Rev. Rul. 72-151

Advice has been requested as to the application of the nonrecognition of gain or loss provisions of section 1031 of the Internal Revenue Code of 1954 under the circumstances described below.

The taxpayer is the sole stockholder of a corporation. In 1958, the taxpayer purchased real property consisting of land and a house, which has been used since that time as rental income producing property. In 1970, the taxpayer exchanged his rental property for farm properties that included real property (farm land and improvements) and personal property (farm machinery) owned by the corporation. The taxpayer will not live on the farm but intends to use the farm property to raise cattle for profit, and the corporation intends to hold the house and lot as rental income producing property. The fair market value of the rental property equalled the fair market value of the farm property at the time of the exchange.

Section 1031(a) of the Code provides that no gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.

Section 1.1031(a)-1(b) of the Income Tax Regulations provides, in part, that the words "like kind" have reference to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under section 1031(a) of the Code, be exchanged for property of a different kind or class. The fact that any real estate involved is improved or unimproved is not material, for that fact relates only to the grade or quality of the property and not to its kind or class. Unproductive real estate held by one other than a dealer for future use or future realization of the increment in value is held for investment and not primarily for sale.

Section 1.1031(a)-1(c) of the regulations provides, in part, that no gain or loss is recognized if a taxpayer who is not a dealer in real estate exchanges city real estate for a ranch or farm or exchanges improved real estate for unimproved real estate.

Section 1031(b) of the Code provides, in part, that if an exchange would be within the provisions of section 1031(a) of the Code, if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

Section 1031(c) of the Code provides, in part, that if an exchange would be within the provisions of section 1031(a) of the Code, if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange shall be recognized.

Section 267 of the Code provides, in pertinent part, that no deduction shall be allowed in respect of losses from sales or exchanges of property (other than losses in cases of distributions in corporate liquidations), directly or indirectly, between persons specified within any one of the paragraphs of section 267(b) of the Code.

Section 267(b) of the Code provides at paragraph (2) that an individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual represents a relationship referred to in section 267(a) of the Code.

Section 1031(d) of the Code provides, in part, that if property was acquired on an exchange described in that section, then the basis shall be the same as that of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized on such exchange. If property so acquired consisted in part of the type of property permitted by that section of the Code, to be received without the recognition of gain or loss, and in part of other property, the basis provided in that subsection shall be allocated between the properties (other than money) received, and for the purpose of the allocation there will be assigned to such other property an amount equivalent to its fair market value at the date of the exchange.

Where, as in the instant case, an exchange under section 1031 of the Code involves multiple assets, the fact that the assets in the aggregate comprise a business or an integrated economic investment does not result in treating the exchange as a disposition of a single piece of property. Rather, an analysis is required of the underlying property involved in the exchange. See Rev. Rul. 55-79, C.B. 1955-1, 370.

Upon analysis of the property involved in the instant case, it is concluded that the rental real property (land and improvements) and the farm real property (land and improvements) are property of like kind for purposes of section 1031 of the Code. However, due to the inclusion of the farm machinery, the exchange does not solely involve property of "like kind" and thus does not come within the provisions of section 1031(a) of the Code.

If the taxpayer realized a gain on the exchange, such gain should be recognized under section 1031(b) of the Code in an amount not in excess of the fair market value of the farm machinery. The total basis of the farm land, improvements, and machinery received by the taxpayer is the adjusted basis of the land and house transferred increased by the amount of any gain recognized, such basis being allocated to the properties. For purposes of allocating such basis to the properties received, an amount equivalent to the fair market value of the farm machinery on the date of the exchange should be assigned as its basis.

If the exchange had resulted in a loss being realized by the taxpayer, sections 1031(c) and 267 of the Code each provide that such loss should not be recognized. In that event, the total basis of the farm land, improvements, and farm machinery received is the adjusted basis of the land and house transferred. This basis should be allocated to the properties received, and for this purpose, there must be allocated to the farm machinery an amount equivalent to its fair market value on the date of the exchange.

Accordingly, in the instant case, since the exchange includes property not of like kind (the farm machinery), the nonrecognition of gain or loss provisions of section 1031(a) of the Code are inapplicable. However, if the taxpayer realizes a gain from the exchange, such gain shall be recognized in accordance with section 1031(b) of the Code but only to the extent of the fair market value of the farm machinery. If the taxpayer realizes a loss from the exchange, such loss shall not be recognized in accordance with sections 1031(c) and 267 of the Code. The basis of the property received by the taxpayer in the exchange is governed by section 1031(d) of the Code.