate stock, and $500. Fran used computer Aand automobile A in her business and will use printer B and automobileB in her business. This transaction results in two exchange groups: (1) computer A andprinter B, and (2) automobile A and automobile B. The fair market values of the properties are as follows. Fair Market Value Fran Transfers: Computer A $1,000 Automobile A 4,000 Fran Receives: Printer B $ 800 Automobile B 2,950 Corporate Stock 750 Cash 500 Because the total fair market value of the propertiestransferred in the exchange groups ($5,000) is $1,250 more than thetotal fair market value of the properties received in the exchangegroups ($3,750), there is a residual group in that amount. It consistsof the $500 cash and the $750 worth of corporate stock. Exchange group surplus and deficiency.For each exchange group, you must determine whether there is an"exchange group surplus" or "exchange group deficiency." Anexchange group surplus is the total fair market value ofthe properties received in an exchange group (minus any excessliabilities you assume that are allocated to that exchange group) thatis more than the total fair market value of the properties transferredin that exchange group. An exchange group deficiency is thetotal fair market value of the properties transferred in an exchangegroup that is more than the total fair market value of the propertiesreceived in that exchange group (minus any excess liabilities youassume that are allocated to that exchange group). Example.Karen exchanges computer A (asset class 00.12) and automobile A(asset class 00.22), both of which she used in her business, forprinter B (asset class 00.12) and automobile B (asset class 00.22),both of which she will use in her business. Karen's adjusted basis andthe fair market value of the exchanged properties are as follows. Adjusted Basis Fair Market Value Karen Transfers: Computer A $ 375 $1,000 Automobile A 1,500 4,000 Karen Receives: Printer B $2,050 Automobile B 2,950 The first exchange group consists of computer A and printer B.It has an exchange group surplus of $1,050 because the fair marketvalue of printer B ($2,050) is more than the fair market value ofcomputer A ($1,000) by that amount. The second exchange group consists of automobile A and automobileB. It has an exchange group deficiency of $1,050 because the fairmarket value of automobile A ($4,000) is more than the fair marketvalue of automobile B ($2,950) by that amount. Recognized gain.Gain or loss realized for each exchange group and the residualgroup is the difference between the total fair market value of thetransferred properties in that exchange group or residual group andthe total adjusted basis of the properties. For each exchange group,recognized gain is the lesser of the gain realized or the exchangegroup deficiency (if any). Losses are not recognized for an exchangegroup. The total gain recognized on the exchange of like-kind orlike-class properties is the sum of all the gain recognized for eachexchange group. For a residual group, you must recognize the entire gain or lossrealized. For properties you transfer that are not within any exchange groupor the residual group, figure realized and recognized gain or loss asexplained under Gain or Loss From Sales and Exchanges,earlier. Example.Based on the facts in the previous example, Karen recognizes gainon the exchange as follows. For the first exchange group, the amount of gain realized is thefair market value of computer A ($1,000) minus its adjusted basis($375), or $625. The amount of gain recognized is the lesser of thegain realized ($625) or the exchange group deficiency ($0), or $0. For the second exchange group, the amount of gain realized is thefair market value of automobile A ($4,000) minus its adjusted basis($1,500), or $2,500. The amount of gain recognized is the lesser ofthe gain realized ($2,500) or the exchange group deficiency ($1,050),or $1,050. The total amount of gain recognized by Karen in the exchange is thesum of the gains recognized with respect to both exchange groups ($0+ $1,050), or $1,050. Basis of properties received.The total basis of properties received in each exchange group isthe sum of the following amounts. The total adjusted basis of the transferred propertieswithin that exchange group. Your recognized gain on the exchange group. The excess liabilities you assume that are allocated to thegroup. The exchange group surplus (or minus the exchange groupdeficiency). You allocate the total basis of each exchange groupproportionately to each property received in the exchange groupaccording to the property's fair market value. The basis of each property received within the residual group(other than money) is equal to its fair market value. Example.Based on the facts in the two previous examples, the bases of theproperties received by Karen in the exchange, printer B and automobileB, are determined in the following manner. The basis of the property received in the first exchange group is$1,425. This is the sum of the following amounts. The adjusted basis of the property transferred within thatexchange group ($375). The amount of gain recognized for that exchange group($0). The amount of excess liabilities assumed allocated to thatexchange group ($0). The amount of the exchange group surplus ($1,050). Because printer B is the only property received within thefirst exchange group, the entire basis of $1,425 is allocated toprinter B. The basis of the property received in the second exchange group is$1,500. This is figured as follows. First, add the following amounts. The adjusted basis of the property transferred within thatexchange group ($1,500). The amount of gain recognized for that exchange group($1,050). The amount of excess liabilities assumed allocated to thatexchange group ($0). Then subtract from that sum the amount of the exchange groupdeficiency ($1,050). Because automobile B is the only property received within thesecond exchange group, the entire basis of $1,500 is allocated toautomobile B. Like-Kind ExchangesBetween Related Persons Special rules apply to like-kind exchanges made between relatedpersons. These rules affect both direct and indirect exchanges. Underthese rules, if either person disposes of the property within 2 yearsafter the exchange, the exchange is disqualified from nonrecognitiontreatment. The gain or loss on the original exchange must berecognized as of the date of that later disposition. Related persons.Under these rules, related persons include, for example, you and amember of your family (spouse, brother, sister, parent, child, etc.),you and a corporation in which you have more than 50% ownership, youand a partnership in which you directly or indirectly own more than a50% interest of the capital or profits, and two partnerships in whichyou directly or indirectly own more than 50% of the capital interestsor profits. For more information on related persons, see NondeductibleLoss under Sales and Exchanges Between Related Personsin chapter 2. Example.You used a panel truck in your house painting business. Your sisterused a station wagon in her landscaping business. In December 1998,you exchanged your truck, plus $200, for your sister's station wagon.At that time, the fair market value (FMV) of your truck was $7,000 andits adjusted basis was $6,000. The FMV of your sister's station wagonwas $7,200 and its adjusted basis was $1,000. You realized a gain of$1,000 (the $7,200 FMV of the station wagon minus the $200 you paidminus the $6,000 adjusted basis of the truck). Your sister realized again of $6,200 (the $7,000 FMV of your truck plus the $200 you paidminus the $1,000 adjusted basis of the station wagon). However, because this was a like-kind exchange, you recognized nogain. Your basis in the station wagon was $6,200 (the $6,000 adjustedbasis of the truck plus the $200 you paid). Your sister recognizedgain only to the extent of the money she received, $200. Her basis inthe truck was $1,000 (the $1,000 adjusted basis of the station wagonminus the $200 received, plus the $200 gain recognized). In 1999, you sold the station wagon to a third party for $7,000.Because you sold it within 2 years after the exchange, the exchange isdisqualified from nonrecognition treatment. On your 1999 tax return,you must report your $1,000 gain on the 1998 exchange. You also reporta loss on the sale of $200 (the adjusted basis of the station wagon,$7,200 (its $6,200 basis plus the $1,000 gain recognized) minus the$7,000 amount realized from the sale). In addition, your sister must report on her 1999 tax return the$6,000 balance of her gain on the 1998 exchange. Her adjusted basis inthe truck is increased to $7,000 (its $1,000 basis plus the $6,000gain recognized). Two-year holding period.The 2-year holding period begins on the date of the last transferof property that was part of the like-kind exchange. If the holder'srisk of loss on the property is substantially diminished during anyperiod, however, that period is not counted toward the 2-year holdingperiod. The holder's risk of loss on the property is substantiallydiminished by any of the following events. The holding of a put on the property. The holding by another person of a right to acquire theproperty. A short sale or other transaction. A put is an option that entitles the holder to sellproperty at a specified price at any time before a specified futuredate. A short sale involves property you generally do not own.You borrow the property to deliver to a buyer and, at a later date,buy substantially identical property and deliver it to the lender. Exceptions to the rules for related persons.The following kinds of property dispositions are excluded fromthese rules. Dispositions due to the death of either relatedperson. Involuntary conversions. Dispositions if it is established to the satisfaction of theIRS that neither the exchange nor the disposition had as a mainpurpose the avoidance of federal income tax. Other Nontaxable Exchanges The following discussions describe other exchanges that may not betaxable. Partnership Interests Exchanges of partnership interests do not qualify as nontaxableexchanges of like-kind property. This applies regardless of whetherthey are general or limited