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Gross Income (continued)

  • 703. What is the “netting” process used to determine whether a taxpayer has a capital loss for the year? Can capital losses be carried into other tax years?

    • Editor’s NoteFor tax years beginning in 2018 and before 2026, the long-term capital gain brackets no longer neatly align with the ordinary income tax brackets. For 2022 with respect to adjusted net capital gain:

      (1) The 0 percent rate will apply to joint filers who earn less than $83,350 (half the amount for married taxpayers filing separately), heads of households who earn less than $55,800, single filers who earn less than $41,675, and trusts and estates with less than $2,800 in income.

      (2) The 15 percent capital gains rate will apply to joint filers who earn more than $83,350 but less than $517,200 (half the amount for married taxpayers filing separately), heads of households who earn more than $55,800 but less than $488,500, single filers who earn more than $41,675 but less than $459,750, and trusts and estates with more than $2,800 but less than $13,700 in income.

      (3) The 20 percent capital gains rate will apply to joint filers who earn more than $517,200 (half that amount for married taxpayers filing separately), heads of households who earn more than $488,500, single filers who earn more than $459,750, and trusts and estates with more than $13,700 in income.1 See Q 704 for the rates that applied in other years.

      The rules discussed in Q 702 essentially establish four groups of capital assets (based upon pre-existing tax rates):

      (1) short-term capital assets, with no special tax rate;

      (2) 28 percent capital assets, generally consisting of collectibles gain or loss, and IRC Section 1202 gain;

      (3) 25 percent capital assets, consisting of assets that generate unrecaptured IRC Section 1250 gain; and

      (4) a group consisting of all other long-term capital assets, with a 0, 15 or 20 percent rate that applies based on the taxpayer’s income levels (see editor’s note, above.

      Within each group, gains and losses are netted. The effect of this process is generally that if there is a net loss from (1), it is applied to reduce any net gain from (2), (3), or (4), in that order. If there is a net loss from (2) it is applied to reduce any net gain from (3) or (4), in that order. If there is a net loss from (4), it is applied to reduce any net gain from (2) or (3), in that order.2

      After all of the netting above, if there are net losses, up to $3,000 ($1,500 in the case of married individuals filing separately) of losses can be deducted against ordinary income.3 Apparently, any deducted loss will be treated as reducing net loss from (1), (2), or (4), in that order. Any remaining net losses can be carried over to other taxable years, retaining its group classifications. If there are net gains, such gains will generally be taxed as described above.

      Generally, to the extent a capital loss described above exceeds the $3,000 limit ($1,500 in the case of married individuals filing separately); it may be carried over to other taxable years, but always retaining its character as long-term or short-term. However, special rules apply in determining the carryover amount from years in which a taxpayer has no taxable income.4


      1. IRC Sec. 1(j)(5), Rev. Proc. 2021-45.

      2. IRC Sec. 1(h)(1), as amended by ATRA; Notice 97-59, 1997-2 CB 309.

      3. IRC Sec. 1211(b).

      4. IRC Secs. 1211(b), 1212(b).

  • 704. How have the capital gain rates for individuals changed between 2003 and the present?

    • Long-term capital gains incurred on or after May 6, 2003 are subject to lower tax rates. For taxpayers in the 25, 28, 33 and 35 percent tax brackets, the rate on long-term capital gains was reduced from 20 percent to 15 percent in 2003 through 2012. For taxpayers in the 10 and 15 percent brackets, the rate on long-term capital gains was reduced from 10 percent to 5 percent in 2003 through 2007, and all the way down to 0 percent in 2008 through 2017. These lower capital gains rates have been made permanent, but the 2017 Tax Act has changed the income thresholds for determining which rate applies.1

      Early in 2013, Congress enacted the American Taxpayer Relief Act of 2012 (“ATRA”) under which the reduced capital gain rates were extended for some taxpayers, while increased rates were placed into effect for higher income taxpayers. ATRA increased the rate on long-term capital gains to 20 percent in 2012-2017 for taxpayers with taxable income that placed them in the highest 39.6 percent tax bracket. The applicable threshold amount was adjusted annually for inflation.2

      For taxpayers in the 10 or 15 percent income tax brackets, the rate on long-term capital gains was 0 percent for 2012-2017. Taxpayers in the 25, 28, 33 and 35 percent tax brackets were taxed at 15 percent on long-term capital gains from 2012-2017.3

      2020 Capital Gains Rates

      For tax years beginning in 2020, the following rates apply: 0 percent rate will apply to joint filers who earn less than $80,000 (half the amount for married taxpayers filing separately), heads of households who earn less than $53,600, single filers who earn less than $40,000, and trusts and estates with less than $2,650 in income.

      The 15 percent capital gains rate will apply to joint filers who earn more than $80,000 but less than $496,600 (half the amount for married taxpayers filing separately), heads of households who earn more than $53,600 but less than $469,050, single filers who earn more than $40,000 but less than $441,450, and trusts and estates with more than $2,650 but less than $13,150 in income.

