Property Transactions

Understanding the tax consequences of buying, selling, and exchanging property is fundamental to tax planning. This section covers basis calculations, gain recognition rules, and several important nonrecognition provisions that allow taxpayers to defer or exclude gains.

Cost Basis: The Starting Point

Cost basis is the foundation for calculating gain or loss on the sale of property. It represents your investment in the property for tax purposes.

Components of Cost Basis

Example: Ruby buys equipment for $61,000, pays $5,000 freight, 6% sales tax ($3,660), and $8,000 installation. Her cost basis is $61,000 + $5,000 + $3,660 + $8,000 = $77,660.

Mortgage Treatment

When property is acquired subject to a mortgage, the full purchase price (including the mortgage amount) is included in cost basis, not just the down payment.

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Adjusted Basis: Tracking Changes Over Time

Adjusted basis is cost basis modified for certain events during ownership:

Increases to Basis (Add)

Decreases to Basis (Subtract)

Formula: Adjusted Basis = Cost Basis + Capital Improvements - Depreciation - Casualty Losses

CFP Exam Tip: Depreciation reduces basis whether or not the taxpayer actually claimed it. Use "allowed or allowable" depreciation.

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Section 1031: Like-Kind Exchanges

Section 1031 allows taxpayers to defer recognition of gain when exchanging real property held for productive use in trade or business or for investment.

Key Requirements (2025-2026)

Critical Deadlines

Important: These deadlines are strict and cannot be extended, even if they fall on weekends or holidays. The 180-day period runs concurrently with the 45-day period (not 45 + 180 days).

Property Identification Rules

When identifying replacement properties, taxpayers may use ONE of these rules:

Boot and Gain Recognition

Boot is any non-like-kind property received in the exchange (cash, debt relief, other property). Gain is recognized to the extent of boot received.

Formula: Recognized Gain = Lesser of (Realized Gain) or (Boot Received)

Basis of Replacement Property

New Basis = FMV of new property - Deferred gain

Or alternatively: New Basis = Adjusted basis of old property + Boot paid - Boot received + Gain recognized

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Section 1033: Involuntary Conversions

Section 1033 allows deferral of gain when property is involuntarily converted due to destruction, theft, seizure, condemnation, or threat of condemnation.

Replacement Period

Key Features

• No qualified intermediary required - taxpayer can hold proceeds directly
• Similar or related in use - replacement property must be similar (stricter than like-kind)
• Condemnation exception - like-kind standard applies for condemned real property
• Extensions available - IRS may grant extensions upon request

Gain Recognition

Gain is recognized only to the extent that the amount realized exceeds the cost of replacement property. If you reinvest the full amount received, no gain is recognized.

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Section 1035: Insurance Contract Exchanges

Section 1035 permits tax-free exchanges of certain insurance products without triggering gain recognition.

Permitted Exchanges

Memory Tip: You can exchange "down" the list (life to annuity) but not "up" (annuity to life). Life insurance has the most favorable tax treatment, so you cannot exchange into it from products with less favorable treatment.

Requirements

• Direct transfer between insurance companies
• Same owner and insured on both contracts
• No constructive receipt of funds
• Partial exchanges allowed for annuities, not life insurance

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Installment Sales

Installment sales allow taxpayers to spread gain recognition over the payment period when they receive at least one payment after the year of sale.

Gross Profit Percentage

The key calculation is the Gross Profit Percentage (GPP):

GPP = Gross Profit / Contract Price

Where:

• Gross Profit = Selling Price - Adjusted Basis - Selling Expenses
• Contract Price = Selling Price - Debt Assumed (but not below GPP)

Annual Gain Recognition

Each year: Taxable Gain = Principal Payment Received x GPP

Example: You sell property with an adjusted basis of $60,000 for $100,000.

• Gross Profit = $100,000 - $60,000 = $40,000
• Contract Price = $100,000
• GPP = $40,000 / $100,000 = 40%
• If you receive $25,000 principal in Year 1: Taxable gain = $25,000 x 40% = $10,000

Interest Charge on Deferred Tax (IRC 453A)

For large installment sales (sales price > $150,000 AND year-end installment obligations > $5 million), an interest charge applies to the deferred tax liability:

The interest charge partially offsets the time-value benefit of deferring taxes through installment sales.

Reporting

• File Form 6252 each year payments are received
• Report interest income separately on Schedule B
• Continue filing Form 6252 even in years with no principal payments (interest-only years)