 Hello and welcome to this session. This is Professor Farhat in which we would look at section 1031 exchanges Section 1031 exchanges falls under the concept of the third gains and the third losses Something that I covered briefly in the prior session. So if you're not sure what the deferred gain What's a realized gain is please look at the prior session but now we need to discuss what is the idea of Section 1031 exchanges which is part of this concept of the third gain and the third losses So what's the big idea think about a company that owns a building and they want to update this building They want to sell and update to a new building. So they want to go go ahead and buy this building So what can they do? Well one option is they can sell this building and let's assume They can sell this building for the sake of illustration for a million dollar Let's make it five Let's assume they can sell this building for five million. That's the amount realized minus the adjusted basis and the adjusted basis for this building. Let's assume is three million So the adjusted basis is three. They would realize a gain of two million. This is the Realized gain now from this realized gain if they did indeed sell it Let's assume they're gonna have to pay for simplicity 20 20 percent in taxes They're gonna have to send the government a 400 000 dollar attacks bill for selling this building well They're gonna take this money and buy this building Well, hold on a second. Let's see what happened here They sold the building but what they really did they replaced their building Let's assume they bought this building. I don't know for eight million or whatever amount They bought it for it doesn't really matter the amount that they bought the building But the point is they sold the building and they purchased the building So the the congress says look this transaction does not warrant that you pay taxes if this is what you are doing however Why don't you do a 1031 exchange basically exchange this building for this building in this way Your gain rather than realized it will be the third. So that's the idea of Section 1031 exchange You defer your gain By doing what by doing an exchange replacing your building with a new building So the transaction would look as an exchange not would look as a sale and simply put you did not sell this Building you did not sell this building and you deposited that money in your account Or you would you would draw this money from the company and you use it for personal use what you did is You sold the building and you replaced it therefore You don't have the ability to pay taxes because you you use those funds. So based on that logic Section 1031 comes into the picture where you don't have to pay taxes on that gain You will have to defer this gain. So that's the basic idea before we proceed any further I have a public announcement about my company farhat lectures.com Farhat accounting lectures is a supplemental educational tool That's going to help you with your CPA exam preparation as well as your accounting courses My CPA material is aligned with your CPA review course such as becker, roger, wiley, gleam, miles My accounting courses are aligned with your accounting courses broken down by chapter and topics My resources consist of lectures multiple choice questions true false questions as well as exercises Go ahead start your free trial today. No obligation. No credit card required And here's what you have to understand A non-recognition treatment for gain and losses is granted for qualified like kind exchanges Now we are not going to go into the nitty gritty of what's considered like kind exchange But on the CPA exam and your accounting course on in the enrolled agents exam They will tell you this is a qualified like kind exchange basically simply put For example, if you have a building if you exchange it for a warehouse, they're pretty flexible Now bear in mind A qualified like kind exchange. We need to know what type of properties we have we are dealing with We are dealing with real properties real properties means real building land something that's attached to the land It's not only has to be real. It has to be used for trade or a business or health for production of income or health for investment So this real property it has to be used in business. It cannot be Personal use property. It cannot be personal properties. Remember, we have personal properties and personal use property The asset exchange must be like kind and nature or character and must serve as a replacement property So remember the idea is you sold the old building To replace it with a new building again, it doesn't have to be building. It could be a warehouse. That's fine as well So personal properties like furniture computer desks those they don't qualify even if they are used in a business They don't qualify personal use property. Obviously. They don't qualify including Personal use property including real personal use property even if you have a land for personal use A building for personal use in a house that doesn't qualify