      The 20 percent capital gains rate will apply to joint filers who earn more than $496,600 (half that amount for married taxpayers filing separately), heads of households who earn more than $469,050, single filers who earn more than $441,450, and trusts and estates with more than $13,150 in income.4

      2021 Capital Gains Rates

      For tax years beginning in 2021, the following rates apply: 0 percent rate will apply to joint filers who earn less than $80,800 (half the amount for married taxpayers filing separately), heads of households who earn less than $54,100, single filers who earn less than $40,400, and trusts and estates with less than $2,700 in income.

      The 15 percent capital gains rate will apply to joint filers who earn more than $80,800 but less than $501,600 (half the amount for married taxpayers filing separately), heads of households who earn more than $54,100 but less than $473,750, single filers who earn more than $40,000 but less than $445,850, and trusts and estates with more than $2,700 but less than $13,250 in income.

      The 20 percent capital gains rate will apply to joint filers who earn more than $501,600 (half that amount for married taxpayers filing separately), heads of households who earn more than $473,750, single filers who earn more than $445,850, and trusts and estates with more than $13,250 in income.5

      2022 Capital Gains Rates

      For tax years beginning in 2022, with respect to adjusted net capital gain, the 0 percent rate will apply to joint filers who earn less than $83,350 (half the amount for married taxpayers filing separately), heads of households who earn less than $55,800, single filers who earn less than $41,675, and trusts and estates with less than $2,800 in income.

      The 15 percent capital gains rate will apply to joint filers who earn more than $83,350 but less than $517,200 (half the amount for married taxpayers filing separately), heads of households who earn more than $55,800 but less than $488,500, single filers who earn more than $41,675 but less than $459,750, and trusts and estates with more than $2,800 but less than $13,700 in income.

      The 20 percent capital gains rate will apply to joint filers who earn more than $517,200 (half that amount for married taxpayers filing separately), heads of households who earn more than $488,500, single filers who earn more than $459,750, and trusts and estates with more than $13,700 in income.6

      In addition, beginning January 1, 2013, an investment income tax of 3.8 percent applies to certain investment-type income (including income received from capital gains). The investment income tax applies for taxpayers whose annual adjusted gross income exceeds the investment income threshold amount ($250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately and $200,000 for all other taxpayers).7 The income threshold used for purposes of the 3.8 percent investment income tax is not adjusted for inflation, and the tax was not changed in the 2017 Tax Act.

      Collectibles gain, IRC Section 1202 gain (i.e., qualified small business stock), and unrecaptured IRC Section 1250 gain continue to be taxed at their previously existing tax rates (i.e., 28 percent for collectibles gain and IRC Section 1202 gain, and 25 percent for unrecaptured IRC Section 1250 gain).8

      Repeal of qualified five-year gain. For tax years beginning after December 31, 2000, if certain requirements were met, the maximum rates on “qualified five-year gain” could be reduced to 8 percent and 18 percent (in place of 10 percent and 20 percent respectively). Furthermore, a noncorporate taxpayer in the 25 percent bracket (or higher) who held a capital asset on January 1, 2001 could elect to treat the asset as if it had been sold and repurchased for its fair market value on January 1, 2001 (or on January 2, 2001 in the case of publicly traded stock). If a noncorporate taxpayer made this election, the holding period for the elected assets began after December 31, 2000, thereby making the asset eligible for the 18 percent rate if it was later sold after having been held by the taxpayer for more than five years from the date of the deemed sale and deemed reacquisition.9 Under JGTRRA 2003, the five-year holding period requirement, and the 18 percent and 8 percent tax rates for qualified five-year gain are repealed. Though this repeal was scheduled to sunset along with the reduced rates, it was made permanent under ATRA.

       


      1. IRC Sec. 1(h)(1), as amended by ATRA; TIPRA 2005 Sec. 102, amending JGTRRA 2003 Sec. 303, Pub. Law No. 115-97.

      2. IRC Secs. 1(i), 1(h), as amended by ATRA, Secs. 101(b)(3)(C) and 102(b).

      3. IRC Sec. 1(h), as amended by ATRA, Sec. 102.

      4. Rev. Proc. 2019-44.

      5. Rev. Proc. 2020-45.

      6. Rev. Proc. 2021-45.

      7. IRC Sec. 1411.

      8. IRC Sec. 1(h).

      9. IRC Secs. 1(h)(2), 1(h)(9), prior to amendment by JGTRRA 2003; JCWAA 2002 Sec. 414(a) and CRTRA 2000 Sec. 314(c), amending TRA ’97 Sec. 311(e).

  • 705. What lower rates apply for qualified dividend income?

    • Under prior law, dividends were treated as ordinary income and, thus, were subject to ordinary income tax rates. Under JGTRRA 2003, “qualified dividend income” (see Q 706) is treated as “net capital gain” (Q 706) and is, therefore, subject to capital gains tax rates. This treatment continues after the 2017 tax reform law was enacted, but the income thresholds for determining which rate applies were changed.