partnership interests or are interests inthe same partnership or different partnerships. However, under somecircumstances such an exchange may be treated as a tax-freecontribution of property to a partnership. See Contribution ofProperty in Publication 541,Partnerships. An interest in a partnership that has a valid choice in effectunder section 761(a) of the Internal Revenue Code to be excluded fromall the rules of Subchapter K of the Code is treated as an interest ineach of the partnership assets and not as a partnership interest. SeeExclusion From Partnership Rules in Publication 541. U.S. Treasury Notes or Bonds Certain issues of U.S. Treasury obligations may be exchanged forcertain other issues designated by the Secretary of the Treasury withno gain or loss recognized on the exchange. See U.S. TreasuryBills, Notes, and Bonds under Interest Income inPublication 550 for more information on the tax treatment of incomefrom these investments. Envelope: For other information on these notes and bonds, call the Bureau ofthe Public Debt at (202) 874-4000, or write to thefollowing address. Attn: Customer Information Bureau of the Public Debt P.O. Box 1328 Parkersburg, WV 26106-1328 Computer: Or, on the Internet, visit: www.publicdebt.treas.gov Insurance Policies and Annuities No gain or loss is recognized if you make any of the followingexchanges. A life insurance contract for another or for an endowment orannuity contract. An endowment contract for an annuity contract or for anotherendowment contract providing for regular payments beginning at a datenot later than the beginning date under the old contract. One annuity contract for another if the insured or annuitantremains the same. If you realize a gain on the exchange of an endowment contract orannuity contract for a life insurance contract or an exchange of anannuity contract for an endowment contract, you must recognize thegain. For information on transfers and rollovers of employer-providedannuities, see Publication 575, Pension and Annuity Income,or Publication 571, Tax-Sheltered Annuity Programs forEmployees of Public Schools and Certain Tax-Exempt Organizations. Cash received.The nonrecognition and nontaxable transfer rules do not apply to arollover in which you receive cash proceeds from the surrender of onepolicy and invest the cash in another policy. However, you can treat acash distribution and reinvestment as meeting the nonrecognition ornontaxable transfer rules if all the following requirements are met. When you receive the distribution, the insurance companythat issued the policy or contract is subject to a rehabilitation,conservatorship, insolvency, or similar state proceeding. You withdraw all amounts to which you are entitled or themaximum amount permitted under the state proceeding. You reinvest the distribution within 60 days after receiptin a single policy or contract issued by another insurance company orin a single custodial account. You assign all rights to future distributions to the newissuer for investment in the new policy or contract if thedistribution was restricted by the state proceeding. You would have qualified under the nonrecognition ornontaxable transfer rules if you had exchanged the affected policy orcontract for the new one. If you do not reinvest all of the cash distribution, the rulesfor partially nontaxable exchanges, discussed earlier, apply. In addition to meeting these five requirements, you must do boththe following. Give to the issuer of the new policy or contract a statementthat includes all the following information. The gross amount of cash distributed. The amount reinvested. The amount of your investment in the affected policy orcontract on the date of the initial cash distribution. Attach the following items to your timely filed tax returnfor the year of the initial distribution. A statement entitled "ELECTION UNDER REV. PROC.92-44" that includes the name of the issuer and the policynumber (or similar identifying number) of the new policy orcontract. A copy of the statement given to the issuer of the newpolicy or contract. Property Exchanged for Stock If you transfer property to a corporation in exchange for stock inthat corporation (other than nonqualified preferred stock, describedlater), and immediately afterwards you are in control of thecorporation, the exchange is usually not taxable. This rule appliesboth to individuals and to groups who transfer property to acorporation. It does not apply in the following situations. The corporation is an investment company. You transfer the property in a bankruptcy or similarproceeding in exchange for stock used to pay creditors. The stock is received in exchange for the corporation's debt(other than a security) or for interest on the corporation's debt(including a security) that accrued while you held the debt. Control of a corporation.To be in control of a corporation, you or your group of transferorsmust own, immediately after the exchange, at least 80% of the totalcombined voting power of all classes of stock entitled to vote and atleast 80% of the outstanding shares of each class of nonvoting