Category: Nontaxable Exchanges; Real Estate
Subject: Section 1031 Exchanges
Title: Boot
IRC Sections: 1031
Filename: 1226.html
Date Produced: 05/95

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Background
Individual taxpayer, TP, owns a second home in Connecticut with a fair market value of $230,000, basis of $130,000, and a mortgage of $100,000. TP plans to enter into a transaction intended to qualify as an exchange under Section 1031 whereby through a facilitator TP will end up with a property in New York, also a second residence, with a fair market value of $200,000 and a mortgage of $70,000.

Issue
Assuming the transaction qualifies in every respect under Section 1031, will TP be required to recognize gain by reason of having received nonqualifying property (boot)?

Answer
TP has received $30,000 of boot and will be required to recognize gain in that amount.

Discussion
First, ignore all the machinations involving the facilitator and consider only what TP receives in the exchange and what TP relinquishes in the exchange. In the final analysis, TP gives up a property worth $230,000 with a $100,000 mortgage for a property worth $200,000 with a $70,000 mortgage.

It is clear that relief of indebtedness counts as boot for purposes of Section 1031. Reg. Sec. 1.1031(b)-1(c).

(c) Consideration received in the form of an assumption of liabilities (or a transfer subject to a liability) is to be treated as "other property or money" for the purposes of section 1031(b). Where, on an exchange described in section 1031(b), each party to the exchange either assumes a liability of the other party or acquires property subject to a liability, then, in determining the amount of "other property or money" for purposes of section 1031(b), consideration given in the form of an assumption of liabilities (or a receipt of property subject to a liability) shall be offset against consideration received in the form of an assumption of liabilities (or a transfer subject to a liability). See §1.1031(d)-2, examples (1) and (2). [Reg. §1.1031(b)-1.]

Clearly, TP can reduce the amount of boot received by the amount of liabilities assumed or taken subject to with respect to the New York property, but to the extent TP has net debt relief, that net amount is considered boot. The regulations do not contain an appropriate example, but consider the following passage, particularly the example, from BNA, Tax Management Portfolio 567-1st.

Existing regulations provide that if each party to an exchange either assumes a liability of the other party or acquires property subject to a liability, then, in determining the amount of money received, consideration given in the form of an assumption of liabilities or a receipt of property subject to a liability is netted against consideration received in the form of an assumption of liabilities or a transfer subject to a liability. \419/ A change included in proposed regulations, but not adopted in final regulations, would have amended the existing regulations to "clarify" that this rule would not apply to the extent of any liabilities incurred by the taxpayer in anticipation of an exchange under Section 1031. See the discussion in VII, C, 4, c, below. \419/ Regs. Section 1.1031(b)-1(c). Under existing regulations, consideration given in the form of cash or other property is netted against consideration received in the form of an assumption of a liability or a transfer of property subject to a liability. Consideration received in the form of cash or other property is not, however, netted against consideration given in the form of an assumption of liabilities or a receipt of property subject to a liability. \420/ \420/ See the examples in Regs. Section 1.1031(d)-2; Coleman v. Comr., fn. 417, above.

Example 1: A taxpayer, in a transaction qualifying under Section 1031, surrenders property (with a fair market value of $200 and subject to a liability of $100) in exchange for property (with a fair market value of $150 and subject to a liability of $50). Since the transaction resulted in a reduction of $50 in the amount of liabilities to which the taxpayer's property was subject, he is deemed to have received boot to that extent. If the transaction were reversed, the taxpayer would have received no boot in the exchange since he experienced a net increase in indebtedness.

It seems very clear to me that the presence or absence of the facilitator makes absolutely no difference to the result set forth above. The regulations provide a number of safe harbor rules allowing taxpayers to enter into multi-party Section 1031 exchanges through the use of various escrow and guaranty arrangements or through the use of a qualified intermediary. I assume that the facilitator in this case is a qualified intermediary under those safe harbor rules. In any event, the thrust of the various safe harbor rules is to effectively ignore certain issues of agency and constructive receipt that had previously presented enormous practical difficulties for multi-party Section 1031 exchanges. I see nothing in the safe harbor rules to indicate that the basic principles and computations regarding gain, basis, and boot in Section 1031 exchanges are affected by the existence of a qualified intermediary or any of the other safe harbor provisions.