      2022 Capital Gains Rates

      For tax years beginning in 2022, the following rates apply (see Q 704 for earlier years): the 0 percent rate will apply to joint filers who earn less than $83,350 (half the amount for married taxpayers filing separately), heads of households who earn less than $55,800, single filers who earn less than $41,675, and trusts and estates with less than $2,800 in income.

      The 15 percent capital gains rate will apply to joint filers who earn more than $83,350 but less than $517,200 (half the amount for married taxpayers filing separately), heads of households who earn more than $55,800 but less than $488,500, single filers who earn more than $41,675 but less than $459,750, and trusts and estates with more than $2,800 but less than $13,700 in income.

      The 20 percent capital gains rate will apply to joint filers who earn more than $517,200 (half that amount for married taxpayers filing separately), heads of households who earn more than $488,500, single filers who earn more than $459,750, and trusts and estates with more than $13,700 in income.1

      The preferential treatment of qualified dividends as net capital gains was scheduled to “sunset” (expire) on December 31, 2012, after which time the prior treatment of dividends was to become effective.2 In other words, dividends were once again to be taxed at ordinary income tax rates. The American Taxpayer Relief Act of 2012 prevented this sunset and made the treatment of qualified dividend income as net capital gain permanent.3

      __________________

      1. IRC Sec. 1(j)(5), Rev. Proc. 2021-45.

      2. IRC Sec. 1(h)(1); TIPRA 2005 Sec. 102, amending JGTRRA 2003 Sec. 303.

      3. ATRA 2012, Pub. Law No. 112-240.

  • 706. What is qualified dividend income?

    • Certain dividends are taxed as “net capital gain” for purposes of the reduction in the tax rates on dividends. “Net capital gain” for this purpose means net capital gain increased by “qualified dividend income” (without regard to this paragraph).1 “Qualified dividend income” means dividends received during the taxable year from domestic corporations and “qualified foreign corporations” (defined below).2

      The term qualified dividend income does not include the following:

      (1) dividends paid by tax-exempt corporations;

      (2) any amount allowed as a deduction under IRC Section 591 (relating to the deduction for dividends paid by mutual savings banks, etc.);

      (3) dividends paid on certain employer securities as described in IRC Section 404(k);

      (4) any dividend on a share (or shares) of stock that the shareholder has not held for more than sixty days during the 121-day period beginning sixty days before the ex-dividend date (as measured under IRC Section 246(c)). For preferred stock, the holding period is more than ninety days during the 181-day period beginning ninety days before the ex-dividend date if the dividends are attributable to a period exceeding 366 days (note, however, that if the preferred dividends are attributable to a period totaling less than 367 days, the holding period stated in the preceding sentence applies).3

      Special rules. Qualified dividend income does not include any amount that the taxpayer takes into account as investment income under IRC Section 163(d)(4)(B).4 If an individual, trust, or estate receives qualified dividend income from one or more dividends that are “extraordinary dividends” (within the meaning of IRC Section 1059(c)), any loss on the sale or exchange of such share(s) of stock will, to the extent of such dividends, be treated as long-term capital loss.5

      A dividend received from a mutual fund or REIT is subject to the limitations under IRC Sections 854 and 857.6 For the treatment of mutual fund dividends and REIT dividends under JGTRRA 2003, see Q 7938 and Q 7977, respectively.

      Pass-through entities. In the case of partnerships, S corporations, common trust funds, trusts, and estates, the rule that qualified dividends are taxable as capital gains applies to taxable years ending after December 31, 2002, except that dividends received by the entity prior to January 1, 2003 are not treated as qualified dividend income.7

      Qualified foreign corporations. The term “qualified foreign corporation” means a foreign corporation incorporated in a possession of the United States, or a corporation that is eligible for benefits of a comprehensive income tax treaty with the United States. If a foreign corporation does not satisfy either of these requirements, it will nevertheless be treated as such with respect to any dividends paid by that corporation if its stock (or ADRs with respect to such stock) is readily tradable on an established securities market in the United States.8

      Common stock (or an ADR in respect of such stock) is considered “readily tradable on an established securities market in the United States” if it is listed on a national securities exchange that is registered under Section 6 of the Securities Exchange Act of 1934 (15 USC 78(f)), or on the NASDAQ Stock Market. 9 As stated by the SEC, registered national exchanges include the following:

