Determining the tax consequences of an exchange transaction begins with an understanding of the terms ìbasisî, ìadjusted basisî, ìgain,î and ìbootî:
Basis is the starting point for determining the tax consequences in any transaction. In most cases the taxpayers ìbasisî is the original cost of the property. For an example, Investor A purchases a strip center for $1,000,000. This would make Investor Aís original basis $1,000,000.
At the time of selling the property and Taxpayer A is considering an exchange, Taxpayer A must understand his/hers specific tax consequences when selling. To establish the ìadjusted basisî of the soon to be relinquished property, Taxpayer A takes the original basis (cost of the property) and adds the cost of any capital improvements made to the property while Taxpayer A owned the property and subtract any depreciation taken.
|$||1,000,000||Basis In Property|
There are two types of gain ìrealized gainî and ìrecognized gain.î
Realized gain is the difference between the total consideration (Cash and Anything else of value) received for a property and the adjusted basis. Keep in mind transaction costs are deducted from the realized gain.
Recognized gain is that portion of the ìrealized gainî which is taxable.
In an exchange of real property, any consideration received other than real property is ìboot.î
Basis in Replacement Property:
Is the tax deferred by carrying over the taxpayerís adjusted basis in the relinquished property.
|$||900,000||Adjusted Basis in Relinquished Property|
|+||$||1,400,000||Additional Debt on Replacement Property|
|$||2,300,000||Basis in Replacement Property|