Discussion:1031 Exchange "Net Boot" Question

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Discussion Forum Index --> Tax Questions --> 1031 Exchange "Net Boot" Question


PVVCPA (talk|edits) said:

14 January 2007
The following 1031 Exchange question seems simple, or does it?

Assume this is a Deferred Exchange utilizing a Qualified Intermediary.

Relinquished Property: Basis $75,000 Sale price $100,000, Loan $0, Exchanger receives boot $10,000, Funds to Qualified Intermediary $90,000.

Replacement Property: Purchase price $120,000, Loan $0, Funds from QI $90,000 Funds from exchanger $30,000

Does the exchanger have a recognized gain?

Those of you that think "Yes" should try running this exchange through your 1031 exchange software or worksheet.

Riley2 (talk|edits) said:

14 January 2007
The answer to your question would vary according to whether the exchange agreement contains the "safe-harbor" language. If the agreement contains the safe-harbor language, the exchanger would not receive the cash until escrow for the replacement property is closed out, in which case the $10,000 in cash received is netted against the $30,000 in cash given. If the safe-harbor language is not present, then the $10,000 in cash received is treated as boot received.

PVVCPA (talk|edits) said:

14 January 2007
If the seller did receive $10,000 of boot at the time of the sale of the relinquished property, then would he have a $10,000 recognized gain?

Or does the fact that he traded up on properties preclude him from recognizing gain?

Blrgcpa (talk|edits) said:

15 January 2007
Sounds like a gain. Everything s/b through the qi.

Riley2 (talk|edits) said:

16 January 2007
If the seller received $10,000 at the time of the sale, then the safe harbor language was not present and this is not a QI arrangment. Yes, the $10,000 gain is taxable.

PVVCPA (talk|edits) said:

16 January 2007
So, let me confirm: The exchanger has a recognized gain of $10,000 and a deferred gain of $15,000. His basis in the replacement property is then $105,000 ($120,000 Purchase, less $15,000 deferred gain). Is this right?


So even though he traded for a higher FMV property, he does not get to eliminate that boot that he received from the sale of the relinquished property?


Mostly all exchange worksheets I have used, calculate boot by merely looking at the change in the FMV of the properties and subtracting exchange expenses. They completely ignore whether or not any boot came out on the sale of the relinquished properties. Those exchange worksheets would say there is no gain in this example.

Kevinh5 (talk|edits) said:

17 January 2007
If the boot had been used for exchange expenses, instead of purchase price, the answer could be different. Try allocating part of the $30k to exchange expenses and see what I mean.

Dennis (talk|edits) said:

17 January 2007
No. The problem is that the worksheets assume the entire transaction is completed through the QI.

Kevinh5 (talk|edits) said:

17 January 2007
scrap the worksheets and face reality.

If part of what he paid for with the $30K is expenses, there are 3 ways of handling these. If you only have 1 set of worksheets you are limited by not knowing about the other 2 ways to deal with cash paid and cash received.

PVVCPA (talk|edits) said:

17 January 2007
Dennis, you are probably right about the assumption. However, that would be an inappropriate assumption as almost every exchange I have seen has had at least a small amount of boot coming out at the sale of the relinquished property. Usually it is a proration of rents or property taxes, or a transfer of security deposits.

Kevinh5 (talk|edits) said:

17 January 2007
often just the acceptance of earnest money is boot received

Death&Taxes (talk|edits) said:

17 January 2007
The transfer of security deposits, proration of rents and property taxes have nothing to do with the selling, but are only part of the transfer and would be so if the transaction were a gift, or that rarity, a same-day swap. These are rental income, expenses or escrow, just as the return of escrowed monies by the mortgage company would be so. These differ from earnest money.

PVVCPA (talk|edits) said:

18 January 2007
D&T, I am not sure if I understand what you are getting at in your last post. While these "transfers" are not the receipt of earnest money, they would still be considered the receipt of boot. Right?

PVVCPA (talk|edits) said:

9 February 2007
Similar discussion exists at Discussion:1031 EXCHANGE-mortgage

Linuxcpa (talk|edits) said:

11 March 2008
The problem I see with the deferred exchange is the divergence between Form 8824's instructions and the reality of a deferred 1031 exchange. A traditional exchange does not include a sale with mortgage payoff and then subsequent purchase and cash payment and or new mortgage. I have yet to see any IRS treasury regulation address this fundamental difference. The regs deal with only two parties, not 4 pretending to be two. The presence of the intermediary can't alleviate a difference between the net value given up by the two parties. Form 8824 doesn't scale to this possibility.

The gain to recognize should be limited to the net excess of debt relief plus cash over cash paid and debts assumed. Keep in mind that this has to be outside of the envelope of the 1031 exchange itself. If the intermediary cuts a check to the client, that protective envelope is pierced, and that is a part of the total boot.

Form 8824's instructions ask us to calculate a deferred gain based upon the fair market value of the property received and not the sales price as shown on relinquishment escrow statement. It is designed to approach the capital gain deferral calculation in a backwards manner, which will work if only two parties are involved exchanging by definition the same dollar value of net assets.

Form 8824 does not include steps to ensure that the taxable gain and basis is properly calculated under all circumstances. The loophole in circumstance will arise when the pretend parties two parties do not exchange the same dollar value of net assets. Form 8824 treats this variance as a part of "Net Amount Paid to the Other Party."

Fundamentally, a gain on a rental property is calculated as follows:

1. Subtract accumulated depreciation from the cost of the property. This is the adjusted basis.

2. Subtract the adjusted basis from the sale price of the property. This is the realized gain. How much to recognize as taxable income is the question.

The portion of the gain that is not taxable should be subtracted from the cost of the replacement property to arrive at its adjusted basis. This basis is then used when calculating future depreciation and capital gains.

If the IRS instructions for Form 8826, line 18 are followed, the realized and ultimately deferred gain calculated on line 19 will be understated by the sum of the following three amounts: 1.) The net increase of the mortgage obligation 2.) Any out of pocket cash provided to the Qualified Intermediary in acquiring the new property. 3) The net FMV of any other non-like property relinquished in the exchange.

So yes, its no wonder there is confusion.

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