      • NYSE MKT LLC (formerly NYSE AMEX and the American Stock Exchange)
      • Cboe BZX Exchange, Inc. (formerly BATS BZX Exchange, Inc.)
      • Cboe BZX Exchange, Inc. (formerly BATS BYX Exchange, Inc.)
      • BOX Exchange LLC (formerly BOX Options Exchange LLC)
      • NASDAQ BX, Inc. (formerly the Boston Stock Exchange)
      • Cboe C2 Exchange, Inc.
      • Cboe Exchange, Inc. (formerly Chicago Board Options Exchange, Incorporated)
      • NYSE Chicago, Inc. (formerly Chicago Stock Exchange, Inc.)
      • Cboe EDGA Exchange, Inc. (formerly BATS EDGA Exchange, Inc.)
      • Cboe EDGA Exchange, Inc. (formerly BATS EDGX Exchange, Inc.)
      • Nasdaq ISE, LLC (formerly International Securities Exchange, LLC)
      • The Investors Exchange, LLC
      • Long-Term Stock Exchange, Inc.
      • Nasdaq GEMX, LLC (formerly ISE Gemini)
      • Nasdaq MRX, LLC (former ISE Mercury)
      • Miami Int’l Securities Exchange
      • MIAX PEARL, LLC
      • MIAX EMERALD, LLC
      • The Nasdaq Stock Market LLC
      • NYSE National, Inc. (formerly National Stock Exchange, Inc.)
      • New York Stock Exchange LLC
      • NYSE Arca, Inc.
      • NASDAQ PHLX, Inc. (formerly Philadelphia Stock Exchange)10

      In order to meet the “treaty test,” the foreign corporation must be eligible for benefits of a comprehensive income tax treaty with the United States that the Treasury Secretary determines is satisfactory for these purposes, and the treaty must also provide for the exchange of tax information. For the current list of tax treaties meeting these requirements, see Notice 2011-64.11

      The term “qualified foreign corporation” does not include any foreign corporation if, for the taxable year of the corporation in which the dividend was paid (or the preceding taxable year), the corporation is a passive foreign investment company (as defined in section 1297).12

      Special rules apply in determining a taxpayer’s foreign tax credit limitation under IRC Section 904 in the case of qualified dividend income. For these purposes, rules similar to the rules of IRC Section 904(b)(2)(B) (concerning adjustments to the foreign tax credit limitation to reflect any capital gain rate differential) will apply to any qualified dividend income.13

      For information reporting and other guidance on foreign stock dividends, see Notice 2006-3;14 Notice 2004-71;15 and Notice 2003-79.16


      1. IRC Sec. 1(h)(11)(A).

      2. IRC Sec. 1(h)(11)(B).

      3. IRC Sec. 1(h)(11)(B).

      4. IRC Sec. 1(h)(11)(D)(i). See also Temp. Treas. Reg. §1.163(d)-1T.

      5. IRC Sec. 1(h)(11)(D).

      6. IRC Sec. 1(h)(11)(D)(iii).

      7. WFTRA 2004 Sec. 402(a)(6), JGTRRA 2003 Sec. 302(f).

      8. IRC Sec. 1(h)(11)(C).

      9. Notice 2003-71, 2003-43 IRB 922.

      10. http://www.sec.gov/divisions/marketreg/mrexchanges.shtml (last accessed February 22, 2020).

      11. 2011-37 IRB 231.

      12. IRC Sec. 1(h)(11)(C)(iii).

      13. See IRC Sec. 1(h)(11)(C)(iv).

      14. 2006-3 IRB 306.

      15. 2004-45 IRB 793

      16. 2003-50 IRB 1206.

  • 707. What are the reporting requirements under JGTRRA 2003?

    • Boxes have been added to Form 1099-DIV to allow for the reporting of qualified dividends (Box 1b) and post-May 5, 2003 capital gain distributions (Box 2b). Likewise, boxes have also been added to Form 1099-B for reporting post-May 5, 2003 profits or losses from regulated futures or currency contracts.1 Payments made in lieu of dividends (“substitute payments”) are not eligible for the lower rates applicable to qualified dividends.2 For the information reporting requirements for such payments, see Notice 2003-67;3 Announcement 2003-75;4 Treasury Regulation Section 1.6045-2(a)(3)(i); TD 9103.5


      1 .See Announcement 2003-55, 2003-38 IRB 597.

      2 .H.R. Rep. No. 108-94, 108th Cong., 1st Sess. 31 n. 36 (2003).

      3 .2003-40 IRB 752.

      4 .2003-49 IRB 1195.

      5 .68 Fed. Reg.74847 (12-29-2003).

  • 708. How are gains and losses treated for “traders in securities”?

    • In general, investors’ losses are classified as capital losses, may be used to offset capital gains, and can only offset up to $3,000 of ordinary income each year (see Q 702). On the other hand, a “trader in securities” (see below) may elect to recognize gain or loss on any security held in connection with a trade or business at the close of any taxable year as if the security were sold at its fair market value at year-end.1 Consequently, gains or losses with respect to such securities—whether deemed sold at year-end under the mark-to-market method of accounting (see Q 7591, Q 7592) or actually sold during the taxable year—are treated as ordinary income or loss.2 Therefore, if a taxpayer is in business as a trader in securities and makes a mark-to-market election (under IRC Section 475(f)(1)) with respect to sales of securities held in connection with his business, the taxpayer’s net loss from that business will be an ordinary loss that is fully deductible.3

      These rules apply only to taxpayers who qualify as traders in securities. For an individual investor to achieve “trader” status, the Tax Court has stated that:

