¹ Sec. 121(d)(10) reads: “If a taxpayer acquired property in an exchange to which section 1031 applied, subsection (a) shall not apply to the sale or exchange of such property if it occurs during the 5-year period beginning with the date of the acquisition of such property.” A different version of Sec. 121(d)(10) relates to property acquired from a decedent after 2009. Section 2(ee) of the Tax Technical Corrections Act of 2005, H 3376 and S 1447, 109th Cong., 1st Sess. (7/21/05), would renumber the latter provision as 121(d)(11). The technical correction would clarify Sec. 121(d)(10) in two ways. First, Sec. 121 denial would require some gain deferral in the Sec. 1031 exchange. Second, Sec. 121 denial would also apply to a person whose basis in the residence is carried over from the taxpayer who engaged in the Sec. 1031 exchange.

² Rev. Proc. 2005-14, IRB 2005-7, 528.

³ See Sec. 121(a) and (b)(1). For a more complete discussion of the implications of Sec. 121 and its regulations, see Dilley, “Tax Planning for the Sale of a Principal Residence,” Part I, 35 The Tax Adviser 30 (January 2004) and Part II, 35 The Tax Adviser 90 (February 2004).

⁴ See Sec. 121(b).

⁵ For this purpose, a “dwelling unit” includes a house, apartment, condominium, mobile home, boat or similar property, which provides basic living accommodations, such as sleeping space, a toilet and cooking facilities; see Regs. Sec. 1.121-1(e)(2), which cross-references Sec. 280A(f)(1), and Prop. Regs. Sec. 1.280A-1(c).

⁶ However, when  Sec. 1031 also applies, an allocation of basis and proceeds is needed; see Rev. Proc. 2005-14, note 2 supra, Section 5, Examples 3–6; see also Example 3 in Part II of this article in the December 2005 issue.

⁷ See Sec. 121(d)(6) and Regs. Sec. 1.121-1(d). If some of the gain is taxable, the entire transaction is reported on Form 4797, Sales of Business Property (Also Involuntary Conversions and Recapture Amounts Under Sections 179 and 280F(b)(2)), Part III, Gain From Disposition of Property Under Sections 1245, 1250, 1252, 1254, and 1255. The gain is carried to Form 4797, Part I; the excluded portion of the gain is shown as a loss, to reduce the gain to the taxable portion. Taxable gain to the extent of prior depreciation is unrecaptured Sec. 1250 gain, which is generally taxed at a 25% maximum rate if a taxpayer has positive net capital gain for the tax year; see Sec. 1(h)(1) and the instructions to 2004 Form 4797, p. 2.

⁸ This is a conversion of business-use property to personal-use property. Of course, no depreciation is allowable after this conversion. As will be discussed in Part II of this article, conversion from personal- to business-use property is also possible. In those circumstances, the property’s depreciable basis is the lower of its fair market value (FMV) or adjusted basis at the conversion date.

⁹ See Regs. Sec. 1.121-1(d)(2) and (e)(1). If no depreciation was deductible because of the Sec. 280A(c)(5) limit on home office deductions, then none of the gain in Example 1 is taxable.

¹⁰ The property is a Sec. 1231 asset, because it was either rented or used in the taxpayer’s business. The portion of the sale allocable to the Sec. 1231 asset is reported on Form 4797. The portion allocable to the personal-use residence is not reported on the return if all the personal-use gain is excluded under Sec. 121.

¹¹ See Regs. Sec. 1.121-1(d)(1) and (e)(1).

¹² See, e.g., Regs. Sec. 1.1031(a)-1(b) and Kate J. Crichton, 122 F2d 181 (5th Cir. 1941). Sec. 1031(h)(1) provides, however, that real property located in the U.S. is not of like-kind to real property located in another country.

¹³ Although Sec. 1031(f) also applies to a deferred loss, the taxpayer generally would not be able to deduct such loss; see Sec. 267(a)(1).

¹⁴ See Regs. Sec. 1.1031(k)-1 (deferred exchange); and Rev. Proc. 2000-37, 2000-2 CB 308, modified by Rev. Proc. 2004-51, IRB 2004-33, 294 (reverse deferred exchange).

¹⁵ If the taxpayer’s intent at the time of the transaction is not to use the replacement property in a trade or business or for investment, then the transaction is not a qualifying like-kind exchange. Thus, a rental building exchanged for a building that the taxpayer intends to use as his or her personal residence does not qualify as a like-kind exchange; compare Dollie Click, 78 TC 225 (1982), with Fred S. Wagensen, 74 TC 653 (1980).

¹⁶ Example 3 would be unchanged by the Tax Technical Corrections Act of 2005, note 1 supra, because P deferred gain in the Sec. 1031 exchange.

¹⁷ The Sec. 121(d)(10) five-year period begins with the property acquisition date in a Sec. 1031 transaction (here, Feb. 18, 2005). Thus, the five-year period ends on Feb. 17, 2010, making Feb. 18, 2010 the first day to sell the condominium without triggering Sec. 121(d)(10).

¹⁸ The Sec. 121(d)(10) five-year period begins with the property’s acquisition date in a Sec. 1031 transaction. Thus, for property acquired on Oct. 24, 1999, the last day of the “bad” five-year period was Oct. 23, 2004, the first day that Sec. 121(d)(10) applied.

¹⁹ See Click, note 15 supra.

²⁰ See Sec. 121(d)(5) and Regs. Sec. 1.121-4(d).

²¹ See Sec. 1033(a)(2)(A) and (B)(i).

²² See Regs. Sec. 1.121-4(d)(4) for a similar example.