Tax 4-2 Analyze a situation to calculate the gain or loss realized, the gain or loss recognized, or the substituted basis for a like-kind exchange.

Question 1

Computations for a Like Kind Exchange

The gain recognized is always [the greater or the lesser of] the gain realized or the boot received.

(4-2, 14)

Answer 1

lesser of

Question 2

Computations for a Like Kind Exchange

We calculate the substituted basis in the acquired property. This is accomplished by…

(4-2, 14)

Answer 2

Reducing the fair market value of the qualifying property received by the amount of the gain that was realized but not recognized.

This currently untaxed gain reduces the basis in the acquired property, such that when the property is sold, there is a larger gain.

Question 3

Computations for a Like Kind Exchange

Assume Michelle Logan has a vending cart out of which she sells food to local businesses during the lunch hour. The vending cart has a fair market value (FMV) of $9,000 and an adjusted basis of $2,000. Michelle still owes $4,000 on the cart. Linda Prescott has offered to trade her newer vending cart, which has a fair market value of $5,000 and an adjusted basis of $3,000, for Michelle’s vending cart in an even exchange. Linda also agrees to take over the payments on the vending cart. The results of the like-kind exchange can be summarized as follows:

1. Calculate Michelle’s realized gain or loss:

(4-2, 14)

Answer 3

$5,000 FMV of property received 
- $4,000 FMV of discharged liability
= $9,000 Total amount realized
-  $2,000 Less adjusted basis of property given up
= $7,000 Gain realized

Without the special like-kind exchange provision, the gain realized of $7,000 would also be recognized; that is, it would be subject to inclusion in computing taxable income.

Question 4

Computations for a Like Kind Exchange

Exchanges of insurance products. Section _____ of the Internal Revenue Code governs tax treatment on the exchange of one life insurance policy for another.

(4-2, 15)

Answer 4

1035

It specifically states that no gain or loss shall be recognized on the exchange of one life insurance contract for another life insurance contract or annuity. This rule also applies to the exchange of an annuity contract for another annuity contract.

Question 5

Computations for a Like Kind Exchange

Module Check

1. In a like-kind exchange, a loss:
   a. may be recognized within certain limitations.
   b. may be recognized without limitation.
   c. may be recognized only by the taxpayer who pays boot.
   d. may not be recognized.

(LO 4-2)

Answer 5

d. may not be recognized.

Losses may not be recognized (deducted) in a like-kind exchange.

Question 6

Computations for a Like Kind Exchange

Module Check

2. The substitute basis of the qualifying asset received in a like-kind exchange is the asset’s:
   a. basis reduced by the gain realized but not recognized.
   b. basis increased by the gain realized but not recognized.
   c. fair market value reduced by the gain realized but not recognized.
   d. fair market value increased by the gain realized but not recognized.

(LO 4-2)

Answer 6

c. fair market value reduced by the gain realized but not recognized.

The substitute basis of a qualifying asset received in a like-kind exchange is the asset’s fair market value reduced by (not increased by) the gain realized but not recognized.

The deferred gain reduces the basis of the acquired asset, such that when that asset is sold, there is a larger gain recognized.

Question 7

Computations for a Like Kind Exchange

Module Check

9. In the computation of the realized gain in a like-kind exchange, it is necessary to compare the
   a. fair market value of the assets received with the adjusted basis of the assets given up.
   b. fair market value of the assets received with the fair market value of the assets given up.
   c. adjusted basis of the assets received with the adjusted basis of the assets given up.
   d. adjusted basis of the assets received with the fair market value of the assets given up.

(LO 4-2)

Answer 7

a. fair market value of the assets received with the adjusted basis of the assets given up.

The gain realized is what really happened in a transaction.

What was received (measured in fair market value) is compared to what was given up (measured in adjusted basis). The difference is the gain realized.

Question 8

Computations for a Like Kind Exchange

Module Check

10. Bob is involved in a like-kind exchange. In the exchange, he assumes a mortgage of $15,000, is relieved of a mortgage of $26,000, and receives $7,000 in cash. How much boot did Bob receive in the transaction?
11. $7,000
12. $11,000
13. $18,000
14. $33,000

(LO 4-2)

Answer 8

3. $18,000

$26,000 old mortgage
- $15,000 new mortgage
= $11,000 net debt relief

$11,000 net debt relief
+ $7,000 cash received
= $18,000 boot

The net debt relief is considered to be boot, as is the cash received. The net debt relief of $11,000 plus the cash received of $7,000 equals $18,000.