      “In order to qualify as a trader (as opposed to an investor) [the taxpayer’s] purchases and sales of securities * * * must have constituted a trade or business. ‘In determining whether a taxpayer who manages his own investments is a trader, and thus engaged in a trade or business, relevant considerations are the taxpayer’s investment intent, the nature of the income to be derived from the activity, and the frequency, extent, and regularity of the taxpayer’s securities transactions.’4 In general, investors purchase and hold securities ‘for capital appreciation and income’ whereas traders buy and sell ‘with reasonable frequency in an endeavor to catch the swings in the daily market movements and profit thereby on a short-term basis.’5 For a taxpayer to be considered a trader, the taxpayer’s trading activity must be ‘substantial,’ and it must be ‘frequent, regular, and continuous to be considered part of a trade or business. * * * Sporadic trading does not constitute a trade or business.’6 (‘We accept the fact that to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity * * *. A sporadic activity * * * does not qualify.’).”7

      In Chen, the taxpayer effected 323 transactions involving the purchase of securities, most of which he held for less than one month. Approximately 94 percent of Chen’s transactions occurred during February, March, and April, with no transactions occurring in six of the other nine months. Chen attempted to retroactively elect mark-to-market accounting as a trader so that he could treat his losses as fully deductible ordinary losses incurred in a trade or business. The Tax Court held that Chen was not a trader in securities eligible to make a mark-to-market election because Chen did not meet the second requirement for trader status—frequent, regular, and continuous trading. In the court’s view, Chen’s purchases and sales of securities were only frequent, regular, and continuous during the months of February, March, and April. The court also noted that Chen maintained a full-time job as a computer chip engineer. According to the court, in cases in which taxpayers have been held to be “traders in securities,” the number and frequency [of trades] indicated that they were engaged in market transactions almost daily for a substantial and continuous period, generally exceeding a single taxable year. Furthermore, those activities constituted the taxpayers’ sole or primary income-producing activity.” The Tax Court concluded that because Chen’s daily trading activities covered only a portion of a single year, and securities trading was not the sole or even primary activity in which Chen engaged for the production of income, Chen was not eligible for trader status.8

      For the circumstances in which a late Section 475(f) election will be allowed, see Vines v. Comm.9

      Traders are allowed to fully deduct their expenses as business expenses. See Q 8052. Conversely, investors’ expenses are classified as miscellaneous itemized deductions and are subject to the 2 percent-of-adjusted gross income (AGI) threshold, all of which were suspended from 2018-2025 under the 2017 tax reform legislation. See Q 733. The expenses of investors are also subjected to additional limitations. See Q 8040 – investment interest expense; Q 8049 – expenses paid in connection with the production of investment income; and Q 8051 – expenses relating to tax questions.


      1. See IRC Sec. 475(f)(1)(A)(i); Chen v. Comm., TC Memo 2004-132.

      2. See IRC Secs. 475(d)(3)(A), 475(f)(1)(D); Chen v. Comm., TC Memo 2004-132.

      3. See IRC Sec. 165(c)(1); Chen v. Comm., TC Memo 2004-132.

      4Moller v. U.S., 721 F.2d 810, 813 (Fed. Cir. 1983).

      5Liang v. Comm., 23 TC 1040, 1043 (1955).

      6Boatner v. Comm., TC Memo 1997-379, affd, 164 F.3d 629 (9th Cir. 1998); see also Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).

      7Chen v. Comm., TC Memo 2004-132.

      8Chen v. Comm., TC Memo 2004-132.

      9. 126 TC No. 15 (2006).

  • 709. How are gains and losses calculated for “traders in securities” when securities are sold subject to nonrecourse liabilities and the mark-to-market rules apply?

    • If a taxpayer who is a securities dealer uses the mark-to-market rules under IRC Section 475(f)(1) with respect to sales of securities held in connection with his or her business, the IRS has provided guidance requiring that the amount of any nonrecourse liabilities be included when calculating the fair market value of the securities.

      The IRS has addressed a situation where two partnerships originated and purchased mortgage loans and issued notes to third-party investors as mortgage-backed securities. The mortgage-backed securities were subject to nonrecourse liabilities. One partnership sold the securities to a third partnership, including the amount of the nonrecourse liabilities when calculating the amount realized in the sale. The purchasing partnership also included the nonrecourse liabilities when calculating its basis in the securities.1

      Both partnerships used mark-to-market accounting under IRC Section 475. However, the partnerships failed to include the value of the nonrecourse liabilities when calculating the fair market value of the securities for purposes of determining year-end gain or loss under the mark-to-market rules. In requiring that the partnerships include the nonrecourse liabilities in calculating fair market value, the IRS found that the fair market value of the property could be no less than the amount of any nonrecourse indebtedness to which the property is subject when determining gain or loss.2 The IRS found further that even if the Internal Revenue Code does not mandate this conclusion, Supreme Court precedent requires inclusion of any nonrecourse debt in determining fair market value for purposes of the mark-to-market rules.3


      1 .ILM 201507019.