stock. Example 1.You and Bill Jones buy property for $100,000. You both organize acorporation when the property has a fair market value of $300,000. Youtransfer the property to the corporation for all its authorizedcapital stock, which has a par value of $300,000. No gain is includedin income by you, Bill, or the corporation. Example 2.You and Bill transfer the property with a basis of $100,000 to acorporation in exchange for stock with a fair market value of$300,000. This represents only 75% of each class of stock of thecorporation. The other 25% was already issued to someone else. You andBill recognize a taxable gain of $200,000 on the transaction. Services rendered.The term property does not include services rendered orto be rendered to the issuing corporation. The value of stock receivedfor services is income to the recipient. Example.You transfer property worth $35,000 and render services valued at$3,000 to a corporation in exchange for stock valued at $38,000. Rightafter the exchange, you own 85% of the outstanding stock. No gain isincluded in income on the exchange of property. However, you recognizeordinary income of $3,000 as payment for services you rendered to thecorporation. Property of relatively small value.The term property does not include property of arelatively small value when it is compared to the value of stock andsecurities already owned or to be received for services by thetransferor if the main purpose of the transfer is to qualify for thenonrecognition of gain or loss by other transferors. Property transferred will not be considered to be of relativelysmall value if its fair market value is at least 10% of the fairmarket value of the stock and securities already owned or to bereceived for services by the transferor. Stock received in disproportion to property transferred.Granada guest houseIf a group of transferors exchange property for corporate stock,each transferor does not have to receive stock in proportion to his orher interest in the property transferred. If a disproportionatetransfer takes place, it will be treated for tax purposes inaccordance with its true nature. It may be treated as if the stockwere first received in proportion and then some of it used to makegifts, pay compensation for services, or satisfy the transferor'sobligations. Money or other property received.If, in an otherwise nontaxable exchange of property for corporatestock, you also receive money or property other than stock, you mayhave a taxable gain. You are taxed only up to the amount of money plusthe fair market value of the other property you receive. The rules forfiguring the taxable gain in this situation generally follow those fora partially nontaxable exchange discussed earlier under Like-KindExchanges. If the property you give up includes depreciableproperty, the taxable gain may have to be reported as ordinary incomefrom depreciation. See chapter 3.No loss is recognized. Nonqualified preferred stock.Nonqualified preferred stock is treated as property other thanstock. Generally, it is preferred stock with any of the followingfeatures. The holder has the right to require the issuer or a relatedperson to redeem or buy the stock. The issuer or a related person is required to redeem or buythe stock. The issuer or a related person has the right to redeem thestock and, on the issue date, it is more likely than not that theright will be exercised. The dividend rate on the stock varies with reference tointerest rates, commodity prices, or similar indices. For a detailed definition of nonqualified preferred stock, seesection 351(g)(2) of the Internal Revenue Code. Liabilities.If the corporation assumes your liabilities, the exchange is notgenerally treated as if you received money or other property. Thereare two exceptions to this treatment. If the liabilities the corporation assumes are more thanyour adjusted basis in the property you transfer, gain is recognizedup to the amount of the difference. However, if the liabilitiesassumed give rise to a deduction when paid, such as a trade accountpayable or interest, no gain is recognized. If there is no good business reason for the corporation toassume your liabilities, or if your main purpose in the exchange is toavoid federal income tax, the assumption is treated as if you receivedmoney in the amount of the liabilities. For more information on the assumption of liabilities, seesection 357(d) of the Internal Revenue Code. Example.You transfer property to a corporation for stock. You also receive$10,000 in the exchange. Your adjusted basis in the transferredproperty is $20,000. The stock you receive has a fair market value(FMV) of $16,000. The corporation also assumes a $5,000 mortgage onthe property for which you are personally liable. Gain is realized asfollows. FMV of stock received $16,000 Cash received 10,000 Liability assumed by corporation      5,000 Total received $31,000 Minus: Adjusted basis of property transferred     20,000 Realized gain $11,000 The liability assumed is not treated as money or other property.The recognized gain is limited to $10,000, the amount of cashreceived.