Wikipedia encyclopedia defines Bifurcated as “to divide into separate parts or accounts”.  In law, “the division of issues in a trial” and as a practical example the “forking of a river into distributaries”.  For purposes of an exchange, an owner occupied two family could be described as a bifurcated property. One part or section of the property represents the owner’s principal residence and the remainder is property held for the productive use in trade or business. The property is divided into separate parts or accounts for federal income tax purposes. It is as if the owner owned two separate properties, one property is the owner’s principal residence and the other property is rental property. If the property were sold, IRC §1031 would apply to the rental portion of the property and IRC §121 would apply to the residence.

There are other examples of bifurcated property for purposes of an exchange. If a property owner owned a parcel of raw land for several years before erecting improvements on the land, the improvements, when constructed, would constitute a new asset separate from the land and not placed in service by the owner until the improvements were complete. If immediately following completion of the construction, the owner sold the property, its separate parts, the land as one part and the improvements as another part, would be treated independently for federal tax purposes. The land was held by the owner for investment and would qualify for an exchange under IRC §1031.  Tax on the gain from the sale of the land could be deferred by acquiring like-kind replacement property as part of an exchange. The improvements would not qualify for an exchange. The sale of the improvements might be characterized as a sale of a short term capital asset subject to short term capital gain rates or as inventory subject to ordinary income tax rates. The determination of weather the improvements constitute a short term asset or inventory would need to be made by the taxpayer and his advisors based on the facts and circumstances of ownership of the improvements in the hands of the taxpayer.

A property does not have to be divided into separate parts for tax or accounting purposes prior to an exchange to be bifurcated. For example, if a taxpayer desired to exchange qualifying property for a new property of lesser value, the taxpayer may want to consider bifurcating the property into two parts, one part having a value similar to the value of the proposed replacement property and the other part taking on the remaining value of the original property. At the time of sale, the taxpayer exchanges the first part for the replacement property of similar value in a fully deferred exchange and sells the second part. The sale of the second part triggers recognition of gain to the extent of the difference between the net sale price allocated to the second part and its proportionate share of the basis. The benefit in having bifurcated the relinquished property prior to the closing is that the gain recognized by virtue of the sale of the second part is less than the taxable boot that would have been received in a partially taxable exchange of the entire property.  The downside is that the replacement property will take on the basis of the bifurcated portion of the property that was exchange and not the adjusted basis of the whole property.    

Some taxpayers have attempted to claim that a vacation home used by the taxpayer for extended periods of time each year and rented for other periods could be bifurcated and treated as two separate properties for tax purposes based on the percentage of time the house was used for each activity. We do not agree with this position and feel that such a transaction, if audited, would be overturned on the fact that the property can not be characterized as property held primarily for a qualifying purpose under IRC §1031. Tax Court Memo 2007-134 supports our position in its finding that a vacation home held primarily for personal use is not consistent with the held for investment intent under IRC §1031.   This was reiterated this year in the T.C. Memo 2007-134 Barry E. Moore et ux. v. Commissioner May 30, 2007.  The IRS has now issued guidelines for treatment of vacation homes in a §1031 exchange under Revenue Procedure 2008-16.

Wikipedia encyclopedia defines Bifurcated as “to divide into separate parts or accounts”.  In law, “the division of issues in a trial” and as a practical example the “forking of a river into distributaries”.  For purposes of an exchange, an owner occupied two family could be described as a bifurcated property. One part or section of the property represents the owner’s principal residence and the remainder is property held for the productive use in trade or business. The property is divided into separate parts or accounts for federal income tax purposes. It is as if the owner owned two separate properties, one property is the owner’s principal residence and the other property is rental property. If the property were sold, IRC §1031 would apply to the rental portion of the property and IRC §121 would apply to the residence.

There are other examples of bifurcated property for purposes of an exchange. If a property owner owned a parcel of raw land for several years before erecting improvements on the land, the improvements, when constructed, would constitute a new asset separate from the land and not placed in service by the owner until the improvements were complete. If immediately following completion of the construction, the owner sold the property, its separate parts, the land as one part and the improvements as another part, would be treated independently for federal tax purposes. The land was held by the owner for investment and would qualify for an exchange under IRC §1031.  Tax on the gain from the sale of the land could be deferred by acquiring like-kind replacement property as part of an exchange. The improvements would not qualify for an exchange. The sale of the improvements might be characterized as a sale of a short term capital asset subject to short term capital gain rates or as inventory subject to ordinary income tax rates. The determination of weather the improvements constitute a short term asset or inventory would need to be made by the taxpayer and his advisors based on the facts and circumstances of ownership of the improvements in the hands of the taxpayer.

A property does not have to be divided into separate parts for tax or accounting purposes prior to an exchange to be bifurcated. For example, if a taxpayer desired to exchange qualifying property for a new property of lesser value, the taxpayer may want to consider bifurcating the property into two parts, one part having a value similar to the value of the proposed replacement property and the other part taking on the remaining value of the original property. At the time of sale, the taxpayer exchanges the first part for the replacement property of similar value in a fully deferred exchange and sells the second part. The sale of the second part triggers recognition of gain to the extent of the difference between the net sale price allocated to the second part and its proportionate share of the basis. The benefit in having bifurcated the relinquished property prior to the closing is that the gain recognized by virtue of the sale of the second part is less than the taxable boot that would have been received in a partially taxable exchange of the entire property.  The downside is that the replacement property will take on the basis of the bifurcated portion of the property that was exchange and not the adjusted basis of the whole property.    

Some taxpayers have attempted to claim that a vacation home used by the taxpayer for extended periods of time each year and rented for other periods could be bifurcated and treated as two separate properties for tax purposes based on the percentage of time the house was used for each activity. We do not agree with this position and feel that such a transaction, if audited, would be overturned on the fact that the property can not be characterized as property held primarily for a qualifying purpose under IRC §1031. Tax Court Memo 2007-134 supports our position in its finding that a vacation home held primarily for personal use is not consistent with the held for investment intent under IRC §1031.   This was reiterated this year in the T.C. Memo 2007-134 Barry E. Moore et ux. v. Commissioner May 30, 2007.  The IRS has now issued guidelines for treatment of vacation homes in a §1031 exchange under Revenue Procedure 2008-16.