Question 9

Computations for a Like Kind Exchange

Module Check

15. Robert McCallum has a truck that he uses to make deliveries for his business. The truck has a fair market value of $21,000 and an adjusted basis of $10,000. Robert still owes $9,000 on the truck. Pasqual Mendez has offered to trade his truck for Robert’s truck in an even trade, taking over payments on Robert’s truck. Pasqual’s truck has a fair market value of $12,000 and an adjusted basis of $10,000.

Calculate Robert’s gain or loss realized, the gain or loss recognized, and the substituted basis of the acquired asset.

(LO 4-2)

Answer 9

Step 1: Calculate Robert’s realized gain or loss

$12,000 (FMV of property received)
+ $9,000 (liability assumed by other party)
= $21,000
- $10,000 (adjusted basis of property given)
= $11,000

Step 2:  Calculate Robert’s recognized gain or loss
Lesser of 
  $11,000 realized gain  
  or
  $9,000 boot received  
= $9,000 boot received

Step 3: Calculate gain realized but not recognized
$11,000 (Gain realized)
- $9,000 (gain recognized)
= $2,000 Gain realized but not recognized

Step 4: Calculate the substituted basis in the acquired asset.
$12,000 (FMV of qualifying property received)
- $2,000 (gain realized but not recognized)
= $10,000 (Substituted basis in property received)

Question 10

Computations for a Like Kind Exchange

Module Check

17. Bill Walsh has a truck he uses in his business. The truck’s fair market value is $14,000, and Bill’s adjusted basis in the truck is $8,000. Bill still owes $5,000 on the truck. Sharon Moore has offered to trade him her small delivery van in an even trade in which she would take over the payments on Bill’s truck. Sharon’s van has a fair market value of $10,000 and her adjusted basis in it is $6,000.

Calculate Bill’s recognized gain, if any, from the exchange.

$0

$5,000

$7,000

$8,000

(LO 4-2)

Answer 10

$5,000

Step 1:
Calculate realized gain or loss.

$10,000 FMV of property received
+ $5,000 boot received (debt assumed by other party)
- $8,000 adjusted basis
= $7,000 Realized gain

Step 2:
Calculate gain recognized.

Lower of realized gain or
boot received

$7,000 or $5,000 = $5,000

Question 11

Computations for a Like Kind Exchange

Practice Test 1

51. John Smith owns a warehouse that has a fair market value of $125,000 and an adjusted basis of $62,000. He wants to acquire Mark Price’s duplex, which has a fair market value of $100,000 and an adjusted basis of $47,000. In the contemplated exchange, Mark will pay John $25,000 in cash.

What is John’s substitute basis in the acquired duplex?

(LO 4-2)

Answer 11

$62,000

  $100,000 FMV of property received
\+ $25,000 Cash Received (Boot)
\+ $0 Debt assumed by other party (Boot)
- $62,000 Adjusted basis of property given
- $0	Cash given to other party
- $0	Debt assumed by self
= $63,000 Realized Gain (or Loss)

Lower of
$63,000 Realized Gain (or Loss)
$25,000 Boot (cash received, debt relieved)
= $25,000 Gain Recognized

$63,000 Realized Gain (or Loss)
- $25,000 Gain Recognized
= $38,000 Gain Realized but Not Recognized

$100,000 FMV of property received
- $38,000 Gain Realized but Not Recognized
= $62,000 Substituted Basis

$25,000 Gain Recognized is subject to taxation

Question 12

Computations for a Like Kind Exchange

65. The substitute basis of a qualifying asset received in a like-kind exchange is
66. the asset’s basis reduced by the gain realized but not recognized.
67. the asset’s basis increased by the gain realized but not recognized.
68. the asset’s fair market value reduced by the gain realized but not recognized.
69. the asset’s fair market value increased by the gain realized but not recognized.

(LO 4-2)

Answer 12

3. the asset’s fair market value reduced by the gain realized but not recognized.

The substitute basis of a qualifying asset received in a like-kind exchange is the asset’s fair market value reduced by the deferred gain (the gain realized but not recognized). This deferred gain reduces the basis of the acquired asset, such that when that asset is sold, there is a larger gain recognized.

Question 13

Computations for a Like Kind Exchange

Vince Torrel is considering trading a refrigerator that he uses in his tavern for a freezer that Jane Watkins has in her basement. The fair market value of the refrigerator is $850, and Vince’s adjusted basis is $125. The fair market value of the freezer is $850, and Jane’s adjusted basis is $175. Vince plans to use the freezer in his tavern. Assume that the exchange is like-kind.

Calculate Vince’s gain or loss realized, the gain or loss recognized, and the substituted basis of the acquired asset.

