8667 / What are the tax consequences if a taxpayer receives consideration other than like-kind property in an exchange that qualifies for nonrecognition treatment?

Editor’s Note: The 2017 tax reform legislation limited the nonrecognition treatment provided under IRC Section 1031 to exchanges of real property that is not held primarily for sale.¹ This provision applies to exchanges occurring after December 31, 2017.

If a transaction otherwise qualifying for nonrecognition treatment under IRC Section 1031 involves the receipt of money or non-like-kind property (“boot”) in addition to the like-kind property received in the exchange, any realized gain on the exchange must be recognized to the extent of the value of the boot received, and the carryover or transferred basis must be adjusted.

Example: Joanne owns a business that has three warehouses. A few years later, Joanne transfers one of the warehouses, which had an adjusted basis of $45,000 and a fair market value of $48,000, to Calin, in exchange for vacant land with a fair market value of $42,000, and $6,000 in cash.

Joanne’s realized gain is $3,000 ($42,000 truck and $6,000 cash received, or $48,000 minus $45,000 basis). Because the cash is boot, Joanne must recognize gain to the extent of the boot. Joanne’s overall gain is $3,000 and the boot is $6,000. As a result, Joanne must recognize the entire $3,000 gain.

Joanne’s carryover basis is increased by the amount of any gain recognized and decreased by the amount of any money received.² As a result, in this case, Joanne’s basis of $45,000 is increased to $48,000 as a result of the $3,000 gain. That $48,000 basis is decreased by the amount of money received, $6,000, to $42,000. As a result, Joanne’s basis in the replacement property is $42,000. Therefore, if Joanne were to sell the land for $42,000 (its fair market value), she would have no gain or loss.³

Similarly, if the person who receives the like-kind property assumes a liability that secures the property, the transferor is treated as having received money to the extent of the assumed liability. If the property received in the exchange is also secured by a liability, then the boot deemed received is only the excess, if any, of the liability transferred with the original property over the liability assumed on the replacement property.⁴

Example: Al owns a warehouse with a basis of $160,000, a value of $200,000, and subject to a mortgage of $150,000. He transfers the warehouse to Asher in exchange for an office building with a value of $175,000, which is subject to a $125,000 mortgage.

From a strictly economic perspective, Al’s amount realized is the fair market value of the office building, $175,000, plus a net assumption by Asher of $25,000 of liability (Al’s property is subject to $150,000 mortgage and Asher’s property is subject to a $125,000 mortgage.) Thus, Al’s realized gain is $40,000 ($200,000 minus $160,000 basis).

Although the transaction is a like-kind exchange, Al must recognize the realized gain to the extent of the boot received. In this case, as a result of the transfer of mortgages, Al is deemed to have received $25,000 in cash ($150,000 minus $125,000).

Of the $40,000 realized gain, Al must recognize $25,000. The balance of the gain, $15,000, is not recognized.

Al’s carryover basis is adjusted as follows: The $160,000 basis is increased to $185,000 by the $25,000 of recognized gain. It is then decreased by $25,000, the amount of money Al is deemed to receive. As a result, Al’s basis in the office building is $160,000.

Therefore, if Al were to sell the office building for $175,000 (its fair market value), he would recognize $15,000 of gain. To recap, Al realized $40,000 of gain with respect to the exchange. Of that amount, $25,000 was immediately recognized and $15,000 was deferred.

Realized Gain Computation
Nonrecognized Portion of Gain
Amount Realized	$200,000
Basis	$160,000
Total Gain Realized	$40,000
Recognized Gain (Mortgage Boot)	$25,000
Deferred Gain	$15,000
Recognized Portion Of Gain (Boot)
Mortgage Given Up	$150,000
Mortgage Taken On	($125,000)
Boot	$25,000
Basis of Building Received
Carryover Basis From Property Given Up	$160,000
Plus: Gain Recognized	$25,000
Less: Cash Boot Deemed Received	($25,000)
Basis of Building Received	$160,000