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In the notice of deficiency, respondent determined that
petitioners failed to meet the requirements for a section 1031
exchange and included in petitioners’ income capital gain from
the sale of the Pacific Grove property. Respondent also
reallocated certain interest and tax expenses attributable to the
Big Sur property from Schedule E (expenses of rental real estate)
to Schedule A (itemized deductions).
OPINION
Section 1031 Exchange
Generally, a taxpayer must recognize the entire amount of
gain or loss on the sale or exchange of property. Sec. 1001(c).
Section 1031(a)(1) contains an exception to this general rule:
(1) In general.--No gain or loss shall be recognized on
the exchange of property held for productive use in a trade
or business or for investment if such property is exchanged
solely for property of like kind which is to be held either
for productive use in a trade or business or for investment.
The purpose of section 1031 is to defer recognition of gain
or loss when an exchange of like-kind property takes place
between a taxpayer and another party. Coastal Terminals, Inc. v.
United States, 320 F.2d 333, 337 (4th Cir. 1963). The basic
reason for this tax treatment is that the exchange does not
materially alter the taxpayer’s economic situation, the property
received in the exchange being viewed as a continuation of the
old investment still unliquidated. Koch v. Commissioner, 71 T.C.
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