What are the Tax Implications of an Involuntary Conversion? - John R. Dundon II, Enrolled Agent
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What are the Tax Implications of an Involuntary Conversion?

What are the Tax Implications of an Involuntary Conversion?

Usually when when economists define a business transaction in a free market society it involves a willing buyer and a willing seller coming together on terms. More often than not however it seems to me that in a wide variety of transactions there is not a willing seller and in some cases not a willing buyer. Without this concept of willingness the definition of an ‘Involuntary Conversion’ can become somewhat perplexing. According to the IRS an involuntary conversion occurs when you receive money such as an insurance or a condemnation award (or even other property) in exchange for your property that was:

  1. Destroyed,
  2. Stolen,
  3. Condemned, or
  4. Disposed of under the threat of condemnation

Involuntary conversions are also called involuntary exchanges and here are some facts that I’ve pulled together:

  1. Gain or loss from an involuntary conversion is usually recognized for tax purposes unless the property is your main home.
  2. You report the gain or deduct the loss on your tax return for the year you realize it.
  3. You can’t deduct a loss from an involuntary conversion of property you held for personal use unless the loss resulted from casualty or theft.
  4. Depending on the type of property you receive, you may not have to report a gain on an involuntary conversion. You do not report the gain if you receive property that is similar or related in service or use to the converted property. Your basis for the new property is the same as your basis for the converted property. The gain on the involuntary conversion is deferred until a taxable sale or exchange occurs.

Contrary to what many people believe when a judge or a court orders that a property be disposed of via public auction it is not from my interpretation of the Internal Revenue Manual considered an ‘Involuntary Conversion’ even if the seller is not a willing seller.