A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. If you receive property in a nontaxable exchange, its basis is generally the same as the basis of the property you exchanged. See Nontaxable Trades in chapter 15.

Like-Kind Exchanges

The exchange of property for the same kind of property is the most common type of nontaxable exchange. To be a like-kind exchange, the property traded and the property received must be both of the following.

1. Qualifying property.
2. Like property.

Qualifying property. In a like-kind exchange, you must hold for investment or for productive use in your trade or business both the property you give up and the property you receive.

Like property. There must be an exchange of like property. The exchange of real estate for real estate or personal property for similar personal property is an exchange of like property.

Example. You trade in an old truck used in your business, which has an adjusted basis of $1,700, for a new one costing $6,800. The dealer allows you $2,000 on the old truck, and you pay $4,800. This is a nontaxable exchange. The basis of the new truck is $6,500 (the adjusted basis of the old one, $1,700, plus the amount you paid, $4,800).

If you sell your old truck to a third party instead for $2,000 and then buy the new one from the dealer, you have a taxable gain of $300 on the sale ($2,000 sale price minus $1,700 basis). The basis of the new truck is the price you pay the dealer for it.

Partially nontaxable exchange. If, in addition to like property, you receive money or unlike property in a like-kind exchange in which you realize a gain, you have a partially nontaxable exchange. You are taxed on the gain you realize, but only to the extent of the money and the FMV of the unlike property you receive.

The basis of property you get is usually the same as the basis of the property you gave up, with the following adjustments.

1. Decrease your basis by the following items.
1. Any money you received in the exchange.
2. Any loss recognized on the exchange.
2. Increase your basis by the following items.
1. Additional costs for the exchange, such as brokerage commissions.
2. Any gain recognized on the exchange.

Allocate this basis first to the unlike property, other than money, up to its FMV on the date of the exchange. The rest is the basis of the like property.

More information. See Like-Kind Exchanges in chapter 1 of Publication 544, Sales and Other Dispositions of Assets, for more information.

Involuntary Conversions

If you receive property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, you can figure the basis of the replacement property you receive using the basis of the old property.

Similar or related property. If you receive property that is similar or related in service or use to the old property, the replacement property's basis is the same as the old property's basis on the date of the conversion. However, you must make certain adjustments as indicated next.

Decrease the basis by both of the following amounts.

• Any loss recognized on the conversion.
• Any money received that was not spent on similar property.

Increase the basis by both of the following amounts.

• Any gain recognized on the conversion.
• Any cost of acquiring replacement property.

Property that is not similar or related. If you receive money or property that is not similar or related in service or use to the old property and you buy replacement property that is similar or related in service or use to the old property, the basis of the replacement property is its cost decreased by the gain not recognized on the conversion.

Example. The state condemned your property. The adjusted basis of the property was $26,000, and the state paid you $31,000 for it. You realized a gain of $5,000 ($31,000 - $26,000). You bought replacement property that is similar in use to the old property for $29,000. You recognize a gain of $2,000 ($31,000 - $29,000), the unspent part of the payment from the state. Your gain not recognized is $3,000, the difference between the $5,000 realized gain and the $2,000 recognized gain. You figure the basis of the replacement property as follows:

Cost of replacement property               $29,000

Minus: Gain not recognized                      3,000

Basis of replacement property              $26,000

Allocating the basis. If you buy more than one piece of replacement property, allocate your basis among the properties based on their respective costs.

Transfer of Property Between Spouses

The basis of property your spouse transferred to you or transferred in trust for your benefit is the same as your spouse's adjusted basis. The same rule applies to a transfer by your former spouse that is incident to divorce. However, adjust your basis for any gain recognized by your spouse on a property transferred in trust. This rule applies only to a transfer of property in trust in which the liabilities assumed plus the liabilities to which the property is subject are more than the adjusted basis of the property transferred.

If the property transferred is a series E or EE United States savings bond, your spouse must include in income the interest accrued to the date of transfer. Your basis in the bond immediately after the transfer is equal to your spouse's basis plus the interest income includible in his or her income.

Your spouse must give you the records needed to determine the adjusted basis and holding period of the property as of the date of the transfer.

For more information about the transfer of property between spouses, see chapter 15.

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