Internal Revenue Service (IRS)
Revenue Ruling (Rev. Rul.)
26 USC § 1031
26 CFR § 1.1031(a)-1
(Also § 1016, 1031, 1034, 1231; 1.1016-5, 1.1031(d)-2, 1.1034-1, 1-1231- 1.)
Exchange of Property Held For Productive Use or Investment
An exchange of unencumbered farm lands, farm buildings, and unharvested crops for ‘like property’ constitutes a nontaxable exchange within the meaning of section 1031(a) of the Internal Revenue Code of 1954.
Where an exchange of farm properties involves a reciprocal assumption of mortgages, any gain resulting from the exchange of mortgages is subject to the tax treatment under the provisions of section 1231 of the Code.
An exchange of personal residences along with farm lands, buildings, and crops is treated as a separate exchange governed by the applicable provisions of section 1034 of the Code.
Advice has been requested as to the treatment, for Federal income tax purposes, of an exchange of farm properties under the circumstances described below.
The taxpayers, during the taxable year, entered into a transaction in which they mutually exchanged their respective farm properties consisting of farm lands, farm buildings, residences, all held for more than six months, and unharvested crops. The lands, buildings, and residences on both properties involved were burdened with substantial mortgages which were reciprocally assumed by the parties to the exchange.
For Federal income tax purposes, such an exchange raises three distinct problems: (1) the treatment of the exchange of the farm with an unharvested crop thereon for similar property; (2) the treatment of the exchange with respect to the reciprocal assumption of mortgages on the respective properties; and (3) the treatment to be accorded the exchange of the residences with the assumption of mortgages thereon.
Section 1031(a) of the Internal Revenue Code of 1954 provides, in part, as follows:
(a) Nonrecognition of Gain or Loss From Exchanges Solely in Kind
No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, * * *) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.
Section 1231(b) of the Code, which provides the special rules for determination of capital gains and losses from the sale or exchange of property used in a trade or business, provides, in part, as follows:
(4) Unharvested Crop
In the case of an unharvested crop on land used in the trade or business and held for more than 6 months, if the crop and the land are sold or exchanged (or compulsorily or involuntarily converted) at the same time and to the same person, the crop shall be considered as ‘property used in the trade or business’.
Inasmuch as section 1231(b)(4) of the Code provides that unharvested crops sold or exchanged with land are considered property used in trade or business, the parenthetical exclusion of section 1031(a) of the Code (stock in trade or other property held primarily for sale) does not apply. The basis of the unharvested crops, in the hands of the vendor or transferor, is adjusted according to section 1016(a)(11) of the Code for production expenses disallowed as a deduction under section 268 of the Code. Thus, where unencumbered farm lands, farm buildings, and unharvested crops are exchanged for ‘like property,’ no gain or loss is recognized from the transaction. The bases of the properties acquired in the hands of each transferee are the same as the bases to them of the properties which each transferred, as provided in section 1031(d) of the Code.
The second problem, in an exchange of the type under consideration, is the effect of the reciprocal assumption of mortgages.
Section 1031(b) of the Code provides, in part, that if an exchange would be within the provisions of section 1031(a) of the Code except for the fact that the property received in exchange consisted not only of property permitted to be received without recognition of gain, but also of other property or money, then the gain to the recipient is recognized in an amount not exceeding the sum of the money received or the fair market value of the other property.
In Walter F. Haass et al. v. Commissioner, 37 B.T.A. 948, the United States Board of Tax Appeals held that where a taxpayer exchanges mortgaged real estate for other real estate, in an otherwise tax-free ‘like kind’ exchange, the amount of the mortgage of which he is relieved is treated as the equivalent of ‘other property or money.’ See also Brons Hotel Inc. v. Commissioner, 34 B.T.A. 376. This holding is incorporated in section 1031(d) of the Code which provides in part, that where, as part of the consideration to the taxpayer, the other party to the exchange assumes a liability of the taxpayer, such assumption (in the amount of the liability) shall be considered as money received by the taxpayer on the exchange. However, it is a long established rule that the Internal Revenue Service will permit a balancing of liabilities when mortgaged property is exchanged for mortgaged property and each party to the exchange assumes the mortgage of the other party. See G.C.M. 2641, C.B. VI-2, 16 (1927). Therefore, in the instant case, should the mortgages reciprocally assumed not cancel each other, any gain resulting from such assumption is treated as a gain on the sale or exchange of a capital asset under section 1231 and taxed accordingly. However, a loss resulting from such a transaction is not recognized under section 1031(c) of the Code. The bases of the respective properties exchanged are determined according to the rules provided in section 1.1031(d)-2 of the Income Tax Regulations, example (2).
The final consideration, in an exchange of the instant type, is the tax treatment of residences (with mortgages thereon) which are exchanged with the farm properties. If these residences were occupied by tenants acting, for example, in the capacity of caretakers or farm workers for the taxpayers, such exchange would be treated under section 1031(a) of the Code as ‘property used in trade or business’ in the same manner as the exchange of the farm lands and buildings. However, where the dwellings are used as personal residences by the taxpayers who are parties to the exchange, an exchange thereof is treated as a separate transaction. Any resulting gain is subject to the provisions of section 1034, pertaining to the sale or exchange of a residence. Any loss on the exchange of a personal residence is recognized under section 1002 of the Code, but is not deductible in computing net income, as provided in section 262 of the Code. In such case, the basis of the residence received upon the exchange is its fair market value on the date of the exchange.
Accordingly, it is held that an exchange of unencumbered farm lands, farm buildings and unharvested crops for ‘like property’ constitutes a nontaxable exchange within the meaning of section 1031(a) of the Code.
Where an exchange of farm properties involves a reciprocal assumption of mortgages, any gain resulting from the exchange of mortgages is subject to the tax treatment under the provisions of section 1231 of the Code. Any loss in such an exchange is not recognized under section 1031(c) of the Code.
An exchange of personal residences along with farm lands, buildings, and crops is treated as a separate exchange governed by the applicable provisions of section 1034 of the Code for gain, and by section 262 of the Code for loss.