Reg. § 1.1245-4 Exceptions and limitations.
(a) Exception for gifts
(1) General rule Section provides that no gain shall be recognized under section upon a disposition by gift. For purposes of this , the term gift means, except to the extent that of this section applies, a transfer of property that, in the hands of the transferee, has a basis determined under the provisions of section or (relating to basis of property acquired by gifts) or section (relating to basis of property acquired from certain decedents who died in 2010). For reduction in amount of charitable contribution in case of a gift of section property, see section and the regulations thereunder.
(2) Examples The provisions of subparagraph (1) of this paragraph may be illustrated by the following examples:
Example 1. A places section property in trust to pay the income from the property to B for his life, and after B's death to distribute the property to C. If the basis of the property to the fiduciary and to C is determined under the uniform basis rules prescribed in , and under the time the fiduciary and C acquire their interests in the property is the time the donor relinquished dominion over the property, then section does not apply to the transfer by A to the trust or to the distribution to C.
Example 2. Assume the same facts as in example (1), except that the fiduciary sells the section property and reinvests the proceeds in other section property which is distributed to C upon B's death. Assume further that under C's basis for the distributed property is the cost or other basis to the fiduciary. Section applies to the sale but not to the distribution.
(3) Disposition in part a sale or exchange and in part a gift Where a disposition of property is in part a sale or exchange and in part a gift, the gain to which section applies is the amount by which
(i) the lower of the amount realized upon the disposition of the property or the recomputed basis of the property, exceeds
(ii) the adjusted basis of the property. For determination of the recomputed basis of the property in the hands of the transferee, see .
(4) Example The provisions of subparagraph (3) of this paragraph may be illustrated by the following example:
Example:
(i) Smith transfers section property, which he has held in excess of 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977), to his son for $60,000. Immediately before the transfer the property in the hands of Smith has an adjusted basis of $30,000, a fair market value of $90,000, and a recomputed basis of $110,000. Since the amount realized upon disposition of the property ($60,000) is lower than its recomputed basis ($110,000), the excess of the amount realized over adjusted basis, or $30,000, is treated as ordinary income under section and not as gain from the sale or exchange of property described in section . Smith has made a gift of $30,000 ($90,000 fair market value minus $60,000 amount realized) to which section does not apply.
(ii) Immediately before the transfer, the amount of adjustments reflected in the adjusted basis of the property was $80,000. Under , $50,000 of adjustments are reflected in the adjusted basis of the property immediately after the transfer, that is, $80,000 of such adjustments immediately before the transfer, minus $30,000 gain taken into account under section upon the transfer. Thus, the recomputed basis of the property in the hands of the son is $110,000.
(b) Exception for transfers at death
(1) General rule Section provides that, except as provided in section (relating to income in respect of a decedent), no gain shall be recognized under section upon a transfer at death. For purposes of this paragraph, the term transfer at death means a transfer of property which, in the hands of the transferee, has a basis determined under the provisions of section (relating to basis of property acquired from a decedent) because of the death of the transferor. For recomputed basis of property acquired in a transfer at death, see .
(2) Examples The provisions of this paragraph may be illustrated by the following examples:
Example 1. Smith owns section property which, upon Smith's death, is inherited by his son. Since the property is described in section , its basis in the hands of the son is determined under the provisions of section . Therefore, section does not apply to the transfer at Smith's death.
Example 2. H purchases section property which he conveys to himself and W, his wife, as tenants by the entirety. Upon H's death in 1970 the property (including W's share) is included in his gross estate. Since the entire property is described in section (1) and (9), its basis in the hands of W is determined under the provisions of section . Therefore, section does not apply to the transfer at H's death. For determination of the recomputed basis of the property in the hands of W, see .
Example 3. Green's will provides for the bequest of section property to trustees to pay the income from the property to his wife for her lifetime, and upon her death to distribute the property to his son. If under the son's unadjusted basis for the property is its fair market value at the time the decedent died, section does not apply to the distribution of the property to the son.
Example 4. The trustee of a trust created by will transfers section property to a beneficiary in satisfaction of a specific bequest of $10,000. If under the principles of the trust realizes a taxable gain upon the transfer, section applies to the transfer.
