Rev. Rul. 61-119

Advice has been requested whether a transaction of the type described below constitutes a sale of used equipment and the purchase of new equipment or whether it is one integrated transaction constituting an exchange with respect to which section 1031(a) of the Internal Revenue Code of 1954 provides for the nonrecognition of gain or loss.

A taxpayer has equipment used in his trade or business for more than six months for which his adjusted basis is $500. This used equipment has a fair market value of $1,000. Better equipment is now available which the taxpayer desires to acquire. Such equipment has a listed retail price of $10,000 but is regularly sold for $9,000.

Ordinarily, the taxpayer would accomplish the exchange by surrendering the old equipment to the dealer and receiving a trade-in allowance to cover part of the cost of the new equipment. Thus, the dealer would bill the taxpayer for $8,000, representing the $9,000 sales price of the new equipment minus the $1,000 trade-in allowance for the old equipment. Alternatively, the dealer's invoice might reflect the new equipment at its list price, or $10,000, in which case the trade-in allowance would be shown as $2,000, leaving $8,000 as the balance due from the customer. In either case, the transaction would be treated as a nontaxable exchange, in view of section 103-1(a) of the Code, which provides, in part, that no gain or loss shall be recognized if property held for productive use in trade or business is exchanged solely for property of a like kind to be held for the same purpose, and in view of section 1.1031(a)-1(a) of the Income Tax Regulations, which provides, in part, that a transfer of property meeting the requirements of section 1031(a) may be within the provision of section 1031(a) even though the taxpayer transfers in addition property not meeting the requirements of section 1031(a) or money.

In the above situation, therefore, no gain or loss would be recognized even though the taxpayer was allowed $1,000 in the first instance, or $2,000 in the second instance, for the used equipment for which his basis was $500. The taxpayer's unrecognized gain on the trade-in would be applied, in accordance with I.T. 2615, C.B. XI-1, 112 (1932), to reduce his basis of the new equipment for depreciation purposes. Thus, the taxpayer's basis for the new equipment would be $8,500, the purchase price less the unrecognized gain on the used equipment.

The question has been raised whether the foregoing authorities will continue to govern the tax consequences of the transaction if, instead of entering into a direct exchange in the manner outlined above, the parties entered into separate contracts, one covering the sale of the old equipment and the other covering the purchase of the new equipment.

The recognition to be accorded a particular transaction for Federal income tax purposes depends upon the substance of the transaction rather than the form in which it is cast. The Internal Revenue Service and the courts look to what is actually done rather than to the formalities of the transaction or to the declared purpose of the participants in gauging its tax consequences. See Harry H. Weiss v. Louis Stearn et al. , 265 U.S. 242, T.D. 3609, C.B. III-2, 51 (1924), and Helvering v. The F. & R. Lazarus & Co. , 308 U.S. 252, Ct.D. 1430, C.B. 1939-2, 208. The courts have held that a sale is to be disregarded where it is a step in a transaction the purpose of which is to make an exchange, and which results in an exchange. See Century Electric Co. v. Commissioner , 192 Fed.(2d) 155, certiorari denied 342 U.S. 954. See also Revenue Ruling 60-43, C.B. 1960-1, 687.

In the instant case the sale of the used equipment and the purchase of the new equipment are reciprocal and mutually dependent transactions. The taxpayer's acquisition of the new equipment from the dealer is contingent upon the dealer taking his used equipment and granting a trade-in allowance equal to or in excess of its fair market value. Moreover, the dealer's acceptance of the old equipment is dependent upon the taxpayer's purchase of the new equipment. Under these circumstances, the transfer of the old equipment to the dealer, irrespective of the form or the technique through which the transfer is accomplished, represents but a step in a single integrated transaction.

Accordingly, it is held that the transfer of the old equipment to the dealer and purchase of the new equipment from him is a nontaxable exchange under section 1031 of the Code, even though the purchaser and the seller execute separate contracts and treat the purchase and sale as unrelated transactions for record keeping purposes.

The fact that the purchase and sale are consummated concurrently, or that the sales price of the new equipment and the trade-in allowance for the old equipment are in excess of the price at which such items are ordinarily sold, may serve as indication that the purchase and sale were not intended as separate or unrelated transactions. However, the absence of either or both of these factors, standing alone, will not be taken to indicate that separate or unrelated transactions were consummated.