Inventories don't qualify securities partnership interests that don't qualify for this type of exchange So let's kind of zoom in we are dealing with real properties And those real properties are used in a business or health for production of income or as an investment Those are the assets that qualify under section 10 31 In a like kind exchange The taxpayer relative economic position changes in form but not in substance and this is this is the whole idea is Yes, you did sell a building buy a building But your economic position did not change. You still have a building. It's a new building Nevertheless, it's a building. In fact, the newly acquired asset Is considered a continuation of the taxpayers old investment. So that's why we don't Make you pay taxes on the gain in an exchange like this An exchange transaction that qualify for the like kind exchange to generally produce Beneficial consequences to the taxpayer. However, it's not tax-free transaction Realized gain and losses Are the third it means they are pushed forward to a future period Unless the taxpayer received receives both now on the exchange sometime you might receive a boot. What is a boot? A boot when the other party remember those the two parties that are exchanging they have to be equal So sometime to equalize the deal The other party might have to pay you cash or give you some boot like stocks or something in In addition to the cash in addition to the property to equalize the deal under those circumstances if you receive a boot The boot might be taxable and we would look at the formula for that taxable amount Always remember that the deferred gain and losses are subsequently recognized when the property is disposed of in a taxable transaction And we're going to see how the concept of that deferral Let's take a look at this simple example to illustrate the overall concept under a non-taxable exchange NIA exchange building with an adjusted basis of 150 with a fair value of 195 So the fair value that she gave up was 195 The adjusted basis of that property was 150 And she exchanges for a land for 195 remember Exchange must be equal. So if I gave up 195 if NIA gave up 195 she expect to receive and return 195 of value which she did Now in her exchange NIA realized a 45 000 gain because The The building was 195 fair value adjusted basis 150 the difference is 45 if she we assume that if she sold it She would realize so the realized gain Is equal to 45 now since she sold the building and bought another real property for business Then the gain the 45 000 gain will be the third will be the third The third means we're going to see what does it mean later? It means it's not tax Tax now it will be taxed later So remember in any transaction the fair market value of the asset given should equal to the fair market value of the asset received or asset or assets received Because the assumption is we are dealing with two rationale individual two rationale parties So if I give up 195 I expect to receive and return 195 just keep that in mind as we're going through this Now let's take a look at when boot is involved Taxpayer are required to recognize a gain in a transaction that qualify under like kind exchange treatment if they Receive a boot so the first thing I want you to understand is if you receive a boot not if you pay a boot And think of boot for now just think of it is cash But it can be other than cash it can be cash securities inventory anything that you give to equalize the deal Boot has defined Any property involved in the exchange other than the like kind exchange it can be cash It could be net debt relief simply somebody paying taken over your debt That's basically given you money or other non qualified property In general the receipt of a boot not the payment triggers a gain Recognition now how much is the gain when boot is involved? So we have to know Okay, we're gonna have a gain, but it doesn't mean the whole gain will be Realized Let let's see the gain will be the lesser of The gain realized or The fair value of the boot received so after you compute the gain You're gonna have to look at the gain and compare it to the gain realized and the fair value of the boot received And the lower of these two amount one or two the lower of these two is the amount that's going to be taxable Losses are the third even when boot is received for losses. It does not matter for losses You defer them you defer them for later So remember we're only dealing with gains An exception applies when the boot consists of non qualified property other than cash In which case the giver of the boot may recognize a gain or a loss on the exchange for the difference between the boot Property fair value and it's adjusted basis and we'll work an example Okay, so bear in mind if you're exchanging something other than the non qualified property For example securities inventory something other than the section 1031 assets and You're exchanging it. It's as if you sold it got the cash and pay the cash So if you exchange it you might have to recognize A gain or a loss because it's basically it's a separate transaction Gains or losses on an unlike kind property are not allowed to be deferred and don't worry We will work an example about this. So we'll work an example showing you this Let's take a look at examples with boot received And a transaction that qualifies for like kind exchange treatment under section 1031 Emily exchange a building with an adjusted basis of 100 fair value of 210 So the fair value is 210 the adjusted basis of 150 If she sold this building she would have a realized gain of 60 And she exchanged it for a parcel of land with a value of 195 Well, that's not enough because I gave up something that's worth 210 In addition Emily received $15,000 in cash. So the other party gave her the land But that's not enough because that will not equal to 210. She gave up to 10 Plus they gave her 15,000 in cash now We have what we called boot received, but at least we see that the exchange is equal What is the amount of the gain or the loss that Emily should recognize in this exchange of this transaction? Well, let's first take a look at the realized Emily realized $60,000 Of gains and I showed you how what's the difference between 210 and 150 Given that she received $15,000 in cash, which is a boot. She is required to recognize the lesser of 60,000 or 15. Well, it's either the gain or the Boot received the lesser of these two the lesser of these two is 15. Therefore 15,000 is Is Realized realized so simply put of the 15 of the 60,000 15,000 is taxable now Is realized and the remainder 45 is The third the third for later so the 45,000 is the third until Emily sells that land into the future in the future Assume that Emily exchange a building with an adjusted basis of 200 and fair value of 210 Now changing the scenario a little bit For a land that's valued of 180 and received cash of 30,000 Now again Now what we're doing now is we are assuming the fair value is 210 The basis is 200 so we have 10,000 of gain The land that you received is 80 plus 30,000 in cash What's the amount of the gain or the loss that she recognized on this exchange? Let's go through it again The realized is 10,000 And she received so the realized gain is 10,000 which is the difference between 210 and 200 and the boot that she received in the exchange is 30,000 Okay, now, what do we have to do as a result? We will choose the lesser of realized gain in boot the realized gain is 10,000 is the lower of the two Let's take a look at another example Assume that Emily exchange a building with an adjusted basis of 200 and a fair market value of 190 Well, what does that mean? Is if we take so the fair market value is 190 the adjusted basis is 200,000 If she sells this building she would experience a loss Now she exchanges for a land valued at 185 and received cash of 5,000 So we did receive a boot. What is the amount of gain or loss? We already know that we have a loss of 10,000 from the exchange realized loss computed as the difference between 190 and 200 also Emily received a cash Boot of 5,000 to equalize the deal because the land is worth 185 The owner of the land had to give Emily another 5,000 to come up to 190 The receipt of the boot does not trigger the recognition of a loss So the loss would always be deferred remember that as a result Emily does not have any recognized gain or loss The entire loss is Postponed until the property is subsequently sold remember we don't recognize a loss If we receive a boot it doesn't matter the loss is always deferred Let's look at an example with boot given Emily exchange a building with an adjusted basis of 200 and fair value of 210 For a land that's worth 215 Now Emily also have to pay cash because she gave up a land That's worth 210 and she received something worth 215 to equalize the deal She's going to have to pay 5,000 Now she give up 215 she received 215 What's the amount of the gain or the loss that Emily should recognize? Emily realized a gain of 10,000 which is the difference between 200,000 the fair value of the of the building and its adjusted basis Now Emily in this situation Paid a boot Paid not did not receive well. Therefore She does not have to recognize Any gain therefore the entire amount is postponed. She did not receive the cash. She paid the cash So remember the boot makes a difference with the gain if the boot is received Emily exchange Emily exchange a building with an adjusted basis of 200 with a fair market value of 180. What do we have here? We have a loss And she exchanges for a land that's worth 210 now Emily She's going to have to equalize this deal because she received a land that's worth 210 She gave up a fair value of 180. She's going to have to come up with the difference The difference Emily also gave Boot with an adjusted basis of 15 and a fair value of 30. So she has to give up another 30,000 Okay, so now she gave up to to 10. She received to 10. She's good What is the amount of the gain or loss? Emily should recognize on this exchange. Well, let's take a look at this transaction slowly Emily would realize a net loss Of 5000 in this