(c) Limitation for certain tax-free transactions
(1) Limitation on amount of gain Section provides that upon a transfer of property described in subparagraph (2) of this paragraph, the amount of gain taken into account by the transferor under section shall not exceed the amount of gain recognized to the transferor on the transfer (determined without regard to section ). For purposes of this subparagraph, in case of a transfer of both section property and non-section property in one transaction, the amount realized from the disposition of the section property (as determined under ) shall be deemed to consist of that portion of the fair market value of each property acquired which bears the same ratio to the fair market value of such acquired property as the amount realized from the disposition of the section property bears to the total amount realized. The preceding sentence shall be applied solely for purposes of computing the portion of the total gain (determined without regard to section ) which shall be recognized as ordinary income under section . For determination of the recomputed basis of the section property in the hands of the transferee, see . Section does not apply to a disposition of property to an organization (other than a cooperative described in section ) which is exempt from the tax imposed by chapter 1 of the Code.
(2) Transfers covered The transfers referred to in subparagraph (1) of this paragraph are transfers of property in which the basis of the property in the hands of the transferee is determined by reference to its basis in the hands of the transferor by reason of the application of any of the following provisions:
(i) Section (relating to distributions in complete liquidation of an 80-percent-or-more controlled subsidiary corporation). See subparagraph (3) of this paragraph.
(ii) Section (relating to transfer to a corporation controlled by transferor).
(iii) Section (relating to exchanges pursuant to certain corporate reorganizations).
(iv) Section 371(a) (relating to exchanges pursuant to certain receivership and bankruptcy proceedings).
(v) Section (relating to exchanges pursuant to certain railroad reorganizations).
(vi) Section (relating to transfers to a partnership in exchange for a partnership interest).
(vii) Section (relating to distributions by a partnership to a partner). For special carryover basis rule, see section and of this section.
(3) Complete liquidation of subsidiary In the case of a distribution in complete liquidation of an 80-percent-or-more controlled subsidiary to which section applies, the limitation provided in section is confined to instances in which the basis of the property in the hands of the transferee is determined, under section , by reference to its basis in the hands of the transferor. Thus, for example, the limitation of section may apply in respect of a liquidating distribution of section property by an 80-percent-or-more controlled corporation to the parent corporation, but does not apply in respect of a liquidating distribution of section property to a minority shareholder. Section does not apply to a liquidating distribution of property by an 80-percent-or-more controlled subsidiary to its parent if the parent's basis for the property is determined, under section , by reference to its basis for the stock of the subsidiary.
(4) Examples The provisions of this paragraph may be illustrated by the following examples:
Example 1. Section property, which is owned by Smith, has a fair market value of $10,000, a recomputed basis of $8,000, and an adjusted basis of $4,000. Smith transfers the property to a corporation in exchange for stock in the corporation worth $9,000 plus $1,000 in cash in a transaction qualifying under section . Without regard to section , Smith would recognize $1,000 gain under section , and the corporation's basis for the property would be determined under section by reference to its basis in the hands of Smith. Since the recomputed basis of the property disposed of ($8,000) is lower than the amount realized ($10,000), the excess of recomputed basis over adjusted basis ($4,000), or $4,000, would be treated as ordinary income under section if the provisions of section did not apply. However, section limits the gain taken into account by Smith under section to $1,000. If, instead, Smith transferred the property to the corporation solely in exchange for stock of the corporation worth $10,000, then, because of the application of section , Smith would not take any gain into account under section . If, however, Smith transferred the property to the corporation for stock worth $5,000 and $5,000 cash, only $4,000 of the $5,000 gain under section would be treated as ordinary income under section .
Example 2. Assume the same facts as in example (1) except that Smith contributes the property to a new partnership in which he has a one-half interest. Since, without regard to section , no gain would be recognized to Smith under section , and by reason of the application of section the partnership's basis for the property would be determined under section by reference to its basis in the hands of Smith, the application of section results in no gain being taken into account by Smith under section .
Example 3. Assume the same facts as in example (2) except that the property is subject to a $9,000 mortgage. Since under section (relating to decrease in partner's liabilities) Smith is treated as receiving a distribution in money of $4,500 (one-half of liability assumed by partnership), and since the basis of Smith's partnership interest is $4,000 (the adjusted basis of the contributed property), the $4,500 distribution results in his realizing $500 gain under section (relating to distributions by a partnership), determined without regard to section . Accordingly, the application of section limits the gain taken into account by Smith under section to $500.
(d) Limitation for like kind exchanges and involuntary conversions
(1) General rule Section provides that if property is disposed of and gain (determined without regard to section ) is not recognized in whole or in part under section (relating to like kind exchanges) or section (relating to involuntary conversions), then the amount of gain taken into account by the transferor under section shall not exceed the sum of:
(i) The amount of gain recognized on such disposition (determined without regard to section ), plus
(ii) The fair market value of property acquired which is not section property and which is not taken into account under subdivision (i) of this subparagraph (that is, the fair market value of non-section property acquired which is qualifying property under section or , as the case may be).
