However, in other situations taxpayers may benefit more from a taxable disposition, and should intentionally avoid or disqualify a property exchange since the nontaxable provisions are mandatory when the statutory requirements are met. These situations include the following:

  • When a taxpayer has current year losses or loss carryovers (capital, net operating, charitable, etc.) that can be used to offset gain resulting from a taxable disposition.
  • When a taxpayer has a built-in loss in the property being disposed of. Nontaxable exchanges not only defer taxable gains, but also losses. In such case, a nontaxable exchange would prevent the taxpayer from recognizing the loss currently.
  • When a wide disparity exists between the capital gains and ordinary tax rates. Here, some taxpayers may benefit from a step-up in basis in the replacement property when a taxable sale at capital gain rates is followed by the purchase of depreciable property.
  • When the gain is passive income that can be used against current or suspended passive activity losses.
  • When paying tax on the gain in the current year may be more beneficial than deferring the tax because of events (such as increases in the taxpayer’s future taxable income, rising tax rates, or changes in the tax treatment of capital gains) that would produce future additional tax.

Normally, the disparity between the capital gain and ordinary income tax rates make a taxable sale followed by a reinvestment of the net proceeds a practical strategy, assuming the sale results in long-term capital gain treatment. In addition, the more the basis in the replacement property can be allocated to depreciable property and the shorter the related recovery period, the more likely a taxable sale will be a favorable alternative since it allows the taxpayer to step up basis in the replacement property.