exchange being the difference First the fair market value Of the asset given up. So she gave up the asset 200,000 minus 80 I'm sorry. Let's put the 180 first not 180 not 80 So the fair value of the asset she gave up 200,000 if she sold this asset She would realize a loss of 20,000. That's the first thing Then she gave up Another property and that property is worth 30,000 And the basis of that property is 15. So we have another Transaction 30 minus 15 would give her a gain Of so this is a gain. This is a loss and that's why we said the net is 5,000 loss. So the net is 5,000 loss. However, just having these loss, let's go through them slowly The net loss stems stems from the realized loss of 20,000 on the like kind exchange And realized loss on the boot. Okay. Emily is required to recognize the gain So she cannot net those two out. You would say, okay, but isn't 20,000 gain 20,000 loss minus the 15 gain. Yes, these two exist No netting you don't net them. You're not allowed to net them. Okay So Emily is required to recognize the loss on the on the boot, but the further realized gain. So simply put the 20,000 loss That she realized on the land. That is the third and the 15,000 gain is realized yes Is realized now in total in total you would say it's a net realized of 5,000 and loss That's realized But when it comes to recognition 20,000 of the loss is the third you cannot net it against the 15,000 gain that is realized Remember what I told you earlier. I told you if the asset is not a like kind exchange But it's part of the deal. It's a separate transaction. It's treated separately and this is what I meant by That separate transaction the 15,000 gain on I don't know what she gave up She gave up some boot. Let's assume stocks that are worth 30 with a adjusted basis of 15 She's gonna have to pay taxes on those separate transaction. Just be aware of this Basis of property received now we're gonna look at when you receive the property now We understand the realized gain realized loss all that now we need to understand How do we compute the basis of the property received? So when we receive the property the basis of the like kind exchange received should reflect any the third gain or the Third loss. So this is where we bury or not bury Basically the third the gain or the loss. So remember we have a the third gain at the third loss I told you it's the third the third until when the third until now when we compute the basis Here's what's gonna happen. We're gonna look at the fair value of the property received There are two ways to do it first. We're gonna use at the fair value method We would look at the fair value of property received Plus we're gonna add the loss not recognized or the third simply put plus Any the third loss the loss that's not recognized just to kind of kind of define it Minus any gain that's not recognized, which is the gain the third simply put fair market value of the property plus loss the third Minus gain The third I just defined it here loss not recognized as the third kind of to remind you it's not recognized Why now we have to kind of it's good to logically understand this? I mean you can memorize why do we add the loss? Why do we subtract the gain? But let me explain it to you because it's worth spending a few minutes on this just to kind of really understand it So you have no doubt when you say I am adding the loss or subtracting the gain. Let's assume you receive You receive a property that's worth $10,000. Okay, this is the fair market value of the property Now in that exchange you had a deferred loss And let's assume the loss was 3000 you had a deferred loss Now what do we do with the deferred loss? If you had a deferred loss and you understand how we come up with the deferred loss from the prior From the prior lecture what we did earlier we learned how to compute the deferred loss So we're going to take this deferred loss and add To the value of the property that we received as a result. We're going to have basis of 13,000 So the question is why do we add the loss? How is that deferring the loss? Here's what's going to happen In the future what you did here is you increased your basis. So in the future, let's assume in the future You sold this asset for 20,000 sell sell it for 20,000 in the future Okay, so what happened is this This 20,000 if you sold it into the future and 20,000 you compare it to the 13,000 the gain will be seven Okay, so what happened is this If you if you did not add the deferred loss and the basis was 10,000 which is the fair value of the asset received your gain will be 10,000 your gain will be 10,000 Which is the difference between 20 and 50 20 And 10 so what happened when you added this $3,000 loss? It reduces your gain from 10 To seven So by increasing your basis by increasing your basis you reduced your gain So you accounted for that loss later when you sold this asset now. You're saying okay now if I sold it again What if I sold it at a loss? Well, if you sold this asset at a loss, let's assume you sold this asset for Let's make it 6,000 if you sold