(2) Examples The provisions of subparagraph (1) of this paragraph may be illustrated by the following examples:
Example 1. Smith exchanges machine A for machine B in a like kind exchange as to which no gain is recognized under section . Both machines are section property. No gain is recognized under section because of the limitation contained in section . The result would be the same if machine A were involuntarily converted into machine B in a transaction as to which no gain is recognized under section .
Example 2. Jones owns property A, which is section property, with an adjusted basis of $100,000 and a recomputed basis of $116,000. The property is destroyed by fire and Jones receives $117,000 of insurance proceeds. Thus, the amount of gain under section , determined without regard to section , would be $16,000. He uses $105,000 of the proceeds to purchase section property similar or related in service or use to property A, and $9,000 of the proceeds to purchase stock in the acquisition of control of a corporation owning property similar or related in service or use to property A. Both acquisitions qualify under section . Jones properly elects under section and the regulations thereunder to limit recognition of gain to the amount by which the amount realized from the conversion exceeds the cost of the stock and other property acquired to replace the converted property. Since $3,000 of the gain is recognized (without regard to section ) under section (that is, $117,000 minus $114,000), and since the stock purchased for $9,000 is not section property and was not taken into account in determining the gain under section , section limits the amount of the gain taken into account under section to $12,000 (that is, $3,000 plus $9,000). If, instead of purchasing $9,000 in stock, Jones purchases $9,000 worth of property which is section property similar or related in use to the destroyed property, section would limit the amount of gain taken into account under section to $3,000.
(3) Certain tangible property If:
(i) A person disposes of section property in a transaction to which section applies,
(ii) Adjustments are reflected in the adjusted basis (within the meaning of ) of such property which are attributable to the use of such property (or other property) as an integral part of an activity, or as a facility, specified in section (i) or (ii), and
(iii) Property is acquired in the transaction which would be considered as section property described in section if such person used the acquired property as an integral part of such an activity, or as such a facility, then (regardless of the use of the acquired property) the acquired property shall be considered as section property described in section . For definition of property described in section , see . Thus, for example, if a person's section property (which is personal property) is involuntarily converted into property A which would qualify as section property only if it were devoted to a specified use, and if the person had so devoted the section property disposed of, then the acquired property is considered as section property described in section and therefore its fair market value is not taken into account under subparagraph (1)(ii) of this paragraph. For recomputed basis of property A, see . Moreover, if property A is not devoted to a specified use and is subsequently involuntarily converted into property B which would qualify as section property only if it were so devoted, then property B is also considered as section property described in section .
(4) Application to disposition of section 1245 property and nonsection 1245 property in one transaction For purposes of this paragraph, if both section property and nonsection 1245 property are acquired as the result of one disposition in which both section property and nonsection 1245 property are disposed of, then except as provided in subparagraph (7) of this paragraph:
(i) The total amount realized upon the disposition shall be allocated (in a manner consistent with the principles of ) between the section property and the nonsection 1245 property disposed of in proportion to their respective fair market values.
(ii) The amount realized upon the disposition of the section property shall be deemed to consist of so much of the fair market value of the section property acquired as is not in excess of the amount realized from the section property disposed of, and the remaining portion (if any) of the amount realized upon the disposition of the section property shall be deemed to consist of so much of the fair market value of the non-section property acquired as is not in excess of the amount of such remaining portion, and
(iii) The amount realized upon the disposition of the non-section property shall be deemed to consist of so much of the fair market value of all the property acquired which was not taken into account in subdivision (ii) of this subparagraph.
(5) Example The provisions of subparagraph (4) of this paragraph may be illustrated by the following example:
Example:
(i) Smith owns section property A with a fair market value of $30,000, and non-section property X with a fair market value of $20,000. Properties A and X are destroyed by fire and Smith receives insurance proceeds of $40,000. He uses all the proceeds, plus additional cash of $10,000, to purchase in a single transaction properties B and Y which qualify under section , and he properly elects under section and the regulations thereunder to limit recognition of gain to the excess of the amount realized from the conversion over the costs of the qualifying properties acquired. Thus no gain would be recognized (without regard to section ) under section . Property B is section property with a fair market value of $15,000, and property Y is non-section property with a fair market value of $35,000.
(ii) The amount realized upon the disposition of A and X ($40,000) is allocated between A and X in proportion to their respective fair market values. Thus, the amount considered realized in respect of A is $24,000 (that is, 30⁄50 of $40,000). (The amount considered realized in respect of X is $16,000 (that is, 20⁄50 of $40,000).)