      2 .IRC Sec. 7701(g).

      3 .Comm. v. Tufts, 461 U.S. 300 (1983), Crane v. Comm., 331 U.S. 1 (1947).

  • 710. What is a “like-kind” exchange? How is it taxed?

    • Editor’s Note: For tax years beginning after 2017, the 2017 Tax Act limits the nonrecognition treatment provided under IRC Section 1031 to exchanges of real property that is not held primarily for sale.1 This provision applies to exchanges occurring after December 31, 2017. An exception exists if either (1) the property involved in the exchange was disposed of on or before December 31, 2017, or (2) the property received in the exchange was received on or before December 31, 2017.2 The new rules also provide that real property located within the U.S. and foreign real property are not of a like-kind.3

      In a like-kind exchange, a taxpayer exchanges property he holds as an investment or for productive use in a trade or business for other property of the same nature or character (but not necessarily of an equivalent grade or quality) that will be held either as an investment or for productive use in a trade or business. The property exchanged must be tangible; stocks, bonds, notes, other securities or evidences of indebtedness, and partnership interests were not eligible for like-kind exchange treatment prior to 2018. An exchange of properties that are of different kinds or classes is not a “like-kind” exchange.4

      A special rule applies to any partnership that has elected under IRC Section 761(a) to be excluded from the application of subchapter K. An interest in such a partnership generally is treated as an interest in each of the assets of the partnership, not as an interest in the partnership.5

      In order to qualify as a like-kind exchange, the transaction must also meet the following requirements: (1) the taxpayer must identify the real property to be received in the exchange within forty-five days after he transfers the real property he relinquishes in the exchange, and (2) he must receive the like-kind real property within 180 days after the date of his transfer or, if earlier, before the due date of his tax return for the tax year (including extensions).6 The Service has privately ruled that it is not authorized under IRC Section 6503(b) to suspend the 180-day replacement period under IRC Section 1031(a)(3) where a taxpayer’s assets are within court custody.7

      For the final regulations replacing the use of the Standard Industrial Classification (SIC) system with the North American Industry Classification System (NAIC) for determining what properties are of a like class for purposes of IRC Section 1031 prior to 2018, see Treasury Regulation Section 1.1031(a)-2; TD 9202.8

      Prior to 2018, the IRS had provided safe harbors for programs involving ongoing exchanges of tangible personal property using a single intermediary (i.e., “LKE programs” or “like-kind exchange programs”).9

      Even prior to 2018, according to the IRS, the like-kind standard was traditionally interpreted more narrowly in the case of exchanges of personal property as compared to exchanges of real property.10

      The Service has ruled that depreciable tangible personal properties were of a like class, even if they did not belong to the same general asset class.11 The Service has also ruled that transfers of relinquished leased vehicles, followed by the acquisition of replacement leased vehicles through a qualified intermediary, were deferred exchanges qualifying for nonrecognition of gain or loss under IRC Section 1031.12

      Prior to 2018, in technical advice, the Service ruled that the exchange of intangible property by a domestic entity for the intangible property of a foreign entity does not qualify as a like-kind exchange to the extent that the exchange is of property used predominantly within the United States for property used predominantly outside the United States. According to the Service—and contrary to the taxpayer’s argument—pre-2018 IRC Section 1031(h)(2)(A) clearly provided that personal property used predominantly within the United States and personal property used predominantly outside the United States are not property of like-kind. The statute did not make a distinction between tangible and intangible personal property. Post-2017, the 2017 Tax Act clearly states that real property located within the United States and real property located outside of the United States are not of like-kind.13

      Gain on an exchange of property that fails to qualify for nonrecognition treatment under the like-kind exchange rules may be reportable under the installment method.14 The Tax Court found that a transaction qualified as an installment sale and not a like-kind exchange where the payment for a transfer of real property was not received until the year after the property’s conveyance.15

      See Q 7840 for an explanation of regulations and safe harbors governing deferred exchanges, and for the procedures governing reverse exchanges.

      For the rules coordinating like-kind exchange tax treatment with the exclusion of gain on the sale of a personal residence, see Q 7846.


      1. IRC Sec. 1031(a)(1).

      2. IRC Sec. 1031(a)(2).

      3. IRC Sec. 1031(h).

      4. IRC Sec. 1031; Treas. Reg. §1.1031(a)-1.

      5. IRC Sec. 1031(a)(2).

      6. IRC Sec. 1031(a)(3).

      7. Let. Rul. 200211016.

      8. 70 Fed. Reg. 28818 (5-19-2005).

      9. See Rev. Proc. 2003-39, 2003-22 IRB 971.

      10. See, e.g., California Federal Life Insurance Co. v. Comm., 680 F.2d 85, 87 (9th Cir. 1982).

      11. Let. Rul. 200327029.

      12. Let. Ruls. 200241013, 200240049.

      13. See TAM 200602034.

      14. Treas. Reg. §1.1031(k)-1(j)(2).

      15Christensen v. Comm., TC Memo 1996-254.