(LO 4-2, pg 57 of text)

Answer 13

$850 FMV of property received
\+ $0 Cash Received (Boot)
\+ $0 Debt assumed by other party (Boot)
- $125 Adjusted basis of property given
- $0	Cash given to other party
- $0	Debt assumed by self
= $725 Realized Gain (or Loss)

Lower of
$725 Realized Gain (or Loss)
$0 Boot (cash received, debt relieved)
= $0 Gain Recognized

$725 Realized Gain (or Loss)
- $0 Gain Recognized
= $725 Gain Realized but Not Recognized

$850 FMV of property received
- $725 Gain Realized but Not Recognized
= $125 Substituted Basis

Question 14

Computations for a Like Kind Exchange

Sandy Matlin owns a delivery van that she uses in her business. The van’s fair market value is $7,700, and the adjusted basis is zero. She is considering trading it for Tom Van Raden’s light truck. Tom’s truck has a fair market value of $6,700, and the adjusted basis is $4,300. Tom also is offering $1,000 cash for the trade. Assume that the exchange is likekind.

Calculate Sandy’s gain or loss realized, the gain or loss recognized, and the substituted basis of the acquired asset.

(LO 4-2, pg 58 of text)

Answer 14

$6,700 FMV of property received
\+ $1,000	Cash Received (Boot)
\+ $0 Debt assumed by other party (Boot)
- $0	Adjusted basis of property given
- $0	Cash given to other party
- $0	Debt assumed by self
= $7,700	Realized Gain (or Loss)

Lower of
$7,700 Realized Gain (or Loss)
$1,000 Boot (cash received, debt relieved)
= $1,000 Gain Recognized

$7,700 Realized Gain (or Loss)
- $1,000 Gain Recognized
= $6,700 Gain Realized but Not Recognized

$6,700 FMV of property received
- $6,700 Gain Realized but Not Recognized
= $0 Substituted Basis

Question 15

Computations for a Like Kind Exchange

Juanita Foster operates a financial planning business. She has a computer (asset class 00.12) with a fair market value of $2,300 and an adjusted basis of $1,000. Juanita has offered to trade the computer and $1,200 cash for Wanda Lane’s printer (also asset class 00.12). The printer has a fair market value of $3,500, and Wanda’s adjusted basis in the machine is $2,000.

Calculate Juanita’s gain or loss realized, the gain or loss recognized, and the substituted basis of the acquired asset.

(LO 4-2, pg 59 of text)

Answer 15

$3,500 FMV of property received
\+ $0 Cash Received (Boot)
\+ $0 Debt assumed by other party (Boot)
- $1,000 Adjusted basis of property given
- $1,200 Cash given to other party
- $0	Debt assumed by self
= $1,300	Realized Gain (or Loss)

Lower of
$1,300 Realized Gain (or Loss)
$0 Boot (cash received, debt relieved)
= $0 Gain Recognized

$1,300 Realized Gain (or Loss)
- $0 Gain Recognized
= $1,300 Gain Realized but Not Recognized

$3,500 FMV of property received
- $1,300 Gain Realized but Not Recognized
= $2,200 Substituted Basis

Question 16

Computations for a Like Kind Exchange

Robert McCallum has a truck he uses to make deliveries for his business. The truck has a fair market value of $21,000 and an adjusted basis of $10,000. Robert still owes $9,000 on the truck. Pasqual Mendez has offered to trade his truck as an even trade and take over payments on Robert’s truck. Pasqual’s truck has a fair market value of $12,000 and an adjusted basis of $10,000.

Calculate Robert’s gain or loss realized, the gain or loss recognized, and the substituted basis of the acquired asset.

(LO 4-2, pg 61 of text)

Answer 16

$12,000 FMV of property received
+ $0 Cash Received (Boot)
+ $9,000 Debt assumed by other party (Boot)
- $10,000 Adjusted basis of property given
- $0 Cash given to other party
- $0 Debt assumed by self
= $11,000 Realized Gain (or Loss)

Lower of
$11,000 Realized Gain (or Loss)
$9,000 Boot (cash received, debt relieved)
= $9,000 Gain Recognized

$11,000 Realized Gain (or Loss)
- $9,000 Gain Recognized
= $2,000 Gain Realized but Not Recognized

$12,000 FMV of property received
- $2,000 Gain Realized but Not Recognized
= $10,000 Substituted Basis

Question 17

Computations for a Like Kind Exchange

Marge Michaels owns a small office building with a fair market value of $175,000 and an adjusted basis of $80,000. Paul Dean has offered to trade a fourplex with a fair market value of $200,000 and an adjusted
basis of $125,000 for Marge’s property. They have agreed to assume each other’s mortgages on the properties. Marge’s office building is subject to a $50,000 mortgage, and Paul’s fourplex is subject to a
mortgage of $100,000. Paul has offered to pay Marge $25,000 in cash to complete the deal.

