44.5 Involuntary Conversions and Tax-Free Exchanges

Involuntary conversions.

Gain may be taxed as ordinary income in either of the following two cases: (1) you do not buy qualified replacement property or (2) you buy a qualified replacement, but the cost of the replacement is less than the amount realized on the conversion (18.23). The amount taxable as ordinary income may not exceed the amount of gain that is normally taxed under involuntary conversion rules when the replacement cost is less than the amount realized on the conversion. Also, the amount of ordinary income is increased by the value of any nondepreciable property that is bought as qualified replacement property, such as the purchase of 80% or more of stock in a company that owns property similar to the converted property.

Distributions by a partnership to a partner.

A distribution of depreciable property by a partnership to a partner does not result in ordinary income to the distributee at the time of the distribution. But the partner assumes the ordinary income potential of the depreciation deduction taken by the partnership on the property. When he or she later disposes of the property, ordinary income may be realized.

Caution

Tax–Free Exchanges

Ordinary income generally is not realized on a tax-free exchange or trade-in of the same type of property (unless some gain is taxed because the exchange is accompanied by “boot” (6.3) such as money). The ordinary income potential is assumed in the basis of the new property. However, where depreciable realty acquired before 1987 is exchanged for land, the amount of any depreciation recapture is immediately taxable in the year of the exchange.

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