What is 1031? | The “Basics” | Terminology | Calculating Gain | Investment Newsletter

Determining the tax consequences of an exchange transaction begins with an understanding of the terms ìbasisî, ìadjusted basisî, ìgain,î and ìbootî:

Basis:
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.

Adjusted Basis:
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.

Example:

  $ 1,000,000 Basis In Property
+ $ 100,000 Capital Improvements
$ 200,000 Depreciation

  $ 900,000 (Adjusted Basis)

Gain:
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.

  $ 1,800,000 Sale Price
  $ 900,000 Adjusted Basis

  $ 900,000 Gain

Recognized gain is that portion of the ìrealized gainî which is taxable.

Boot:
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