Calculate Marge’s gain or loss realized, the gain or loss recognized, and the substituted basis of the acquired asset.

(LO 4-2, pg 62 of text)

Answer 17

$200,000 FMV of property received
+ $25,000 Cash Received (Boot)
+ $50,000 Debt assumed by other party (Boot)
- $80,000 Adjusted basis of property given
- $0 Cash given to other party
- $100,000 Debt assumed by self
= $95,000 Realized Gain (or Loss)

Lower of
$95,000 Realized Gain (or Loss)
$25,000 Boot (cash received, debt relieved)
= $25,000 Gain Recognized

$95,000 Realized Gain (or Loss)
- $25,000 Gain Recognized
= $70,000 Gain Realized but Not Recognized

$200,000 FMV of property received
- $70,000 Gain Realized but Not Recognized
= $130,000 Substituted Basis

$25,000* boot received (*Mortgage assumption not included as boot because she assumed a greater liability than the other party assumed.)

Question 18

Computations for a Like Kind Exchange

Hugh Windomere and Willy Day both collect Oriental rugs for investment purposes. Hugh has a relatively common large rug in his collection with a fair market value of $30,000 and an adjusted basis of $10,000. Willy has offered to trade a rare rug in his collection for Hugh’s much larger rug. Willy’s rare rug has a fair market value of $18,000 and an adjusted basis of $7,750. Hugh is also to receive cash of $12,000.
Calculate Hugh’s gain or loss realized, the gain or loss recognized, and the substituted basis of the acquired asset.

(LO 4-2, pg 62 of text)

Answer 18

$18,000 FMV of property received
\+ $12,000 Cash Received (Boot)
\+ $0 Debt assumed by other party (Boot)
- $10,000 Adjusted basis of property given
- $0	Cash given to other party
- $0	Debt assumed by self
= $20,000 Realized Gain (or Loss)

Lower of
$20,000 Realized Gain (or Loss)
$12,000 Boot (cash received, debt relieved)
= $12,000 Gain Recognized

$20,000 Realized Gain (or Loss)
- $12,000 Gain Recognized
= $8,000 Gain Realized but Not Recognized

$18,000 FMV of property received
- $8,000 Gain Realized but Not Recognized
= $10,000 Substituted Basis

Question 19

Computations for a Like Kind Exchange

Morgan Russell is contemplating the exchange of a vacant lot that he owns for another parcel of land. Morgan is not a dealer in property, and he purchased the lot he owns for investment purposes. Morgan’s vacant lot has a fair market value of $54,000 and an adjusted basis of $40,000. The land he wants to acquire has a fair market value of $36,000, and its owner has an adjusted basis in it of $24,000. Morgan is also to receive $6,000 in cash and an automobile with a fair market value of $12,000.

Calculate Morgan’s gain or loss realized, the gain or loss recognized, and the substituted basis of the acquired asset.

(LO 4-2, pg 62 of text)

Answer 19

$36,000 FMV of property received
\+ $18,000 Cash Received (Boot)
\+ $0 Debt assumed by other party (Boot)
- $40,000 Adjusted basis of property given
- $0	Cash given to other party
- $0	Debt assumed by self
= $14,000 Realized Gain (or Loss)

Lower of
$14,000 Realized Gain (or Loss)
$18,000 Boot (cash received, debt relieved)
= $14,000 Gain Recognized

$14,000 Realized Gain (or Loss)
- $14,000 Gain Recognized
= $0 Gain Realized but Not Recognized

$36,000 FMV of property received
- $0 Gain Realized but Not Recognized
= $36,000 Substituted Basis

Question 20

Practice Test 2

Computations for a Like Kind Exchange

32. Dave Oldham owns office equipment that has a fair market value of $45,000 and an adjusted basis of $18,000. Through an exchange, he acquires some office furniture from Frances Ford that has a fair market value of $80,000 and an adjusted basis of $50,000. In the exchange, Dave pays Frances $35,000.

What is Dave’s substitute basis in the acquired property?

$18,000

$35,000

$50,000

$53,000

(LO 4–2)

Answer 20

$53,000

  $80,000 FMV of property received
\+ $0 Cash Received (Boot)
\+ $0 Debt assumed by other party (Boot)
- $18,000 Adjusted basis of property given
- $35,000 Cash given to other party
- $0	Debt assumed by self
= $27,000 Realized Gain (or Loss)

Lower of
$27,000 Realized Gain (or Loss)
$0 Boot (cash received, debt relieved)
= $0 Gain Recognized

$27,000 Realized Gain (or Loss)
- $0 Gain Recognized
= $27,000 Gain Realized but Not Recognized

$80,000 FMV of property received
- $27,000 Gain Realized but Not Recognized
= $53,000 Substituted Basis