²³Rev. Proc. 2005-14, IRB 2005-7, 528, Section 4.

²⁴This rule is not a concession by the IRS. The contrary rule (no increase in replacement propertys basis by the excluded gain) would, in this context, transmute the Sec. 121 exclusion into a mere deferral.

²⁵The three-year window applies, because A owned and used the house as her principal residence for at least the 24-month period immediately before moving in with her fianc.

²⁶Under Regs. Sec. 1.168(i)-4(b)(1), on a conversion of personal-use property to business or income-producing property, depreciation is determined as though the property were placed in service on the conversion date. The depreciable basis immediately after the conversion is the lesser of its fair market value (FMV) or its adjusted depreciable basis at that time.

²⁷Sec. 121 does not require the property to be the taxpayers principal residence on the sale or exchange date.

²⁸According to Regs. Sec. 1.1031(j)-1(a)(1), [a]n exchange is a multiple-property exchange if (1) more than one exchange group is created, or (2) one exchange group is created, but there is more than one property being received or transferred within that exchange group.

²⁹See Regs. Sec. 1.1031(j)-1(b)(3)(i).

³⁰See Regs. Sec. 1.1031(j)-1(b)(2)(iii).

³¹Compare Sec. 121(d)(5). Rev. Proc. 2005-14, note 23 supra, models the Sec. 121/1031 relationship after the Sec. 121/1033 relationship in Sec. 121(d)(5). In the Sec. 121/1031 context, reduction of the amount realized by the Sec. 121 excluded gain is equivalent to Principles 4 (boot in excess of excluded gain) and 5 (excluded gain included in basis); see Example 5 of this article, infra.

³²See Regs. Sec. 1.1031(j)-1(b)(3)(i).

³³This could be accomplished, for example, by allowing her niece use of the house rent-free. A must be careful to satisfy the Sec. 121 two-of-five-year use test at the time of the exchange (the ownership test is clearly satisfied).

³⁴The relinquished house is a Sec. 1231 asset (rental real estate); the potentially taxable gain from its disposition is Sec. 1231 gain. It is assumed that such gain will be treated as long-term capital gain.

³⁵A, of course, must meet the other conditions of Sec. 121 to obtain the exclusion on a subsequent sale.

³⁶As the potential Sec. 1031 deferral becomes greater, the riskiness of this Sec. 121(d)(10) avoidance strategy increases. In particular, A must ensure that (1) she and her fianc will break up; (2) she will convert the property to her principal residence; (3) she will sell the property before July 1, 2011; (4) she will meet the Sec. 121 two-of-five-year use test (as well as the ownership test) before the sale; and (5) the present value of the tax benefit of the Sec. 121 exclusion on the sale exceeds the lost tax benefit of the earlier failed Sec. 1031 transaction.

³⁷See, e.g., Bayard Sharp, 199 FSupp 743 (DC DE 1961), affd, 303 F2d 783 (3d Cir. 1962); and Rev. Rul. 72-111, 1972-1 CB 56.

³⁸Because $120,000 of proceeds were allocated to the relinquished office.

³⁹See Regs. Sec. 1.1031(j)-1(b)(3)(i).

⁴⁰See Regs. Sec. 1.1031(j)-1(b)(2)(iii).

⁴¹This is (($30,000 FMV $140,000 basis of relinquished residence)/$240,000 proceeds allocated to the relinquished residence); see Regs. Sec. 1.1031(j)-1(d), Example 5.

⁴²See Regs. Sec. 1.121-1(e)(1) and (4), Examples (5) and (6); and Rev. Proc. 2005-14, note 23 supra, Section 5, Examples (3)(6). Note: Sec. 121 is applied first to exclude realized gain on the relinquished residence and then on the relinquished office.

⁴³See Regs. Sec. 1.1031(j)-1(b)(3)(i).

⁴⁴See note 31, supra.

⁴⁵See Regs. Sec. 1.121-1(e)(1) and (4), Examples (1)(3); and Rev. Proc. 2005-14, note 23 supra, Section 5, Example (2).

⁴⁶It is assumed that the Sec. 1231 gain will be treated as long-term capital gain.