(iii) The $24,000 realized upon the disposition of A is deemed to consist of the fair market value of B ($15,000) and $9,000 of the fair market value of Y. (The $16,000 realized upon the disposition of X is deemed to consist of $16,000 of the fair market value of Y. Also, $10,000 of the fair market value of Y is attributable to the additional cash of $10,000.)
(iv) Assume that A has an adjusted basis of $5,000, and a recomputed basis of $40,000. Since the amount considered realized upon the disposition of A ($24,000) is lower than its recomputed basis ($40,000), the amount of gain which would be recognized under section , determined without regard to section , is $19,000, that is, the amount realized ($24,000) minus the adjusted basis ($5,000). Since no gain is recognized (without regard to section ) under section , and since $9,000 of the property acquired in exchange for section property A is non-section property Y, section limits the amount of gain taken into account under section to $9,000.
(6) Cross references For the manner of determining the recomputed basis of property acquired in a transaction to which section applies, see . For the manner of determining the basis of such property, see .
(7) Coordination with section 1250 For purposes of this paragraph, if section property and section property are disposed of in one transaction in which the property acquired includes section property, the allocation rules of shall apply.
(e) Limitation for section 1071 and 1081 transactions
(1) Section 1071 and 1081(b) transactions If property is disposed of and gain (determined without regard to section ) is not recognized in whole or in part because of the application of section (relating to gain from sale or exchange to effectuate policies of F.C.C.) or section 1081(b) (relating to gain from sale or exchange in obedience to order of S.E.C.), then the amount of gain taken into account by the transferor under section shall not exceed the sum of:
(i) The amount of gain recognized on such disposition (determined without regard to section ),
(ii) In the case of a transaction to which section applies, the fair market value of property acquired which is not section property and which is not taken into account under subdivision (i) of this subparagraph, plus
(iii) The amount by which the basis of property, other than section property, is reduced (pursuant to an election under section or pursuant to the application of section 1082(a)(2)), and which is not taken into account under subdivision (i) or (ii) of this subparagraph.
(2) Section 1081(d)(1)(A) transaction No gain shall be recognized under section upon an exchange of property as to which gain would not be recognized (without regard to section ) because of the application of section 1081(d)(1)(A) (relating to transfers within system group). For recomputed basis of property acquired in a transaction referred to in this subparagraph, see .
(3) Examples The provisions of this paragraph may be illustrated by the following examples:
Example 1. Corporation X elects under section to treat a sale of section property for $100,000 as an involuntary conversion subject to the provisions of section , but does not elect to reduce the basis of depreciable property pursuant to an election under section . The corporation uses $35,000 of the proceeds to purchase section property and $40,000 to purchase other property. Both properties qualify as replacement property under section . Assuming that the amount of gain under section (determined without regard to this paragraph) would be $70,000, and that $25,000 of gain would be recognized (without regard to section ) upon the application of section , the amount of gain taken into account under section is $65,000 ($25,000 plus $40,000).
Example 2.
(i) Assume the same facts as in example (1) except that the corporation elects under section to reduce its basis for property of a character subject to the allowance for depreciation under section by the amount of gain which would be recognized without regard to the application of section , that is, by $25,000. Assume further that under section the corporation may reduce the basis of depreciable property consisting of property A, which is section property with an adjusted basis of $30,000, and property B, which is property other than section property with an adjusted basis of $20,000. Under , the $25,000 of unrecognized gain is applied to reduce the basis of property A by $15,000 (30,000/50,000 of $25,000) and the basis of property B by $10,000 (20,000/50,000 of $25,000).
(ii) The amount of gain which would be recognized (determined without regard to section ) under section is zero, i.e., the amount determined in example (1) ($25,000), minus the amount of the reduction in basis of depreciable property pursuant to the election ($25,000). The amount of gain taken into account under section is $50,000, i.e., the sum of (a) the gain which would be recognized without regard to section (zero), (b) the cost of property acquired which is not section property ($40,000), plus (c) the amount by which the basis of property B is reduced ($10,000). For method of increasing basis of property B, see , and for recomputed basis of property A, see .
(f) Limitation for property distributed by a partnership
(1) In general For purposes of section (relating to certain tax-free transactions), the basis of section property distributed by a partnership to a partner shall be deemed to be determined by reference to the adjusted basis of such property to the partnership.