  • 711. How is the tax treatment of a like-kind exchange altered if, in addition to like-kind property, the taxpayer also receives cash or nonlike-kind property in the exchange?

    • Editor’s Note: For tax years beginning after 2017, the 2017 Tax Act limits the nonrecognition treatment provided under IRC Section 1031 to exchanges of real property that is not held primarily for sale.1  This provision applies to exchanges occurring after December 31, 2017.  An exception exists if either (1) the property involved in the exchange was disposed of on or before December 31, 2017, or (2) the property received in the exchange was received on or before December 31, 2017.2 The new rules also provide that real property located within the U.S. and foreign real property are not of a like-kind.3

      Receipt of “boot.” If the taxpayer receives only like-kind property in the exchange, no taxable gain or loss is reported on his income tax return as a result of the exchange regardless of his tax basis in and value of the respective properties.4 However, if in addition to like-kind property, the taxpayer receives cash or other property that is different in kind or class from the property he transferred (i.e., nonlike-kind property is often referred to as “boot”), any gain he realizes in the exchange will be taxable to the extent of the sum of the amount of cash and the fair market value of the nonlike-kind property received; any loss realized in such an exchange may not be taken into account in calculating the taxpayer’s income tax.5

      If the taxpayer receives only like-kind property, but transfers cash or other nonlike-kind property as part of the exchange, regulations indicate that the nonrecognition rules apply to the like-kind properties, but not to the “boot.”6

      Recapture. In a like-kind exchange where boot is given or received, the recapture provisions applicable to certain depreciable property apply (see Q 716). If property for which an investment credit was taken is exchanged before the investment credit recapture period ends, a percentage will be recaptured (see Q 7894).7


      1. IRC Sec. 1031(a)(1).

      2. IRC Sec. 1031(a)(2).

      3. IRC Sec. 1031(h).

      4. IRC Sec. 1031(a).

      5. IRC Secs. 1031(b), 1031(c); Treas. Reg. §1.1031(b)-1.

      6. Treas. Reg. §§1.1031(a)-1(a)(2), 1.1031(d)-1(e). See Allegheny County Auto Mart, 12 TCM (CCH) 427, aff’d per curiam, 208 F.2d 693 (3rd Cir. 1953); W.H. Hartman Co. v. Comm., 20 BTA 302 (1930).

      7. IRC Sec. 50(a)(1).

  • 712. How is the tax treatment of a like-kind exchange altered if one or more parties assumes a liability of the other party or receives property subject to a liability in the exchange?

    • Editor’s Note: For tax years beginning after 2017, the 2017 Tax Act limits the nonrecognition treatment provided under IRC Section 1031 to exchanges of real property that is not held primarily for sale.1 This provision applies to exchanges occurring after December 31, 2017. An exception exists if either (1) the property involved in the exchange was disposed of on or before December 31, 2017, or (2) the property received in the exchange was received on or before December 31, 2017.2 The new rules also provide that real property located within the U.S. and foreign real property are not of a like-kind.3

      If, in an exchange, one party assumes a liability of the other party or receives property subject to a liability, he will be deemed to have transferred “boot” in an amount equal to the liability. The party who transfers the property subject to the liability or whose liability is assumed will be deemed to have received the “boot.” If each party to an exchange either assumes a liability of the other party or acquires property subject to a liability, the amounts of such liabilities will be offset and only the difference will be treated as “boot” given and received by the applicable parties.4 Generally, liabilities that qualify to offset or reduce any taxable boot received are those to which the property received was subject to prior to the exchange and that then are assumed as part of the exchange.5

      The Service ruled that if a partnership enters into an exchange that qualifies as a deferred like-kind exchange, in which property subject to a liability is transferred in one taxable year of the partnership, and property subject to a liability is received in the following taxable year of the partnership, the liabilities must be netted for purpose of IRC Section 752. Any net decrease in a partner’s share of partnership liability must be taken into account for purposes of IRC Section 752(b) in the first taxable year of the partnership, and any net increase in a partner’s share of partnership liability must be taken into account for purposes of IRC Section 752(a) in the second year of the partnership.6


      1. IRC Sec. 1031(a)(1).

      2. IRC Sec. 1031(a)(2).

      3. IRC Sec. 1031(h).

      4. Treas. Reg. §1.1031(d)-2. See Rev. Rul. 59-229, 1959-2 CB 180.

      5. See Treas. Reg. §1.1031(d)-2, Ex. 2.

      6. Rev. Rul. 2003-56, 2003-23 IRB 985.

  • 713. What is the tax basis of property received in a tax-free (or partially tax-free) like-kind exchange?

