 Hello and welcome to the session in which we would look at a section 1031 exchange or called a like kind exchange. This topic is covered on the CPA exam. This topic is covered on the enrolled agent exam. This topic is covered in an income tax course. And on the CPA exam specifically, this topic gives students many problems because when you learn section 1031 like kind exchange, you have to know how to compute realized gain, recognized gained, the third gain, and basis of the new property. Also, what's going to be involved in this transaction is something called the boot. In addition to the boot, you're going to have some time liabilities. And this is what I would do in this problem. I will introduce the liability factor in this exchange. So it is a challenging topic for many, especially for CPA candidates. So if you're a CPA candidate, I strongly suggest you check out my website, farhatlectures.com. I don't replace your CPA review course. You can keep that. I don't replace that. I wish I can do it, but I can do it. So you need a CPA review course. I can be a useful addition to your CPA review course. How so? I can explain the material differently. I can give you an alternative or a backup explanation that might help you understand your material, which in turn could help you understand your CPA review course, which in turn could add 10 to 15 points to your exam score. Your risk is one month of subscription. You try it. You like it. You keep it. If not, you would cancel. Your potential gain is passing the exam. And if not for anything, take a look at my website to find out how well your university is doing on the CPA exam. I do have resources for other courses as well. Also, if you haven't connected with me on LinkedIn, please do so. Like this recording, share it with other, connect with me on Instagram, Facebook, Twitter, and Reddit. Please connect with me on Reddit if you haven't done so. So this problem, I can give you this problem in a form of an MCQ. I can give you this problem in a form of a simulation. And within the simulation, I can give you an easy simulation. I can give you a medium simulation, or I can give you a hard simulation, just based on this information. The point I am trying to make before I work this problem is the simulations are no more than a multiple choice question phrased differently. For example, I can give you this problem and ask you as a multiple choice, what is the realized gain? And give you A, B, C, D, and you have to choose the realized gain. Or I can give you this information, ask you to compute the recognized gain, or I can give you this information, ask you to compute the deferred gain. So this is a multiple choice questions. Also, I can take the information in this, from this exercise and build an actual simulation. So I can show you the mortgage paperwork that they have 14,000 on the mortgage without telling you that. So you have to look up the mortgage paper and you would see that the balance is 14,000. I can give you an amortization schedule and I can give you the date and I'll tell you when the exchange took place. Therefore, you would know what's the balance. I can give you the purchase order when they purchase this building. I can give you the purchase order and when you add up all the cost for the purchase, it will be 33,000. So notice, I can also tell you about the cash transfer. I can show you a bank statement. I can show you an email that they're confirming the cash. I can show you many different things rather than telling you $11,000 in cash. So the point I'm trying to make is this. Whether this is a multiple choice or CPA simulation, the key is to understand how section 1031 works like kind exchanges. Let's go ahead and take a look at this problem. So we have Adam who owns a building that has an adjusted basis of 33. The building is subject to a mortgage of 14,000. Adam transferred the building to Milo in exchange for, so Milo gave him 11,000 in cash and a warehouse with a fair market value of 36,800. The first thing you want to make sure in this problem, I mean, although you don't have to do it, but the first thing I want to make sure you understand it is the exchange makes sense. The exchange makes sense. What does that mean? It means Adam has an adjusted basis of 33,000. They're not telling us the fair market value and subject to a $14,000 mortgage. Now, he transferred to Milo. What did Milo gave Adam? Milo gave him cash, 11,000 in cash. Also Milo gave Adam a warehouse and the warehouse is worth 36,800. Also, what Milo did took away the liability from Adam, which is kind of they pay off their liability. Well, the debt, they assume the debt which is worth 14,000. So the first thing I want you to see is how much did Milo gave Adam? So why is that important? Well, that's important because it's the, the math has to make sense. In other words, what Milo gave is 11,000 plus 36,800 plus 14,000, the total of 61,800. What does that mean? It means Adam's building is worth 61,800. Although we're not given the fair market value of the asset. We're not, we are not told how much is the fair market value of the asset for Adam. But based on what Milo gave Adam, we would know that the fair market value, the fair market value is 61,800. Why is the fair market value important? Because what you receive is the fair market value. You're going to have to compare