When you receive cash other than the like-kind property in a like-kind exchange, the cash is treated as “boot.” Boot does not render the transaction ineligible for non-recognition treatment but it does require you to recognize gain to the extent of the cash received. The same is true for other non-like-kind property in a like-kind exchange. In other words, anything you receive in addition to the like-kind property, such as relief from debt from a mortgage or additional property that is not like-kind will force you to recognize the gain realized.
An example helps to show the gain computation and basis adjustments in a like-kind exchange where boot is received:
You want to transfer land with an adjusted basis of $70,000 and a fair market value of $100,000 in a like-kind exchange. As replacement property you will receive land from Charlie that is like-kind to the one you will transfer. However, Charlie’s land has a fair market value of only $80,000. To equalize the value of the like-kind properties being exchanged, Charlie will give you $20,000 in cash. Because the $20,000 is not like-kind property, the like-kind exchange rules treat it as boot and you will have to recognize gain to that extent. Your computation will be as follows:
$80,000 FMV of like-kind land received
+$20,000 cash received
$100,000 Your amount realized
– $70,000 Your adjusted basis of the land transferred
$30,000 Realized gain
However, because you will receive only $20,000 of cash (boot), you will recognize only $20,000 of the gain realized. The rest of the gain or $10,000 will be preserved for a future date when the acquired property is recognized in a taxable transaction as a result of your like-kind exchange.
Basis adjustment. Gain that is not recognized when cash is present in a like-kind exchange will be “preserved” by adjusting your basis in the new property to reflect the remaining gain. The basis rules achieve the gain preservation by first allocating the gain realized to boot to the extent of its fair market value, then to the like-kind property in proportion to its relative fair market value in the like-kind exchange.
The basis of the acquired property will be the adjusted basis of the property transferred, increased by recognized gain and decreased by loss recognized or money received in the exchange. In the above example, your adjusted basis in the replacement property will be $70,000. Because the fair market value of the replacement property is $80,000, the $10,000 of realized but unrecognized gain will be preserved in your adjusted basis.
Cash in excess of gain. In addition, if the fair market value of boot received exceeds the gain realized, only this amount of realized gain is recognized.
If, in our example, your adjusted basis were $90,000, your realized gain would only be $10,000 ($100,000 amount realized minus $90,000 adjusted basis). In that case, your recognized gain would be limited to $10,000 even though you received $20,000 in cash.
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Contributed by David Gentile, Gentile Pismeny & Brengel, LLP
Certified Public Accountants and Advisors