This section provides a foundational overview of how gains and losses on property dispositions are treated for tax purposes. The core principle is the distinction between a "realized" gain, which occurs when you sell an asset, and a "recognized" gain, which is the portion of the realized gain that is actually taxable in the current year. Several special provisions in the tax code allow taxpayers to either permanently exclude or temporarily defer the recognition of a realized gain.
Calculation of Realized Gain or Loss
Generally, the gain or loss realized on a sale is the difference between the amount you receive and your adjusted basis in the property.
Unless a specific exclusion or deferral provision applies, the entire realized gain is recognized and taxable.
Homeowner's Exclusion
This provision allows taxpayers to exclude a significant portion of the gain from the sale of their principal residence. This section explains the exclusion amounts, qualification rules, and how to handle special situations like the hardship provision. Note that losses on the sale of a personal residence are not deductible.
Exclusion Amounts
$500,000
For married couples filing jointly.
$250,000
For single, MFS, and Head of Household filers.
Qualification Rules
Ownership Test: Must have owned the home for at least 2 of the past 5 years.
Use Test: Must have used the home as a principal residence for at least 2 of the past 5 years.
The two years do not need to be continuous.
The exclusion can generally be used only once every two years.
Hardship Provision Calculator
If you sell your home due to a change in employment, health, or other unforeseen circumstance but don't meet the 2-year rule, you may qualify for a reduced exclusion. Use this calculator to estimate it.
Your reduced exclusion is
Involuntary Conversions
An involuntary conversion occurs when your property is destroyed, stolen, or condemned. This section explains how you can defer recognizing a gain by reinvesting the proceeds into similar property, preventing undue hardship from an event outside your control.
Gain Recognition Rules
The key to deferral is what you do with the insurance or condemnation proceeds you receive.
If you reinvest the entire amount into similar property, no gain is recognized. The gain is deferred.
If you do not reinvest the full amount, you must recognize gain equal to the lesser of the realized gain or the proceeds not reinvested (the "boot").
Reinvestment Period
General Rule: 2 years from the end of the tax year the gain was realized.
Condemned Business/Investment Real Property: 3 years.
Federally Declared Disaster (Principal Residence): 4 years.
Like-Kind Exchanges (Section 1031)
A like-kind exchange is a powerful tax-deferral strategy for investors and business owners, allowing them to swap one investment property for another without triggering immediate capital gains tax. This section explores how these exchanges work, especially when "boot" (non-like-kind property, such as cash or debt relief) is involved. This only applies to real property.
Scenario Explorer
Select a scenario to see how the realized gain, recognized gain, and deferred gain change based on the transaction details.
Installment Sales
The installment method allows you to defer tax by recognizing gain over several years as you receive payments from the buyer, rather than all at once in the year of sale. This is available for sales of property where at least one payment is received after the tax year of the sale. This section includes a calculator to demonstrate the process.
Installment Gain Calculator
Gross Profit Percentage:
Gain Recognized This Year:
Divorce Property Settlements
The transfer of property between spouses as part of a divorce or separation agreement is generally a nontaxable event. This provision simplifies the division of assets by avoiding immediate tax consequences for either party.
Key Rules
Nontaxable Event: No gain or loss is recognized by the transferring spouse.
Carryover Basis: The recipient spouse's basis in the property is the same as the transferor's adjusted basis. The gain is deferred until the recipient eventually sells the property.
Carryover Holding Period: The recipient also inherits the transferor's holding period for the property.
Treasury and Capital Stock Transactions
This section covers the tax treatment of a corporation's transactions involving its own stock. These are generally treated as capital transactions, not as events that generate taxable income or deductible losses.
Key Rule
A corporation is exempt from gain recognition on transactions in its own stock. This includes:
The sale or exchange of its stock (including treasury stock).
The receipt of money or other property in exchange for its stock.
Essentially, a corporation cannot generate taxable income or a deductible loss from dealing in its own shares.
