CES Boot and Gain Recognition 2 — Questions and Answers
Question 1: The adjusted basis of replacement property in a completed 1031 exchange is generally calculated as:
- The fair market value of the replacement property at acquisition
- The FMV of replacement property minus the deferred (unrecognized) gain (Correct answer)
- The original cost of the relinquished property plus improvements
- The net sale price of the relinquished property minus exchange costs
Correct answer: The FMV of replacement property minus the deferred (unrecognized) gain
The replacement property's basis equals its FMV minus the still-deferred gain, which effectively carries the built-in gain forward into the new property.
Question 2: A taxpayer's realized gain on the relinquished property is correctly calculated as:
- Amount realized (sale price less selling costs) minus the adjusted basis of relinquished property (Correct answer)
- Replacement property FMV minus relinquished property FMV
- Boot received minus qualifying exchange expenses
- Net equity in replacement property minus net equity in relinquished property
Correct answer: Amount realized (sale price less selling costs) minus the adjusted basis of relinquished property
Realized gain equals the amount realized (gross proceeds minus selling costs) less the adjusted basis of the property given up, following standard gain computation rules.
Question 3: In a fully qualifying 1031 exchange, depreciation recapture under IRC §1250 is:
- Immediately recognized as ordinary income at the time of the exchange
- Deferred along with the capital gain into the replacement property's basis (Correct answer)
- Permanently eliminated by the exchange transaction
- Only deferred on residential rental property, not commercial property
Correct answer: Deferred along with the capital gain into the replacement property's basis
A valid 1031 exchange defers both the capital gain and the §1250 depreciation recapture; the unrecognized gain and recapture carry into the replacement property's lower basis.
Question 4: A taxpayer can eliminate mortgage boot arising from reduced debt on replacement property by:
- Paying down the relinquished property's mortgage before listing the property
- Adding cash to the exchange or acquiring replacement property with equal or greater debt (Correct answer)
- Requesting a waiver from the IRS by filing Form 8824 with an explanation
- Splitting the transaction into two separate like-kind exchanges
Correct answer: Adding cash to the exchange or acquiring replacement property with equal or greater debt
Mortgage boot is neutralized when the taxpayer either contributes additional cash to the exchange or assumes debt on replacement property equal to or exceeding the debt relieved.
Question 5: Under the boot netting rules, which of the following can directly offset mortgage boot?
- Cash added by the taxpayer into the exchange (Correct answer)
- Cash received by the taxpayer from the qualified intermediary
- The qualified intermediary's escrow fee
- Depreciation allowed on replacement property after acquisition
Correct answer: Cash added by the taxpayer into the exchange
Cash contributed by the taxpayer to complete the exchange directly offsets mortgage boot, reducing net boot and the amount of gain recognized.
Question 6: Which of the following would NOT constitute boot in a 1031 exchange?
- Net mortgage relief of $50,000 from reduced debt on replacement property
- $10,000 in cash disbursed to the taxpayer at closing
- Personal property worth $5,000 received from the buyer
- An additional parcel of qualifying like-kind real estate received from the buyer (Correct answer)
Correct answer: An additional parcel of qualifying like-kind real estate received from the buyer
Like-kind real property received as part of the exchange is not boot; it qualifies for full tax deferral alongside the primary replacement property.
Question 7: When a taxpayer pays cash boot to the other party (rather than receiving it), the tax consequence to the paying taxpayer is:
- The cash paid is deductible as an exchange expense reducing taxable income
- No boot is received by the paying taxpayer, so no gain is triggered by that cash (Correct answer)
- The cash paid creates a tax credit equal to the capital gains rate times the amount paid
- The cash paid permanently reduces the taxpayer's realized gain on future dispositions
Correct answer: No boot is received by the paying taxpayer, so no gain is triggered by that cash
Boot taxation applies only to boot received; a taxpayer who pays cash into the exchange receives no boot from that payment and therefore triggers no additional gain recognition.
CES Boot and Gain Recognition 2
The adjusted basis of replacement property in a completed 1031 exchange is generally calculated as: