IRS Revenue Ruling 79-44 (Rev. Rul. 79-44)
Internal Revenue Service (I.R.S.)
Revenue Ruling (Rev. Rul.)
Published: 1979
EXCHANGE OF JOINTLY OWNED FARM PROPERTIES; ONE SUBJECT TO MORTGAGE
26 CFR 1.1031(d)-2: Treatment of assumption of liabilities.
Exchange of jointly owned farm properties; one subject to mortgage. Two unrelated farmers transferred their undivided one-half interests in two jointly owned parcels of farmland, only one of which was subject to a mortgage, to each other so that each farmer became the sole owner of one parcel and continued to use that parcel as farmland. The farmer receiving the unmortgaged parcel gave the other a promissory note in the amount of one-half the mortgage on the other parcel. The transfer is an exchange under section 1001(a) of the Code. Gain on the exchange is recognized only to the farmer receiving the note and only to the extent of the fair market value of such note.
ISSUES
Is the transfer of interests in real property held by tenants in common that results in the conversion of two jointly owned parcels into two individually owned parcels a nontaxable partition or an exchange under section 1001(a) of the Internal Revenue Code of 1954?
If the transfer is an exchange, does it qualify for treatment as a like-kind exchange under section 1031 of the Code?
FACTS
Two unrelated individuals, A and B, neither of whom are dealers in real estate, respectively owned undivided one-half interests in two separate parcels of land as tenants in common. Both parcels were used in the taxpayers' business of farming. One parcel was subject to a mortgage for which A and B were each personally liable in the face amount of 1,000x dollars.
A and B rearranged their interests so that each owned 100 percent of a separate parcel. At the time of the transaction, each parcel had a fair market value of 2,000x dollars and an adjusted basis of 100x dollars. A received the parcel subject to the mortgage and B received the remaining parcel, which was free of debt. B also executed a promissory note to A in the amount of, and with a fair market value of, 500x dollars to compensate A for taking the property subject to the mortgage. A and B continued to use the parcels in their respective businesses of farming.
LAW AND ANALYSIS
Section 1001(a) of the Code provides that gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis in section 1011 for determining gain.
Section 1001(c) of the Code provides that the entire amount of the gain shall be recognized unless an exception provided in subtitle A of the Code applies.
Section 1031(a) of the Code provides that no gain shall be recognized if property held for productive use in trade or business or for investment is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.
Section 1031(b) of the Code provides that if other property (in addition to property permitted to be received without recognition of gain) or money is received in an exchange, any gain shall be recognized in an amount not in excess of the sum of money and the fair market value of the other property.
Section 1.1031(d)-2 of the Income Tax Regulations provides that the amount of any liabilities of a taxpayer assumed by the other party to an exchange is treated as money received by the taxpayer upon the exchange. Example (2)(c) of this regulation illustrates that the amount of a taxpayer's liabilities assumed by the other party to an exchange is offset by the amount of money paid by the taxpayer and the amount of the other party's liabilities assumed by the taxpayer as a result of the exchange. However, the amount of cash or other property received by a taxpayer in an exchange is not offset by the taxpayer's assumption of the liabilities of the other party in the exchange.
Rev. Rul. 73-476, 1973-2 C.B. 300, holds that any gain or loss realized by three taxpayers who each exchanged an undivided interest in three separate parcels of real estate that were not subject to mortgages for a 100 percent ownership of one parcel is not recognized pursuant to section 1031(a) of the Code.
In this case, the transfer of interests in real property held by tenants in common that resulted in the conversion of two jointly owned parcels into two individually owned parcels is an exchange. The provisions of section 1001(a) of the Code apply to the exchange for purposes of determining the amount of gain realized. However, because the property interests exchanged are like-kind property that were being used in the taxpayers' business of farming and have continued to be so used after the exchange, the provisions of section 1031 apply to determine to what extent, if any, the gain is to be recognized.
As a result of the exchange, A owns 100 percent of one parcel of real estate, with a fair market value of 2,000x dollars and subject to a mortgage of 1,000x dollars. The value of the one-half interest received by A was 1,000x dollars, one-half of the fair market value of the real estate. The value of the mortgage liability assumed by A as a result of the exchange was 500x dollars. A also received a note from B for 500x dollars. The note received by A is other property for purposes of section 1031(b) of the Code. A realized a gain of 950x dollars computed as follows:
Value of property received .................................... 1,000x dollars
Other property received (note) .................................. 500x
------
Total consideration received .................................. 1,500x
Less: Adjusted basis of property transferred (one-half
of 100x dollars) ....................................... 50x
Liabilities to which new property is subject ............ 500x 550x ------
Gain realized ................................................... 950x dollars
For purposes of section 1031(b) of the Code the amount of 'other property or money' received by A is 500x dollars. Consideration received by A in the form of money or other property is not offset by consideration given in the form of an assumption of liabilities or receipt of property subject to a liability. Accordingly, under section 1031(b), 500x dollars of the 950x dollar gain will be recognized. See section 1.1031(d)-2 of the regulations.
B received 100 percent ownership of the parcel of real estate that was not subject to a mortgage. The value of the one-half interest received by B is 1,000x dollars, one-half of the fair market value of the real estate. B realized a gain of 950x dollars computed as follows:
Value of property received .................................... 1,000x dollars
Liabilities subject to which old property was
transferred ................................................... 500x
------
Total consideration received .................................. 1,500x
Less: Adjusted basis of property transferred (one-half
of 100x dollars) ....................................... 50x
Other property paid (note) .............................. 500x
---- 550x
------
Gain realized ................................................... 950x dollars
For purposes of section 1031(b) of the Code, the amount of 'other property or money' received by B is zero. Consideration received by B in the form of a transfer subject to a liability of 500x dollars is offset by consideration given in the form of other property. Accordingly, under section 1031 (b), B will not recognize any of the gain to be realized from the exchange. See section 1.1031(d)-2 of the regulations.
HOLDING
The transfer of interests in real property held by tenants in common that resulted in the conversion of two jointly owned parcels into two individually owned parcels is an exchange under section 1001(a) of the Code.
Because the property interests that were exchanged are like-kind property that were being used in the taxpayers' business of farming and have continued to be so used after the exchange, the provisions of section 1031 of the Code apply. Under section 1031, A will recognize the gain realized from the exchange, but not in excess of the fair market value of the note received from B. B will not recognize any of the gain realized from the exchange.
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