this asset for 6,000 later into the future you will compare six to the 13 Well six to the 13 is seven Okay, rather than comparing six to the 10 if we compare it six to the 10 the loss will be four Now the loss is seven So what you did is you recapture that loss down the road when you sold this asset So by deferring the loss you increase the basis by increasing the basis You're either going to reduce the gain in the future or increase your loss, which is you recapture your loss Now the same concept would apply If you receive an asset of fair market value of 10,000 and now we have a deferred gain of 3,000 the deferred gain of 3,000 it would reduce your basis the 7,000 So how would reduce in my basis deferred my gain? Same concept in the future If you sold this asset for 20,000 in the future and your basis is seven You have a gain of 13 Okay Now if you sold it for 20 and your basis was 10 Your gain will be Your gain that's where am I doing losses here? So 20 minus seven 20 minus seven equal to 13 gain This is so basically what happened is you recaptured that additional 3,020 minus 10 if you did not reduce your basis Your gain will be 10. So what happened this the third gain was recaptured later on So this is what we meant by this Okay, and if you sold it at a loss, let's assume you sold it for 5,000 You compare the 5,000 to 7,000 and you only have 2,000 of losses versus if you sold it for 5 in the basis What's then you would have a losses of Five so simply put that the third gain would increase your gain in the future Or reduce your loss in the future. So it doesn't go away but By burying the the third gain and the third loss into the new asset it will be it will be recaptured down the road On the other hand the basis in the boot received is the fair value of the boot. So if you received a boot The fair value of the boot is the basis. So if you received cash, if you received 10,000 in cash Well, the basis of the cash is 10,000 if you received the boot The basis of that boot is the fair value of the boot. So that's separate from the like kind exchange asset Let's look at an example Miriam exchange in office building she uses in her business for a land that has a fair value of 523 At the time of the exchange the office building has an adjusted basis of 48 So the difference between 523 and 523 and 480 Is her gain is her realized gain And a fair market Let's take a look at an example Miriam exchange in office building She uses in her business for a land has a fair value of 523 So she got a land with a fair value of 523 at the time of the exchange The office has an adjusted basis of 480 and a fair value of 523 Now we know that Miriam will have a gain a realized gain at least 523 minus 480 Okay, let's take a look at this determine the amount of the gain realized and recognized. Well, let's first look at the gain Given that this is a like kind exchange it qualified under section 1031 The gain is the difference between 523 and 480 which is a gain of 43,000 Look, she did not receive any boot Therefore the total gain is deferred The question is what is her basis? What is her basis on the property the basis in the property? Remember the fair market value of the asset received the fair market value that the of the asset received is 523 Then we reduce it by any deferred gain minus 43 the deferred gain So the basis is 480 so 523 Plus the deferred loss which is 0 minus the deferred gain equal to 480 therefore her basis is 480. So what happened? By deferring the gain We lower the basis So in the future when we sell when she sells this land her basis are lower Which make her gains are higher or if we show that at a loss her losses will be smaller Which is with which is we recapture the gain Now let's take a look at another example. Assume now that the building has an adjusted basis of 480 And a fair value of 420. So what we did here? We changed the value and now we have a loss loss And the land that she received is 420 But now she has a loss Miriam has a loss because she exchanged a building that has a loss Determined the amount of the gain Realized if any and and the basis well actually she received a lot. She She realized a loss, which is 480 minus 420 Now what are we going to do with this loss? What do we do with losses? Remember? We always defer the losses We don't have to worry about About realizing the loss because it's always deferred The loss should be deferred. Therefore the loss recognized as zero and her basis will be The fair value of the asset received plus the deferred loss minus the deferred gain We have no deferred gain therefore what we did with the loss we deferred it and how do we defer it? We increase the basis of the asset Let's take a look at this example and a transaction that qualifies for like kind exchange treatment Jane and George exchanges the following asset Jane gave up a building with a basis of 25 and a fair market value of 120 so right there we would say that 120 minus 25 Jane will have a realized gain realized gain of 95 George gave up a building with the basis of 30 And a fair value of 90 