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The Exchange Equation: Balancing the Exchange


The Exchanger can quickly calculate whether there will be recognized gain based on the following principals:

  1. Taxable boot is defined as non like-kind property the Exchanger may receive as part of an exchange. Cash boot is the receipt of cash and mortgage boot (also referred to as debt relief) is a reduction in the Exchanger’s mortgage liabilities on a replacement property. Generally, capital gain income is recognized (and therefore taxable) to the extent there is boot.

  2. For a fully deferred exchange, an Exchanger must reinvest all net equity and acquire property with the same or greater debt. Compare the relinquished property with the replacement property in terms of: Value, Net Equity (after deducting costs of sale) & Debt.

Example 1

The Exchanger is acquiring property of greater value, reinvesting the entire net equity and increasing the mortgage on the replacement property. Analysis: There is no boot and no recognized gain.

Example 2

The Exchanger keeps $50,000 of the exchange proceeds, reinvesting only $150,000 as a down payment on the replacement property. Analysis: There is $50,000 of cash boot which results in recognized (taxable) gain.

Example 3

The Exchanger acquires property of a lower value and while reinvesting all equity in the replacement property, acquires less debt in the process. Analysis: The Exchanger has reduced the debt by $100,000 (mortgage boot) which results in a recognized (taxable) gain.

Download a one page PDF of this information: The Exchange Equation

Special thanks to Asset Preservation Inc., a 1031 Exchange Company

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