Determining the Tax Year of a Deferred Income
There are certain transactions in which the elements of agreement, delivery, and payment are not the basis for determining the tax year of a deferred revenue. Find examples below:
Sale of Property under the 1031 Exchange—Although this taxation rule has been superseded by another rule for Capital Gains Tax, the same will be discussed for those transactions falling under the 1031 category or those that occurred prior to the revision of the Capital Gains Tax.
A 1031 exchange is one where a property held for investment was sold but the proceeds from said sale remain intact and are held under escrow by the real estate agent. The sales proceeds will be released from escrow only if they will be used to buy a replacement property of the “like-kind" and with relatively the same value as the property sold. This way, no income will be recognized and only the payment of the Capital Gains Tax is deferred.
In the event that the replacement property purchased has a lower value, which will leave an excess in the amount held in escrow by the real estate agent, said excess will be reported by the latter to the IRS for taxation purposes. The excess represents income on the part of the seller that was deferred pending the purchase of a "like kind" property. In our example, however, the replacement property purchased was not a "like kind;" hence the seller will be required to pay the corresponding Capital Gains Tax on the excess within 30 days after the prescribed period for 1031 exchange transactions.
For more information about the latest rules on Capital Gains Tax on sale of real estate, readers may refer to a separate article entitled: "IRS Tax Information when Flipping a House".