(2) Adjustments reflected in the adjusted basis If section property is distributed by a partnership to a partner, then, for purposes of determining the recomputed basis of the property in the hands of the distributee, the amount of the adjustments reflected in the adjusted basis of the property immediately after the distribution shall be an amount equal to:
(i) The potential section income (as defined in ) of the partnership in respect of the property immediately before the distribution, reduced by
(ii) The portion of such potential section income which is recognized as ordinary income to the partnership under .
(3) Examples The provisions of this paragraph may be illustrated by the following examples:
Example 1.
(i) A machine, which is section property owned by partnership ABC, has an adjusted basis of $9,000, a recomputed basis of $18,000, and a fair market value of $15,000. Since the fair market value of the machine is lower than its recomputed basis, the potential section income in respect of the machine is the excess of fair market value over adjusted basis, or $6,000. The partnership distributes the machine to C in a complete liquidation of his partnership interest to which section does not apply. C, who had originally contributed the machine to the partnership, has a basis for his partnership interest of $10,000. Since section provides that section does not apply to a distribution of property to the partner who contributed the property, no gain would be recognized to the partnership under section (without regard to the application of section ). By reason of the application of section , C's basis for the property would, under section , be equal to his basis for his interest in the partnership, or $10,000.
(ii) Since section applies to the distribution, and since subparagraph (1) of this paragraph provides that, for purposes of section , C's basis for the property is deemed to be determined by reference to the adjusted basis of the property to the partnership, the gain taken into account under section by the partnership is limited by section so as not to exceed the amount of gain which would be recognized to the partnership if section did not apply. Accordingly, the partnership does not recognize any gain under section upon the distribution.
(iii) Immediately after the distribution, the amount of the adjustments reflected in the adjusted basis of the property is equal to $6,000 (that is, the potential section income of the partnership in respect of the property before the distribution, $6,000, minus the gain recognized by the partnership under section , zero). Accordingly, C's recomputed basis for the property is $16,000 (that is, adjusted basis, $10,000, plus adjustments reflected in the adjusted basis, $6,000).
Example 2. Assume the same facts as in example (1) except that the machine had been purchased by the partnership. Assume further that upon the distribution, the partnership recognizes $4,000 gain as ordinary income under section . Under section , gain to be taken into account under section by the partnership is limited to $4,000. Immediately after the distribution, the amount of adjustments reflected in the adjusted basis of the property is $2,000 (that is, potential section income of the partnership, $6,000, minus gain recognized to the partnership under section , $4,000). Thus, if the adjusted basis of the machine in the hands of C were $11,333 (see, for example, the computation in paragraph (d)(2) of example (6) of ), the recomputed basis of the machine would be $13,333 ($11,333 plus $2,000).
(g) [Reserved]
(h) Timber property subject to amortization under section 194
(1) In general For purposes of section , in determining the recomputed basis of property with respect to which a deduction under section was allowed for any taxable year, a taxpayer shall not take into account amortization deductions claimed under section to the extent such deductions are attributable to the amortizable basis (within the meaning of section ) of the taxpayer acquired before the tenth taxable year preceding the taxable year in which gain with respect to the property is recognized.
(2) Example The principles of of this section are illustrated by the following example:
Example: Assume A owns qualified timber property (as defined in section ) with a basis of $30,000. In 1981, A incurs $12,000 of qualifying reforestation expenditures and elects to amortize the maximum $10,000 of such expenses under section . The $10,000 of deductions are taken during the 8-year period from 1981 to 1988. If A sells the property in 1990 for $60,000 a gain of $28,000 ($60,000—adjusted basis of $32,000) is recognized on the sale. Since the sale took place within 10 years of the taxable year in which the reforestation expenditures were made, $10,000 of the gain is treated as ordinary income, and the remaining $18,000 of gain would be capital gain, if it otherwise qualifies for capital gain treatment. In order to avoid ordinary income treatment of the gain attributable to the reforestation expenditures incurred in 1981, A would have to wait until 1992 to dispose of the property.
(i) Effective/applicability date This section applies on and after January 19, 2017. For rules before January 19, 2017, see § as contained in 26 CFR part 1 revised as of April 1, 2016.
[T.D. 6832, 30 FR 8581, July 7, 1965, as amended by T.D. 7084, 36 FR 268, Jan. 8, 1971; T.D. 7207, 37 FR 20799, Oct. 14, 1972; T.D. 7728, 45 FR 72650, Nov. 3, 1980; T.D. 7927, 48 FR 55851, Dec. 16, 1983; T.D. 9811, 82 FR 6241, Jan. 19, 2017]