Like-kind home exchanges: IRS allows both exclusion and deferral of gains.

• Author: Josephs, Stuart R.
• Position: Federal tax

Rev. Proc. 2005-4 (IRB 2005-7, Feb. 14, 2005) clarifies that homeowners, who may exclude gain from a sale or exchange of their principal residence, also may defer gain from a like-kind exchange of the same property.

Background

Generally, under IRC Sec. 121, taxpayers may exclude gain of up to $250,000 ($500,000 for certain joint returns) from the sale or exchange of the taxpayer's principal residence. Taxpayers must have owned and used the property as their principal residence for at least two years during the five years preceding the sale or exchange, and must not have used the exclusion during the previous two years.

This exclusion also may apply to a business portion of a home, but not to depreciation for business use after May 6, 1997. This limitation applies only to depreciation allocable to the portion of the property eligible for the exclusion.

Taxpayers using a portion of a property for residential and a portion for business purposes is treated as using the entire property as the taxpayer's principal residence to satisfy the two year use requirement if the residential and business portions are within the same dwelling unit.

Sec. 1031(a) provides that no gain or loss is recognized on the exchange of property held for use in a business or investment (relinquished property) if it is exchanged solely for property of like kind (replacement property) that is to be held for use in a business or investment.

Under Sec. 1031(b), if a taxpayer also receives cash or other non-like-kind property (boot) in an exchange otherwise qualifying under Sec. 1031(a), the taxpayer must recognize gain to the extent of the boot.

Sec. 1031 does not apply to property used solely as a personal residence.

The basis of property acquired in an exchange is its fair market value, unless otherwise provided in the Code [for example, Sec. 1031(d)] or the regulations.

Under Sec. 1031(d), the basis of the replacement property is the same as the basis of the relinquished property, decreased by the amount of cash received and increased by the amount of gain recognized by the taxpayer in the exchange.

Neither Secs. 121 nor 1031 address the application of both provisions to a single exchange of property.

Computing Gain and Basis

(1) Sec. 121 Applied Before Sec. 1031. Sec. 121 must be applied to the gain realized before applying Sec. 1031.

(2) Applying Sec. 1031 to Gain Attributable to Depreciation. Although the exclusion does not apply to gain attributable to depreciation...