Question

Your supervisor has asked you to research the following situation concerning Owen and Lisa Cordoncillo. Owen and Lisa are brother and sister. In May 2014, Owen and Lisa exchange business pickup trucks. Lisa gives up a blue pickup truck with an adjusted basis of $2,000 and a fair market value of $6,000. In return for this property, Lisa receives from Owen a red pickup truck with a fair market value of $5,500 and cash of $500. Owen’s adjusted basis in the truck he exchanges is $2,500. In March 2015, Owen sells the blue pickup truck to a third party for $5,800. Required: Go to the IRS website (www.irs.gov). Locate and review Publication 544, Chapter 1, Non taxable Exchanges. Write a file memorandum stating the amount of Owen and Lisa’s gain recognition for 2014. Also determine the effect, if any, of the subsequent sale in 2015. (An example of a file memorandum is available at the website for this text located at www.cengagebrain.com.)

Answer 1

ANSWER:

Research Solution:

Whitten-burg, Altus-Buller, and Gill CPAs San Diego, CA April 13,20xx

Relevant Facts

Owen and Lisa Cordoncillo exchanged business pickup trucks in May 2014. Owen and Lisa are brother and sister. Lisa gave a blue pickup truck with an adjusted basis of $2,000 and a fair market value of $6,000 in exchange for a red pickup tmck from Owen. Owen’s red pickup truck at the time of the exchange had a fair market value of $5,500 and an adjusted basis of $2,500. In addition, Owen gave Lisa $500 cash. The following March, Owen sold the blue pickup truck to a third party for $5,800.

Specific Issues

What are the amounts of Owen and Lisa’s gain recognition for 2014? What are the effects, if any, of the sale in 2015?

Conclusions

In 2014, Owen will have a $3,000 gain realized on the exchange of which $0 will be recognized. Lisa will have a $4,000 gain realized of which $500, the amount received in cash, will be recognized.

The sale in 2015 causes disqualification from non-recognition treatment. Owen will be required to recog­nize the $3,000 gain deferred from 2014 and Lisa will recognize the remaining gain of $3,500. In addition, Owen will have to report any additional gain or loss from the sale of the truck.

Support

Exchanges of like-kind property, such as the exchange of business trucks, generally qualify as a non-taxable exchange. The parties involved would recognize gain in an amount equal to the lesser of (1) the gain real­ized or (2) the “boot” received. In 2014, Owen would have a $3,000 gain realized ($6,000 - $500 - $2,500) and $0 “boot” received. His gain recognition in 2014 would therefore be $0. Lisa would have a $4,000 gain realized ($5,500 + $500 - $2,000) and $500 “boot” received. Her 2014 gain recognition would be $500, the amount of the “boot” received.

According to IRS Publication 544, special rules apply when related parties are involved. In this case, since Owen and Lisa are brother and sister, they are considered to be a related party. Like-kind exchanges between related parties can be disqualified if, within 2 years after the exchange, either party disposes of the exchanged property. This disqualification can cause gain recognition of the previously deferred amount.

In 2015, when Owen sells the truck, he causes automatic disqualification of the like-kind exchange for both Lisa and himself. Owen will be required to recognize immediately the amount of gain deferred in 2014, $3,000. Lisa will also have to recognize the 2014 gain deferred of $3,500 ($4,000 - $500).

In addition, Owen will be required to recognize any additional gain or loss from the sale of the truck in 2015.

Actions to Be Taken

Review results with client.

Preparer: Trevor Malcolm Reviewer: Martha Altus-Buller