    • Editor’s Note: For tax years beginning after 2017, the 2017 Tax Act limits the nonrecognition treatment provided under IRC Section 1031 to exchanges of real property that is not held primarily for sale.1 This provision applies to exchanges occurring after December 31, 2017.  An exception exists if either (1) the property involved in the exchange was disposed of on or before December 31, 2017, or (2) the property received in the exchange was received on or before December 31, 2017.2 The new rules also provide that real property located within the U.S. and foreign real property are not of a like-kind.3

      The tax basis of like-kind property received in a tax-free (or partially tax-free) like-kind exchange is generally equal to the adjusted tax basis of the like-kind property given. There are, however, two exceptions. First, if an individual transfers cash or nonlike-kind property or assumes a liability of the other party to the exchange (i.e., the transferee) that exceeds the liabilities (if any) assumed by the transferee, the individual’s tax basis in the like-kind property received is equal to his adjusted tax basis in the property given increased by the sum of (1) the amount of cash and the fair market value of nonlike-kind property given and (2) the net liability assumed.

      Second, if liabilities assumed by the transferee exceed the liabilities (if any) assumed by the individual (transferor) and no other cash or boot is transferred by the individual, the individual’s tax basis in the like-kind property he receives is equal to his adjusted tax basis in the like-kind property given decreased by the net amount of liabilities assumed by the transferee.4

      The tax basis of any nonlike-kind property received in a like-kind exchange is the fair market value of the nonlike-kind property on the date of the exchange.5


      1. IRC Sec. 1031(a)(1).

      2. IRC Sec. 1031(a)(2).

      3. IRC Sec. 1031(h).

      4. IRC Sec. 1031(d), Treas. Reg. §1.1031(d)-2.

      5. Treas. Reg. §1.1031(d)-1(c).

  • 714. How is a like-kind exchange between related parties taxed?

    • Editor’s Note: For tax years beginning after 2017, the 2017 Tax Act limits the nonrecognition treatment provided under IRC Section 1031 to exchanges of real property that is not held primarily for sale.1 This provision applies to exchanges occurring after December 31, 2017. An exception exists if either (1) the property involved in the exchange was disposed of on or before December 31, 2017, or (2) the property received in the exchange was received on or before December 31, 2017.2 The new rules also provide that real property located within the U.S. and foreign real property are not of a like-kind.3

      If a like-kind exchange that results in nonrecognition of gain or loss occurs between related parties, followed by a disposition of either property within two years of the date of the last transfer that was part of the like-kind exchange, then the original transaction will not qualify for nonrecognition treatment.4 For purposes of this rule, the term “disposition” does not include dispositions resulting from the death of the taxpayer or (if earlier) the related person. The two-year disposition rule also will not apply to involuntary conversions, so long as the exchange occurred before the threat or imminence of the conversion. An exception is also provided where it can be established that neither the exchange nor the subsequent disposition had as its principal purpose the avoidance of income tax.5

      “Related persons,” for purposes of this rule, include the following: (1) members of the same family (i.e., brothers, sisters, spouses, ancestors and lineal descendants); (2) an individual and a corporation of which the individual actually or constructively owns more than 50 percent of the stock; (3) a grantor and a fiduciary of a trust; (4) fiduciaries of two trusts if the same person is the grantor of both; (5) a fiduciary and a beneficiary of the same trust; (6) a fiduciary of a trust and a beneficiary of another trust set up by the same grantor; (7) a fiduciary of a trust and a corporation of which the grantor of the trust actually or constructively owns more than 50 percent of the stock; (8) a person and an IRC Section 501 tax-exempt organization controlled by the person or members of his family (as described in (1) above); (9) a corporation and a partnership if the same person actually or constructively owns more than 50 percent of the stock of the corporation, and has more than a 50 percent interest in the partnership; (10) two S corporations if the same persons actually or constructively own more than 50 percent of the stock of each; (11) an S corporation and a C corporation, if the same persons actually or constructively own more than 50 percent of the stock of each; (12) a person and a partnership of which the person actually or constructively owns more than 50 percent of the capital interest or profits interest; (13) two partnerships if the same persons actually or constructively own more than 50 percent of the capital interest or profits interest of each; or (14) generally, an executor and a beneficiary of an estate.6

      Any transaction, or series of transactions, structured to avoid the related party rules for like-kind exchanges will not qualify for nonrecognition treatment.7 The Service has ruled that a taxpayer who transfers relinquished property to a qualified intermediary for replacement property formerly owned by a related party is not entitled to nonrecognition treatment under IRC Section 1031(a) if, as part of the transaction, the related party receives cash or other nonlike-kind property for the replacement property.8 If the risk of holding any property is substantially diminished by a short sale, by the holding of a put option, or by another person holding a right to acquire the property, then the running of the two-year period will be suspended during the period that the option or other right is held.9


      1. IRC Sec. 1031(a)(1).

      2. IRC Sec. 1031(a)(2).

      3. IRC Sec. 1031(h).

      4. IRC Sec. 1031(f)(1).

      5. IRC Sec. 1031(f)(2).

      6. IRC Secs. 1031(f)(3), 267(b), 707(b)(1).

      7. IRC Sec. 1031(f)(4).

      8. Rev. Rul. 2002-83, 2002-49 IRB 927.

      9. IRC Sec. 1031(g).