1977, March, Pg. 472. Tax Tips.

6 Colo.Law. 472

Colorado Lawyer

1977.

1977, March, Pg. 472.

Tax Tips

472Vol. 6, No. 3, Pg. 472Tax TipsTax-Free Exchanges Under § 1031

The general rule, provided by I.R.C. § 1002, is that the sale or exchange of property is a taxable event. However, where a taxpayer exchanges property for that of a similar nature and has not therefore substantively changed his position, it would appear to be inequitable to levy a tax at that point in time. This conclusion was part of the reason for the enactment of I.R.C. § 1031.

This section provides that no gain or loss will be recognized if property held for productive use in a trade or business or for investment is exchanged solely for property of a like-kind to be held for either of these purposes. Except as otherwise provided hereafter, realized gain or loss on a qualifying exchange will be deferred until the disposition of the acquired property. Section 1031 is not elective and may not be waived; therefore, any transaction coming within its province will be subject to its provisions.

Qualifying PropertyAs mentioned above, property held for productive use in a trade or business or for investment qualifies for the provisions of § 1031. Specifically excluded from § 1031 is stock-in-trade or other property held primarily for sale by a taxpayer, stock, bonds, notes, choses in action, certificates of trust or beneficial interest, and other securities or evidence of indebtedness.

The terms "property held for productive use in a trade or business" and "property held for investment" are interchangeable. Therefore, property held for one of these purposes may be exchanged under § 1031 for property to be held for the other.

The fact that nonqualifying property is either given up or received will not prevent the application of § 1031 so long as one side of the transaction is not represented entirely by such nonqualifying property.

If a taxpayer received nonqualifying property then he will recognize gain on the transaction in an amount equal to the lesser of the realized gain or the amount of nonqualifying property received (which may include cash).(fn1) No loss may be recognized in a § 1031 exchange except as provided below.(fn2)

If a taxpayer gives up nonqualifying property, he will be deemed to have received in exchange for such property an amount equal to its fair market value on the date of exchange.(fn3) If this nonqualifying property has appreciated in value, gain will be recognized on the transaction just as though the property had been sold for cash.(fn4) If the property had depreciated in value so that its tax basis exceeded its fair market value, then a loss will be recognized.(fn5)

In addition to the foregoing requirements, qualifying property received in a § 1031 exchange must also be of like-kind to the property given up. The term "like-kind" has reference to. . . "the nature or character of the property and not to its grade or quality. One kind or class of property may not. . . be exchanged for property of a different kind or class".(fn6) Essentially this means that real property may be exchanged for another type of real property, but not for personal property and vice-versa. The concept of like-kind property has been broadly interpreted in the real estate area. Improved property may be exchanged for unimproved property, city real estate may be exchanged for a ranch or a farm, and a lease-hold with a fee in excess of thirty years may be exchanged for a fee interest.(fn7) Of course, if one of the parties to the transaction holds property as a dealer, as opposed to for productive use in a trade or business or for investment, § 1031 will not apply to him.

In a transaction that includes both qualifying and nonqualifying property, the IRS has ruled that property may not be viewed in the aggregate even though it may consist of an integrated business. Therefore, in an exchange of residential real estate for a farm consisting of real estate and machinery, the machinery was...