and a security with the basis of 20 and a fair value of 30 Okay, so what George gave up is a building that's worth 90,000 with the basis of 30 Now we have a gain here of 60,000 on the building But that's not enough because if George gave up only 90 and Jane gave him 120 Well, he's going to have to give up something else cash or boot and to give up securities with the basis of 20 fair value of Fair value of 30 basis of 20 therefore 30 minus 20 Equal to 10 this is also Realized and we immediately say this is also Recognized why realized and recognized? Because the securities are not part of the like kind exchange So usually you have to understand from this transaction immediately We have 10,000 that's realized and recognized and we have 60,000 here of gain that's realized We're gonna have to find out how much of it is recognized or not So make sure we are starting from this point here. Okay. Now. We also have to understand for George The basis that he gave up What he gave up is what he gave up in total what George gave up in total is 120, right? Which is the let me change colors here, which is the building And the securities total of 120. He have to do this because he received A total of 120. Now, what's his basis? Well his basis we would say 30,000 here And what what's gonna happen is since this amount will be realized and recognized his basis will be the 30,000 So his total gain Will be 60,000 Why because The basis of the securities becomes 30,000 now we can go back and say, okay Let's assume the basis is 10 and we're gonna see what would happen. Okay, but this is what we have at this point So let me show you the figures and we would assume that the basis of the securities is 20 and we're gonna get to the same answer But let's look at this. Let's first look at Jane Jane fair value of property received 90 plus 90 plus 30 equal to 120 And this is basically what she gave up 120 minus her basis will give her a realized gain of 95 So for Jane, we already computed this a realized gain of 95 She received a boot of 30,000, which is the securities Well, how much is she gonna recognize the lesser of 95 and 30 the lesser of is 30 and she will defer 65 so of the 95,000 for Jane The taxable amount right now is 30 and the deferred amount is 65,000 now Let's look at George We said George's fair value of the asset given up is 120 in total And we're gonna consider the basis as 30 because George paid 10,000 in taxes on the securities. Therefore, it's gonna increase his basis to 30 therefore realized gain is 60 received no boot There's no gain recognition Then the deferred amount is 60 Now, let's assume we we we did this in a different way. Let's assume. We said, okay, George gave up Which is this is what we did here actually gave up two asset for one He had the gain of 60,000 a realized gain And for the other one, he had a gain of 10,000, which is realized and recognized simply put if we assume that 120 and we assume the basis rather than 60 use it as 50 120 minus 50 is 70,000 Of the 70,000 10,000 of this gain is has to be realized because it's a non non like kind exchange We go back to 10,000 gains realized And 60,000 deferred So whether you said the basis they're not really 60 they're 50 Okay, if you want to say the basis are 50 for George Then George will have a total of 70,000 of gain 10,000 immediately recognized and what's left is Deferred that's basically how it works or you can say 120 and I'm going to assume his basis In the land is 30 in the securities is 30 because he paid the taxes Therefore the gain is 60 and now all of it is deferred, which is it we come back to the same Answer because we recognize the 10,000 separately Okay, let's go go ahead and summarize this The securities are not part of the like kind exchange. Therefore George has to recognize The difference between 30 and 10 30 and 20 as a gain which is a 10,000 dollar gain as a result the adjusted basis of the property given up Is equal to the adjusted basis of the building Which is 30,000 plus the fair value of the securities given up the fair value 30,000 Which is 30 plus 30 will give us the 60,000. This is just another Way to look at it Now determine Jane and George's basis for the like kind exchange. What is the formula? Well, the formula is this fair value of the property received minus the deferred gain plus the deferred loss Let's take a look at this for Jane Fair value of property received is 90,000 That's what Jane received fair value of property received 90,000 And the deferred gain was 65 Therefore the basis is 25 George the fair value of the property received is 120 the deferred gain is 60. Therefore the basis is Again the fair value of the property received now. You might be saying Hold on a second. Didn't Jane receive the additional 30,000? Yes, she did receive the additional 30,000, but that was not part of the like kind Property that was not part of the like kind property another way to compute the basis is using the what's called the code approach I prefer the fair value approach But you I want to show you the code approach in