Question

If the taxpayer elects to defer the gain on an involuntary conversion, when does the holding period of the replacement property begin?

1) On the date of purchase
2) On the date of the involuntary conversion
3) On the date of the taxpayer's election to defer the gain
4) On the date of the taxpayer's tax return filing

Answer 1

The holding period of the replacement property after an involuntary conversion begins on the date of the involuntary conversion itself, with the original property's holding period tacked on to the new one for tax purposes.

Step-by-step explanation:

The holding period of the replacement property begins on the date of the involuntary conversion.

When a taxpayer experiences an involuntary conversion, such as property destruction due to a natural disaster, and receives an insurance payout, they may choose to defer recognizing the gain on their taxes by purchasing replacement property. In cases of involuntary conversion, the Internal Revenue Code allows the taxpayer to defer the gain if they reinvest the proceeds in similar or related use property. The holding period for the new, replacement property is deemed to start on the same date as the holding period for the converted property. This means that, for tax purposes, the amount of time the taxpayer held the original property is tacked onto the holding period of the replacement property. This tacking is important as it can affect the characterization of gains as short-term or long-term when the replacement property is eventually sold.