 Hello and welcome to this session. This is Professor Farhad in which we will discuss section 1031 specifically when liability is involved in the transaction. So before we start this session I want to make sure you understand what section 1031 is. Please go to the prior session, actually prior two sessions and one of them I explained section 1031 like kind exchanges and details. Then I work an example, a comprehensive example. In this session we would look at liability involved. In a non-taxable exchange transaction a liability assumed by the taxpayer is treated as a boot given. What does that mean? Simply put if you sell an asset let's assume you're selling your home, let's just I'm a lousy drawer but I'm going to go ahead and try to draw a home here like a two-year-old drawing a home and let's assume the selling price is $300,000. That house comes with a mortgage. Simply put the bank has a mortgage against this house and let's assume the mortgage is for $100,000. There's a $100,000 mortgage attached to that house. You agreed to buy my house so when you buy the house guess what the mortgage comes with it. So how much did you really pay for the house? Well you technically paid $400,000. Why? Well you paid me cash $300,000 and you took over my liability. I'm no longer have to pay $100,000. It is as if you gave me $100,000 it's as if you gave me $100,000 I went to the bank and I paid the bank off. That did not happen. All that happened is you took over my mortgage. It's the same thing. I'm no longer responsible for that $100,000. Well that $100,000 that's liability assumed by you is a boot to me. So it's technically as if you paid me a boot in terms of cash. So when someone assume a liability and that's basically that's the basic idea. Now let's keep going. Before we proceed any further I have a public announcement about my company farhatlectures.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. If the other party assumes the taxpayers that the liability in this case represent a boot received by the taxpayer. Why is this important? Because in a section 1031 exchange when boot is involved it might trigger again. As previously mentioned when received by the taxpayer the boot triggers again recognition to the extent of the amount of the boot. Let's take a look at this example. Andy and Nick exchange office building the property given by Andy had an adjusted basis of 80 and a fair value of 95. Well if it's 95 minus 80 we have a realized gain of 15,000 so far for Andy. In addition it was subject to a liability of 12,500. Well we have a liability of 12.K on this building. That was transferred to Nick. So Nick took over this liability as if Nick paid you an additional 12,500. On the other hand the property given by Nick has an adjusted base had an adjusted basis of 75, fair value of 82,500. Now we're looking at Nick minus it's 82,500 minus 75 so Nick had a realized gain of 7,500. Now determine the amount of gain and loss realized and recognized. Well we already computed the realize for both party and Andy would have a recognized gain. Why? Because Nick took over the mortgage 12,500 there's a boot and the gain recognized as the lesser of the boot or realized gain the boot is lower. Yeah let's take a look at it. The amount realized by Andy is 15,000 the gain realized by Andy. In addition the liability transferred to Nick is considered a boot received by Andy and I told you would would choose the lesser of 15 and 12,000. Now let's take a look at Andy's Nick situation. Nick realized gain is 7,500 computed as the difference between 82,500 and 75. Nick did not receive any boot therefore should not recognize any gain it's as simple as that. Determine Andy's and Nick basis and the properties they received. Well Andy's basis and the in the receive property equal to the fair value of the property which is 82,500 minus the amount of the third gain. Well remember we had realized gain of 15,000 of which 12,500 was recognized therefore the third or the non-taxable portion is 12,500 therefore we'll take the fair value of the asset received minus 12,500 which will give us a basis of 80,000. We could also compute this using the code approach starting with the adjusted basis of the property given up the adjusted basis for the property for Andy is 80,000 minus the fair value of the boot received because that boot received is taxable well that's it it's taxable so it's going to bring us to 12,500 plus the gain recognized which is again the gain recognized on the boot which is going to give us also 80,000 so 80,000 80,000 this is the code approach. Now let's take a look at Nick as far as Nick the basis equal to the amount of the fair value of the asset received 80 95,000 and the total amount of gain realized we have to do what not realized realized but not recognized which is 7,500 so the fair value of the asset received is 95 minus the third gain with the third the full 7,500 which will give Nick a basis of 87,500 we can do the same thing with the code approach adjusted basis of the property given up by Nick is 75 the adjusted basis of the boot given and he gave a boot of 12,500 well that's equal to 87,500 which is the same thing as the fair value method. Now let's take a look at another example Tom and Jill exchanged their investment properties in accordance with the following terms Tom transferred a parcel of land with an adjusted basis of 103 fair value of 140 again the difference between those is a realized gain for Tom Tom's land is subject to a mortgage of 20,000 that will be assumed by Jill so Tom has a mortgage will be assumed by Jill Jill