What value entered California's property factor when replacement property was acquired through an involuntary conversion or property exchange?

Plain-English summary

California Legal Ruling 409 explained how to value replacement property in the California property factor after an involuntary conversion or an exchange.

The general rule was carryover original cost when federal gain was not recognized. For property-factor purposes, "original cost" meant the federal basis at acquisition before federal adjustments: prior depreciation was added back and unrecognized gain was ignored.

If the taxpayer recognized gain when replacing involuntarily converted property with dissimilar property, the replacement property's actual cost became the property-factor value instead.

Capital additions increased the carried value, while unreinvested proceeds, cash, boot, or dissimilar property could produce a partial-disposition reduction.

Involuntary conversion: similar replacement property

When the taxpayer received property similar or related in use or service, federal section 1033 carried the old property's basis into the replacement property.

For the California property factor, the ruling carried over the old property's original cost rather than its adjusted federal basis. That meant adding back previously deducted depreciation and disregarding unrecognized gain.

Involuntary conversion: money or dissimilar property

The result depended on the gain election.

Gain not recognized

The replacement property carried the converted property's original cost for property-factor purposes, again reversing prior depreciation and ignoring the unrecognized gain.

Gain recognized

The replacement property entered the property factor at its own cost.

Cash-award adjustments

When an involuntary conversion produced a cash award:

• If replacement cost exceeded the award, the excess was a subsequent capital addition.
• If replacement cost was less than the award, the unreinvested difference was a partial disposition of the original property.

If the award consisted of similar property, improvements to that property were capital improvements. If the award mixed similar and dissimilar property, the dissimilar property was treated as a partial disposition.

Property exchanges

For property acquired in an exchange, the ruling followed the federal carryover-basis rule in section 1031(d).

The replacement property's California property-factor value carried over the exchanged property's original cost, with prior depreciation added back and unrecognized gain disregarded.

Capital additions and improvements increased that value. Cash or other boot received reduced it as a partial disposition because that portion of the transferred property was not replaced with the same type of property.

What this means for you

Multistate businesses

Under the historical rule, property-factor value did not necessarily equal current fair market value, insurance proceeds, or adjusted tax basis. The original-cost history had to be reconstructed.

Property owners replacing converted assets

Track the old property's original cost, accumulated federal depreciation, recognized or unrecognized gain, award amount, replacement cost, and any portion not reinvested.

Accountants and tax professionals

Separate federal basis computation from the California property-factor adjustment. Then apply capital-addition and partial-disposition rules to the carried original cost.

Common questions

Q: Did the replacement property's adjusted federal basis automatically become its property-factor value?

A: No. The ruling used federal basis before federal adjustments, adding back depreciation and disregarding unrecognized gain.

Q: What happened when section 1033 gain was not recognized?

A: The converted property's original cost carried into the replacement property for factor purposes.

Q: What happened when gain was recognized on a dissimilar-property replacement?

A: The replacement property's own cost was used.

Q: How did unreinvested insurance or condemnation proceeds affect value?

A: The amount by which the cash award exceeded replacement cost was treated as a partial disposition.

Q: How was boot in a property exchange treated?

A: Cash or other boot was a partial disposition reducing the carried original-cost amount.

Citations and references

• Cal. Rev. & Tax. Code § 25130
• Former 18 Cal. Code Regs. § 25130(a)(1)
• I.R.C. §§ 1031(d) and 1033(b), (c)
• Treas. Reg. §§ 1.1031(d)-1, 1.1033(a)-2(c), and 1.1033(c)-1

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 409

Original ruling text

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Legal ruling 409

STATE OF CALIFORNIA
Franchise Tax Board - Legal Division

October 6, 1977

Value is to be Ascribed to Replacement Property Acquired as the Result of an Involuntary Conversion or an Exchange for Property Factor Purposes

Question

What value is to be ascribed to replacement property acquired as the result of an involuntary conversion or an exchange for property factor purposes.

Decision

See Discussion.

Discussion

Revenue and Taxation Code Section 25130 provides in part:

Property owned by the taxpayer is valued at its original cost.

Cal. Admin. Code, titl. 18, § 25130(a)(1) provides in part:

Property owned by the taxpayer shall be valued at its original cost. As a general rule "original cost" is deemed to be the basis of the property for federal income tax purposes (prior to any federal adjustments) at the time of acquisition by the taxpayer and adjusted by subsequent capital additions or improvements thereto and partial disposition thereof, by reason of sale, exchange, abandonment, etc. [Emphasis added.]

In the case of an involuntary conversion, the basis of replacement property for federal income tax purposes is determined as follows:

(1) If the taxpayer receives property similar or related in use or service to the converted property, the basis of the replacement property is the same as the basis of the converted property. [IRC Section 1033(b)]

(2) If the taxpayer receives money or property not similar or related in use or service to the converted property, the basis of the replacement property will depend on whether or not the taxpayer elects to recognize the gain from the involuntary conversion [IRC Section 1033(b); Federal Reg. 1.1033(a)-2(c)].

If the taxpayer elects not to recognize the gain under situation (2) above, the basis of the replacement property for federal income tax purposes is the same as the basis of the converted property [IRC Section 1033(b)]. As unrecognized gain is a federal adjustment (as is depreciation previously deducted), it is disregarded for property factor valuation purposes under Regulation 25130(a)(1). If the taxpayer elects to recognize the gain under situation (2) above, the basis of the replacement property for federal income tax purposes is the cost of the replacement property [IRC Section 1033(c); Federal Reg. 1.1033(c)-1].

Thus, where property similar or related in use or service is received, or money or property not similar or related in use or service is received and the taxpayer elects to not recognize the gain, the value of the replacement property for property factor purposes is the carry-over of the "original cost" of the converted property (i.e., the basis of that property for federal income tax purposes, adding back depreciation previously deducted and disregarding unrecognized gain). If, however, the election is made to recognize the gain in situation (2) above, the value of the replacement property for property factor purposes is the cost of the replacement property.

As indicated above, although federal adjustments, such as unrecognized gain and depreciation previously deducted, are disregarded in establishing "original cost," Regulation 25130(a)(1) provides for adjustments for subsequent capital additions and partial disposition by reason of sale, exchange, abandonment, etc. Thus, in the case of an involuntary conversion involving a cash award where the cost of the replacement property exceeds the amount of the cash award, the additional cost will be considered as a subsequent capital addition. If the cost of the replacement property is less than the cash award, the difference between the amount of the cash award and the cost of the replacement property will be deemed a partial disposition of the original property because part of the cash award was not converted into property similar to the original property. In the case of an involuntary conversion involving an award of similar property, improvement to that similar property will be considered as a subsequent capital improvement. If the award consists of both similar and dissimilar property, the receipt of dissimilar property will be deemed a partial disposition of the original property because part of that property was disposed of through receipt of dissimilar property.

In the case of property acquired by an exchange, the basis of replacement property for federal income tax purposes is the same as that of the property exchanged. [IRC Section 1031(d); Federal Reg. 1.1031(d)-1] The federal adjustments attendant to such a transaction (e.g., depreciation previously deducted) are disregarded for property factor purposes [Regulation 25130(a)(1)].

Thus, the value of the replacement property for property factor purposes is the carry-over of the "original cost" of the exchanged property (i.e., the basis of that property for federal income tax purposes, adding back depreciation previously deducted and disregarding unrecognized gain).

As in the case of involuntary conversions, adjustments are to be made for capital additions or improvements as well as partial dispositions (e.g., receipt of cash or other "boot" will be considered as a partial disposition because the property received was not the same type as the property transferred).

Last updated: 09/24/2025