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Unformatted text preview: 151 Chapter 11 Property Transactions: Nonrecognition of Gains and Losses SUMMARY OF CHAPTER This chapter deals with situations where there may be nonrecognition of gain or loss. Sometimes the gain or loss may be permanently excluded, meaning that the gain or loss will never be included in taxable income, such as in the case of a sale of a residence for taxpayers with a realized gain of less than $500,000 ($250,000 for single taxpayers). In other cases, however, nonrecognition is temporary in that there is deferral of recognition. This is because the basis of the replacement property will be adjusted to reflect the deferred gain or loss. In this chapter, sales of residence, like-kind exchanges, and involuntary conversions are discussed in detail. Less attention is devoted to exchanges of property for stock or partnership interests, exchanges of life insurance policies, exchanges of stock in the same corporation by a shareholder, exchanges of U.S. obligations, and reacquisitions of real property. Sale of a Personal Residence The Taxpayer Relief Act of 1997 repealed Code Sec. 1034 (deferral of gain on sale of residence) and amended Sec. 121 (the once-in-a-lifetime exclusion of gain). ¶11,001 The General Rules Married taxpayers may exclude up to $500,000 of gain upon the sale of their residence and single taxpayers may exclude up to $250,000 of their gain. (Code Sec. 121(b)(1) and (2).) Taxpayers must have owned and occupied the residence for two out of the last five years prior to the sale. (Code Sec. 121(b)(3)(A).) For married taxpayers, the exclusion is allowed if (1) either spouse meets the ownership test, (2) both spouses meet the use test, and (3) neither spouse is ineligible for exclusion because of a sale or exchange of a residence within the last two years. (Code Sec. 121(b)(2)(B), (C), and (D).) Because this exclusion replaces the deferral of gain provision of Code Sec. 1034 and the one-time $125,000 exclusion for taxpayers age 55 or older, application of the exclusion does not result in a reduction of the basis of a replacement residence as was the case under prior law. Taxpayers may elect out of this exclusion provision for any sale or exchange. ¶11,005 Principal Residence In order to obtain nonrecognition of gain, the residence must be a principal residence. A principal residence is the home in which the taxpayer lives. If the residence is converted to business or rental property, the nonrecogni- tion provision may still apply if the two-year ownership and occupancy test is met. ¶11,015 Special Provisions Special provisions are included in the new law to consider other types of transactions or events or to take into consideration various types of taxpayers. These include a pro-ration of the exclusion if the sale is due to a change in place of employment, health, or unforeseen circumstances even if a taxpayer does not meet the ownership or usage requirement. The amount of the exclusion is $250,000 or $500,000 multiplied by the portion that is the shorter of (1)requirement....
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