A General Guide to Tax Deferred Exchanges
By: P. Patrick Ashouri, Esq.

Cost Basis: This is where all tax related calculations in an exchange begin. Cost Basis essentially refers to your original cost in acquiring a given property. Therefore, if the original purchase price of the property you anticipate exchanging was $275,000, your Cost Basis is $275,000.

Adjusted Basis: At the time of your exchange it is necessary to determine your current, or adjusted basis. This is accomplished by subtracting any depreciation reported previously, from the total of the original cost basis, plus the value of any improvements.

Capital Gain: “Realized Gain” and “Recognized Gain” are the two types of gain found in exchange transactions. Realized Gain reflects the difference between the total consideration or total value received for a given property and the adjusted basis.

Recognized Gain reflects that portion of the Realized Gain, which is ultimately taxable. The difference between realized and recognized gain exists because not all realized gain is ultimately determined to be taxable and issues such as boot can affect how and when gain is recognized.

Net Sales Price: This figure simply represents the sales price, less costs of sale.

Net Purchase Price: This figure simply represents the purchase price, less costs of purchase.

Boot: When considering an exchange of real property, the receipt of any consideration other than real property is determined to be “boot”. So, essentially, a working definition of boot is: any property received which is not considered like-kind. And remember, non like-kind property in an exchange is taxable. Therefore, boot is taxable.

There are two types of boot, which can occur, in any given exchange. They are mortgage boot and cash boot. Mortgage boot typically reflects the difference in mortgage debt, which can arise, between the exchange or relinquished property and the replacement property.

As a general rule, the debt on the replacement property has to be equal to, or greater than, the debt on the relinquished or exchange property. If it is less, you'll have what is called "overhanging debt" and the difference will be taxable.

Lets assume for example that you are selling your relinquished property for $375,000 and that it has a mortgage of $250,000. At closing, the mortgage will be paid off and the balance of $125,000 will be held y your facilitator.

Suppose that you then find a new property also costing $350,000, with a mortgage of $225,000 that you will assume. The assumption of this debt, along with your exchange trust fund of $125,000 will complete your purchase. Under this example you would have to pay tax on $25,000 of capital gains because your debt decreased by that amount.

Likewise, cash boot reflects the amount of cash or other value received.

New Adjusted Basis: This figure reflects the necessary adjustments to your basis after the replacement property is acquired. Since the amount of deferred gain must be considered, the calculation below will serve as a method for determining the new adjusted basis on the replacement property.

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