Mr. Z owns three homes. He lives in the San Francisco home full time. The other two he and his wife vacation in each year. He is considering replacing the house he has in Palm Springs, California, with another house in the same area. The new home is a little bigger and has a floor plan he prefers. The two Palm Springs properties have almost the same fair market value. Mr. Z would like to know if he can exchange the properties instead of selling the one he has now and then buying the new one. He has a lot of built-up appreciation in the current Palm Springs home and he doesn't want to have to pay taxes on it. Someone told him at a cocktail party that he can avoid paying taxes if he does an exchange.
Mr. Z and his wife own the home outright. There is no mortgage on the property. They use the property occasionally. This last year they vacationed at the home for about two or three weeks - they aren't sure of the exact days. They have never rented the property and refuse to rent either the old or new property. They don't need the money and don't like strangers in their house.
Mr. Z explains that he holds each of his vacation homes for two reasons. One reason is for vacations for him and his wife. Another key reason for owning the homes is for their investment value. He chooses homes only in areas where he believes there are high appreciation possibilities.
Can Mr. Z take advantage of the tax-free exchange rules in the IRC? How will you advise him?
a. Write a memo to your supervisor communicating your research results.
b. Write a letter to Mr. and Mrs. Z communicating your research results.
c. Assume that Mr. and Mrs. Z exchange properties in accordance with the non recognition provisions. They file a tax return not reflecting any income from this transaction. The Z's receive a letter from the IRS indicating that it is treating the transaction as taxable. Write a letter to the IRS protesting this finding.