case it's in your cpr view course or in your book The code approach is basically starting with the basis of like kind asset given So you start with the basis versus the fair market value approach where you start with the fair market value received Then you add to it adjusted basis of the boost of the boot given if you're giving if you are Giving any boot you will add the adjusted basis and this makes sense if your paying cash should increase your basis If you recognize any gain in the transaction, you will increase your basis Remember if you recognize the gain it means you already paid the taxes on that gain If you paid the taxes the amount becomes part of your basis. Remember gain recognized is means what it means you pay the taxes If you pay the taxes it should increase your basis because the basis are not taxable the basis are already kind of You already pay the taxes for them. So this is important to understand this once you pay the taxes on something That becomes part of your basis Minus fair value of boot received so if you receive any boot obviously if you receive benefit cash That's going to be reduce your basis Less any loss recognize if you recognize the losses It's going to reduce your basis because you already recognize the loss you took the deduction If you took the deduction you cannot take it twice you took the deduction Guess what reduce your basis you took the deduction you cannot take the deduction And don't change your basis you took the deduction reduce your basis Okay Let's go back to the example To the previous example between George and Jane and let us determine the basis and the property using the code approach Well, Jane gave up a building with a basis of 25 and a fair value of 120 George gave up a building with the basis of 30 and a fair value of 90 and the securities with the basis of 20 And a fair value of 30 basically the same example Let's do Jane first Jane recognize a gain of 30 000 if you remember the fear that the the lower between remember we We said it's the gain was 95 the realized gain was 95 And the boot was 30 so we recognize the lower of the two of 30 000 So let's take a look at the Jane using the code approach She's going to start with her basis the basis of the property she gave up is 20 25 000 so we start We start with the basis 25 000 adjusted basis of boot giving Jane did not give any boot Gain recognized Yes, she recognized you remember 30 000 Since she recognized 30 000 that amount was taxable to her because it's taxable It's going to increase her basis. So that's why plus recognized gain Minus fair fair market value of boot received. Well, the boot received is 30 000 If she recognizes the gain on it, she's going to have to deduct this Minus any loss recognized loss recognize is zero. Well, her basis is 25 000 which is back to the same formula that we worked with Gave us 25 000 so you add what the gain was recognized Then you subtract any fair market value of boot received if you receive the boot It should be removed from the formula So 25 000 and notice here we have using the fair market value approach We got to how much we got to 25 000 as well. So notice in either way you will get the 25 000 now Let's do the same thing But computing the basis for George using the Code approach. So let me go back and show you that The basis for Jane. Give me one moment, please. Let's go back to that slide. I went back very far Okay So notice Jane is 25. Now we're going to go back to George and recognize Compute the basis of 60 000. Okay, let's let's look at the code approach now for George for George Adjusted basis of like kind asset giving the adjusted basis. Let me just look at the numbers here The adjusted basis George give up a building of 30 000 That's the adjusted basis of the like kind asset given plus the adjusted basis of the boot giving And he also gave a boot with an adjusted basis of 20 adjusted basis of 20 Remember when he gave up this boot of adjusted basis of 20 The fair value of that boot was 30 30 plus 20. Remember this triggered again again, that's realized and Recognized so there is a recognized gain of 10 000 Minus fair value of boot received George did not receive receive any boot minus loss recognize George did not recognize any loss 30 plus 20 plus 10 equal to 60 And this is the code approach again the code approach and the fair fair market value approach should give you the same answer Which is 60 000 and the basis for George is 60 000 So make sure you are comfortable and understand how the code approach works because the code approach It has more pieces and if you understand the pieces of it, you should be in good shape What should you do now? Whether you are a cpa ea or an accounting student go to farhat lectures dot com Look at additional mcqs through false questions. That's going to help you understand this topic better Section 1031 exchange is an important topic on the cpa exam. You cannot Go to the exam or ea exam or taking An income tax course and not knowing this topic in depth I'm always here to help you. Good luck study hard and stay safe