Like-Kind Exchange With Cash and Mortgage Boot
Tanya owns a duplex that she has rented 100% to tenants since 2015. Its fair market value is $900,000, its adjusted basis is $320,000, and it is subject to a $250,000 mortgage. She wants to exchange it for a single-family rental. On May 1, 2024, she transfers the duplex to a qualified intermediary. On June 10, 2024 (day 40), she identifies three replacement properties in writing. On October 23, 2024 (day 175), she closes on one replacement property with a fair market value of $700,000, subject to a $100,000 mortgage, and she receives $50,000 cash to balance the equity. Tanya has claimed $180,000 of depreciation on the duplex. She files her return on extension. She wants to know how much gain she must recognize, what character it has, and what her basis will be in the replacement property. She did not identify any other property.
1. Does the exchange qualify under §1031? Address the timing rules.
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The exchange qualifies. Section 1031 applies to real property held for productive use in a trade or business or for investment and exchanged for real property of like kind. Both properties are rental real property. Tanya used a qualified intermediary and identified replacement property in writing on day 40, within the 45-day identification period. She closed on day 175, within the 180-day exchange period. Because she files on extension, the 180-day period is not shortened by the return due date. The cash and mortgage boot do not disqualify the exchange; they trigger partial recognition.
2. Compute Tanya's realized gain, recognized gain, and character.
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Realized gain = $900,000 FMV - $320,000 adjusted basis = $580,000.
Boot received = $50,000 cash + ($250,000 mortgage relieved - $100,000 mortgage assumed) = $50,000 + $150,000 = $200,000.
Recognized gain = lesser of realized gain ($580,000) or boot ($200,000) = $200,000.
Character: $180,000 is unrecaptured §1250 gain attributable to depreciation, taxed at a maximum 25% rate. The remaining $20,000 is long-term capital gain. The $380,000 balance is deferred.
3. Compute Tanya's basis in the replacement property and explain what would change if she had identified on day 50.
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Basis in the replacement property = adjusted basis of relinquished property + gain recognized - boot received = $320,000 + $200,000 - $200,000 = $320,000. Equivalently, FMV $700,000 - deferred gain $380,000 = $320,000.
If Tanya had identified on day 50, she would have missed the 45-day deadline. The exchange would fail, and she would be treated as selling the duplex for $900,000. She would recognize the full $580,000 gain: $180,000 unrecaptured §1250 gain and $400,000 long-term capital gain. Her basis in the replacement property would be its $700,000 cost.