How is gain calculated in a partial 1031 exchange and are selling expenses included?
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In a partial §1031 exchange, the taxpayer exchanges real property held for productive use in a trade or business or for investment for like-kind real property, but also receives some "boot"—that is, money or non-like-kind property. In this scenario, the gain is recognized only to the extent of the boot received, and the calculation of gain and the treatment of selling expenses are governed by specific rules in the Internal Revenue Code, Treasury Regulations, and IRS guidance.
1. Calculation of Gain in a Partial §1031 Exchange
a. Realized Gain
The realized gain is the difference between the amount realized on the exchange and the adjusted basis of the property relinquished:
- Amount realized includes the fair market value (FMV) of the like-kind property received, any cash or non-like-kind property received, and any liabilities of the taxpayer assumed by the other party (or to which the property is subject), minus selling/exchange expenses.
- Adjusted basis is the taxpayer’s basis in the relinquished property, adjusted for improvements, depreciation, etc.
Formula:
Realized Gain = (FMV of like-kind property received + cash received + FMV of other property received + liabilities assumed by other party) – (selling/exchange expenses) – (adjusted basis of property given up)
b. Recognized Gain
Under §1031(b), if the taxpayer receives boot (money or non-like-kind property), the recognized gain is the lesser of:- The realized gain, or- The sum of the money and the FMV of the non-like-kind property received (the boot).
Formula:
Recognized Gain = Lesser of (Realized Gain, Net Boot Received)
c. Example
Suppose a taxpayer exchanges property with an adjusted basis of $100,000 for like-kind property worth $120,000 and receives $30,000 in cash, paying $5,000 in selling expenses.
- Amount realized: $120,000 (like-kind) + $30,000 (cash) = $150,000
- Less selling expenses: $150,000 – $5,000 = $145,000
- Less adjusted basis: $145,000 – $100,000 = $45,000 (realized gain)
- Recognized gain: Lesser of $45,000 (realized gain) or $30,000 (boot) = $30,000
2. Treatment of Selling/Exchange Expenses
Selling or exchange expenses (such as brokerage commissions, attorney fees, deed preparation fees, etc.) are subtracted from the amount realized in computing the realized gain. This reduces both the realized gain and the recognized gain (since the boot is effectively reduced by these expenses).
- IRS Revenue Ruling 72-456 and IRS Publication 544 confirm that selling expenses are subtracted from the total consideration received to determine the amount realized, and thus reduce the gain realized and the gain recognized in a partial exchange.
Example from Rev. Rul. 72-456:If a taxpayer receives $20,000 in like-kind property and $10,000 in cash, and pays a $2,000 brokerage commission:- Total received: $30,000- Less commission: $2,000- Amount realized: $28,000- Less basis: (e.g., $12,000)- Realized gain: $16,000- Recognized gain: $8,000 (lesser of realized gain or net cash received after offsetting commission)
3. Basis of Replacement Property
The basis of the like-kind property received is generally:- The basis of the property given up,- Decreased by any money received,- Increased by any gain recognized,- Increased by selling/exchange expenses paid.
Formula:
Basis of Replacement Property = Adjusted basis of relinquished property – money received + gain recognized + selling/exchange expenses paid
4. Summary of Key Points
- In a partial §1031 exchange, the recognized gain is limited to the amount of boot received (money and non-like-kind property), after reducing the boot by selling/exchange expenses.
- Selling/exchange expenses are subtracted from the total consideration received to determine the amount realized, thus reducing both realized and recognized gain.
- The basis of the replacement property is adjusted for the recognized gain, money received, and selling/exchange expenses.
In summary: Gain in a partial §1031 exchange is calculated as the amount realized (including all property and boot received, minus selling/exchange expenses) minus the adjusted basis of the relinquished property. Recognized gain is limited to the net boot received. Selling/exchange expenses are included in the calculation by reducing the amount realized, thereby reducing both realized and recognized gain.
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