Question

In a like-kind exchange, if there is a mortgage you are receiving/assuming and one you are giving up, is that a part of the AB? How does that fit into the calculation of finding a gain, loss and the new adjusted basis?

Answer 1

Yes, its a part of AB.

When property is exchanged in a like-kind exchange, the relinquished property (property given up) may have debt attached to it (whether a mortgage on real property or debt on personal property). Similarly, replacement property (property received) also may have a mortgage attached to it, and/or the taxpayer also may need to borrow money to complete the exchange.

Tax Consequences of Mortgage Assumption:

Debt affects the parties’ realized gain or loss and basis, because an assumption of liabilities is treated as boot (generally, money or other “unlike” property) received or paid. The assumption of liabilities impacts the parties in the following ways:

• If one taxpayer assumes a liability as part of the exchange, the taxpayer is treated as giving boot.
• A taxpayer whose liability is assumed is treated as receiving boot.
• If each taxpayer in the exchange assumes and relinquishes a liability, the liabilities are offset and only the excess is treated as boot.
• Boot given in the form of assumed liability cannot offset boot received in the form of cash or property.
• If a taxpayer does not assume the mortgage on mortgaged property received in the exchange, the taxpayer is treated as if the taxpayer assumed the mortgage

Example: Netting Mortgages. Sam owns Highland Properties (HP), and Ted owns Valley Park Estates (VPE), two like-kind properties. Sam relinquishes HP to Ted in exchange for VPE. Following is the information about each of these properties.
Highland Properties (HP)
FMV = $500,000
Sam’s mortgage = $425,000
Sam’s adjusted basis = $375,000

Pursuant to the exchange, Sam assumed Ted’s mortgage and Ted assumed Sam’s mortgage. Also, because Sam’s equity of $75,000 in HP ($500,000 FMV – $425,000 mortgage) is greater than Ted’s equity of $12,500 in VPE ($450,000 FMV – $437,500), Ted pays Sam the difference of $62,500 in cash ($75,000 – $12,500).

Sam’s gain is $125,000, which considers the shifting of mortgages between the properties:

Highland Properties debt shifted to Ted $425,000

+ Cash received (boot) 62,500

+ FMV of Valley Park Estates (replacement property) 450,000

– Basis of Highland Properties (relinquished property) (375,000)

– Valley Park Estates debt assumed (437,500)

Gain realized $125,000

Although Sam has a realized gain of $125,000, his recognized gain is $62,500 (recognized gain is limited to the amount of boot received; however, while Sam is allowed to net the mortgage he relinquished with the mortgage he assumed, he is not allowed to net the mortgage he assumed with the cash he received). In total he is able to defer $62,500 of gain.

Sam’s basis in the replacement property is $387,500, and, calculated as follows:
Adjusted basis of HP (relinquished property) $375,000
FMV of boot given (debt assumed) $437,500
Gain recognized $62,500
FMV of boot received ($425,000 debt transferred + $62,500) $(487,500)
Adjusted basis in VPE (replacement property) $387,500