transferred a property with an adjusted basis of 91 and a fair value of 130 again the difference between those two will be the realized gain for Jill the property is also subject to 10,000 which will be assumed by Tom so notice they both have mortgage on their property and they're they're taken over each other's mortgage okay determine the amount of gain realized and recognized by Tom and Jill let's start with the realized the amount of gain realized by Tom is 37 which is the difference between 140 and 103 the amount realized by Jill equal to 39,000 which is 130 minus 91 already kind of covered this now in this question we have to be careful both both parties are assuming the liabilities on each other's behalf so what do we have to do we have to net them out and see who's assuming more liabilities so think of it this way think of it this way first Tom has a land that's subject to a $20,000 mortgage and Jill has a land that's subject to $10,000 mortgage simply put a Jill is paying off 20,000 Jill paying let me just write it down think of it this way Jill is paying 20,000 and Tom paying 10,000 what do we have to do we have to net them out and when we net them out we find out that Jill paid an additional 10,000 so really Jill that's really paying the boot and Tom is receiving the boot okay because we have to net them out the party receiving the boot would recognize again for the lesser of the gain and the gain realized or the boot received so already determined that Tom will end up with the boot of 10,000 now given that the liability is assumed by Jill equal to 20,000 while the liability is assumed by Tom equal to 10 Tom is considered to have a boot of 10,000 because he ended up with more assets under those circumstances Tom would recognize again of 10 because the realized the realized gain for Tom is the realized gain is 37 so of that 37 what's going to happen 10 will be taxable now and 27 will be the third or non-taxable for now the third and Jill will recognize no gain why because overall although Tom took over 10,000 but she took over 20,000 therefore it's we net them out okay determine the basis of Tom and Jill in the properties they received from the exchange Tom's basis equal to the fair value of the property received which is 130 minus any deferred gain how much gain did we defer 39,000 at 27,000 of gain as I told you because 10,000 was taxable the total gain was 37 as a result the basis is 103 Jill's basis is the fair market value of the asset received of the property received 140 minus any deferred gain she deferred 39,000 none of her gains were taxable therefore her basis is 101 one more topic we need to discuss section 1031 and that's time requirements okay does the transaction have to happen simultaneously not at all the taxpayer has 45 days after giving up his property to identify a like kind replacement so you have 45 days to identify it I found this property this property is a suitable property as a replacement okay then the identified property must be received by the taxpayer within the earlier of 180 days after the taxpayer transfer his old property so from the date you transfer your property you have 180 days to get the new one or the due date the one that comes earlier the due date include an extension of the income tax return covering the year in which the transfer occur or before the due date the earlier of these two we would look at an example let's assume Ray owns a commercial building in the in the center of the city he would like to expand his business and interested in buying his neighbor's garage to use as a storage for some inventory and believe it or not my friend going through the same transaction his neighbor wants to buy his home to expand his business so it happens that's that's a real example his neighbor agrees to sell the garage that had an adjustment of 20,000 and a fair value of 85,000 provided that Ray can buy him a like kind replacement property for the same value so the neighbor said okay I'm willing to sell you but you have to find me I don't want the money find me another property and I will you know close the deal the deal was made and the garage was transferred on August 15th so it appears that they that they that Ray secured another property for him by the end of August Jad Ray's neighbor identified the replacement property of 85,000 so we did replace we did identify within 45 days we want to make sure we close the deal now and informed Ray that he could acquire the acquisition was completed October 12th and the property was transferred November 1st so you have from August till November 1st I would say this is one less than 180 days does this exchange qualify for the like kind exchange treatment and the answer is yes Jay identified the replacement property less than 45 days following the transfer of the original property in addition the replacement property was transferred within 180 days following the transfer of the original garage which is way earlier than the due date of the income tax return so we are in good shape as a result what would happen is this jad would realize a gain of 65 which none of it will be taxable it will be deferred what should you do now as a CPA candidate enrolled agent or student go to far hat lectures and look at additional resources multiple choice through false exercises that's going to help you do better prepare for your exams or for your classes this is an important topic section 1031 like kind exchanges the third gains the third losses don't walk into the exam without being comfortable with this topic good luck study hard and of course stay safe