1031 Like-Kind Exchange - Part 2 (with Boot)

Understanding the treatment of Boot in a 1031 Like-Kind exchange is crucial for real estate investors. Boot refers to non-qualifying property involved in the exchange, such as cash or relief from liabilities. In some cases, due to time constraints, the value of the new property may not match the old one, leading to the exchange of additional property or cash to equalize the Fair Market Value (FMV).

It's important to note that any excess gain triggered by boot must be recognized in the exchange as it is considered non-qualified property. The gain recognized is limited to the lesser of boot received or the realized gain during the transactions. Remember, only boot received triggers gain, not boot paid, which is viewed as a purchase transaction.

Furthermore, when an exchange involves both assumed liabilities and relief of liabilities, they should be netted together. If the net assumed liabilities exceed a certain threshold, it is considered boot paid, while if the net relief exceeds this threshold, it is classified as boot received. Understanding these nuances is key to navigating 1031 exchanges effectively.

Example 1 - boot received other than liability:

A taxpayer owns real estate held for investment that is worth $40,000 and has an adjusted basis of $25,000. The taxpayer exchanges this property for other real estate held for investment worth $35,000 and $5,000 in cash.

Determine the realized gain and recognized gain from the like-kind exchange.

Answer:

Realized amount: $40,000 (cash - $5,000 & FMV of new Building - $35,000)

Less: AB of old Property: $25,000

Realized Gain= Realized amount - AB of old property = $40,000 - $25,000 = $15,000

Recognized Gain= $5,000 ( Lesser of realized gain or Boot received)

Deferred Gain= $10,000 (Realized gain - Recognized gain)

Let's keep aside a formula and apply a logic here, What if we only received the property $35,000 and not cash. Then the gain would be $10,000 which is a qualified 1031 exchange. Since it's a exchange between real assets. The addition of $5,000 gain we realized in the above example is purely because of the cash we received in addition to qualified 1031 property. So we have to recognize $5,000 since it's not a qualified 1031.

Continuing with the above example:

Determine the taxpayer's basis in the new property.

Basis of new property = FMV of new property received - Deferred gain + Deferred Loss = $35,000 - $10,000 = $25,000 (which is equal to our old asset basis)

Let's incase if we sell the new property in the same date for $35,000. Then we will recognize a gain of $10,000 (Sale Price $35,000 - AB $25,000). This $10,000 is nothing but the gain which you deferred in the Like-Kind exchange.

Example 2 - Boot with liability:

A taxpayer owns a warehouse used solely for business and that is worth $20,000 and has $5,000 of remaining secured debt but he purchased it for $35,000 and has taken depreciation of $18,000. The taxpayer exchanges this property for other real estate held for investment worth $18,000 and has $3,000 of remaining secured debt attached which the taxpayer agrees to assume from the other party.

Determine the gain or loss realized by the tax payer on the exchange?

Determine the gain or loss recognized by the tax payer on the exchange?

Determine the gain or loss deferred during the exchange?

Determine the taxpayer's basis in the new property.

Answer:

Here, we have both Liability relief of $5,000 as well as liability assumed of $3,000 and liability relief is more than liability assumed. So if we net together it will be considered as boot received of $2,000.

Realized amount: $20,000 (FMV of new Building - $18,000 & Liability relief (Boot received) - $2,000)

Less: AB of old Property: $17,000 (Cost $35,000 - Acc Dep $18,000)

Realized Gain= Realized amount - AB of old property = $20,000 - $17,000 = $3,000

Recognized Gain= $2,000 ( Lesser of realized gain or Boot received)

Deferred Gain= $1,000 (Realized gain - Recognized gain)

Basis of new property = FMV of new property received - Deferred gain + Deferred Loss = $18,000 - $1,000 = $17,000 (which is equal to our old asset basis)

Example 3 - Boot paid:

A taxpayer owns a warehouse used solely for business and that is worth $20,000 but he purchased it for $35,000 and has taken depreciation of $18,000. The taxpayer exchanges this property for other real estate held for investment worth $22,000 and agrees to pay $2,000 in cash in addition to the old warehouse

Determine the gain or loss realized by the tax payer on the exchange?

Determine the gain or loss recognized by the tax payer on the exchange?

Determine the gain or loss deferred during the exchange?

Determine the taxpayer's basis in the new property.

Answer:

Here we have a boot (cash) paid of $2,000

Realized amount: $22,000 (FMV of new Building - $22,000)

Less: AB of old Property: $17,000 (Cost $35,000 - Acc Dep $18,000)

Less: Boot Paid: cash $2,000

Realized Gain= Realized amount - AB of old property - Boot Paid= $22,000 - $17,000 - $2,000 = $3,000

Recognized Gain= 0 ( Lesser of realized gain or Boot received) (Boot paid will not trigger gain since we are considering it as purchase)

Deferred Gain= $3,000 (Realized gain - Recognized gain)

Basis of new property = FMV of new property received - Deferred gain + Deferred Loss = $22,000 - $3,000 = $19,000 (which is equal to our old asset basis plus Boot paid since we are considering it as a purchase)

Let's incase if we sell the new property in the same date for $22,000. Then we will recognize a gain of $3,000 (Sale Price $22,000 - AB $19,000). This $3,000 is nothing but the gain which you deferred in the Like-Kind exchange.