the fair market value to the basis in order to compute the realized gain. So simply put, for number one, we received in total 61,800 as I computed minus the basis of 33,000. And that's going to give Adam a, what's called a realized gain, a realized gain of how much? Well, the difference between those two is 28,800. So this is the realized. This is what actually happened. This is the actual gain. The next thing they're going to ask you is, or they could ask you, they don't want the realized gain. You want to know the realized gain. That's the first thing you do. They want to know how much is the recognized gain. Now, this is a like kind exchange. We're going, we're going building for a warehouse. This is a like kind exchange. So how much of the gain you would realize? Well, if there is no boot, if there is no cash, no assumption of that will be none. That's the beauty of the like kind exchange. You defer all the gain. But here, since you received boot, you have to determine the amount of the gain you have to realize. Well, you're going to have to compare two numbers, the lesser of realized gain, 28,800. And that's why I told you you have to compute the realized gain or the boot received because if you receive boot, it means you can pay your taxes. Therefore, that's the extent of that you pay taxes. What, what boot did Adam receive? Adam received $11,000 in cash and Milo took over the debt of 14,000. Therefore, the boot, this is the boot, and this is the realized amount. So the recognized amount is the smaller of these two. The smaller of these two is 25,000. Therefore, Adam will have to recognize $25,000 in gain, although the gain was 38,000, 28,800. Okay, good. That's good. So we figured out the realized gain. We figured out the recognized gain. Well, simply put how much gain was the third? It means it's not 28,800, not 28,000. How much of the gain is the third? The third means Adam will be taxed on that gain later. Well, the difference between those two, whether it's not recognized as the third, it doesn't, it doesn't get erased. It just gets the third. Now, what does it mean gets the third? Well, we're going to see what does that mean in a moment. The third means it means it's part of your basis into the future. Okay, it's part of your basis. Now, how do we reflect this, the third gain into the basis? We're going to find out in a moment. Now the question four asks for basis of new property. So that's fine. Now you want to compute the basis of the new property. There are more than one way to compute the basis of the new property. And this is what I do on my website. There is the fair market value method. There is the basis method. And there's formulas that you have to be, you have to be comfortable with, familiar with, because you might be giving more information than what's, what am I giving in this problem? So make sure if you are not comfortable with this topic to go to farnhat-lectures.com and I will show you the formula. Okay. So for example, I'm going to do the basis. I'm going to use both methods just for this example, but make sure you know both methods. So this way you are comfortable. Well, I can say my basis is my old basis. So this is the basis. My old basis are 33,000. My old basis are 33,000. I booked a gain of 25,000. Remember, plus the recognized gain. So this is my basis. So I'm going to start with my basis plus any recognized gain. Why? Well, I did recognize 25,000 of gain. Why would I increase my basis with the gain? The reason is simple. I increase my basis because I already got that amount taxed. In other words, since I recognized the gain, I paid my taxes on this. Then I received boot of 25,000. The boot gets deducted minus the boot. The boot is 25. So plus 25 minus 25, my basis in the new property is 33,000. And I'm using what's called the basis method. There's the basis method or the fair market value method. Now there's more to this. For example, if you are giving any boot, the adjusted basis of the boot giving will be in addition. So you just want to make sure you know this. Any loss, if you recognize the loss, the loss is deducted. So if you have a loss, the loss is deducted, but we don't have a loss here. If you give in any boot, if you give in any boot, you will add the basis of the old boot. That's why it's called the basis method because you're using the basis, just kind of if you want to remember this. But again, go to my website if you want more explanation and details about this. Now this is the basis method. Let's take a look at the fair market value method. How would we solve this problem if we want to use the fair market value method? Well, the fair market value method, as the word suggests, it's the fair market value of the asset that you received minus any the third gain, minus 3800, and that's going to give us 33,000, which they should be the same. Now why did I deduct this the third gain? Well, you can memorize it, but if you understand it, it will make your life easier. The third means it's going to be taxed later. So as a result, what you do now is you reduce your basis. By reducing your basis, your future tax is higher. Your future tax is higher. And this is what you did. You reduced your basis by making your future tax higher. That's all what you did. And this is why we deducted the third gain. And what we did here, we added the recognized gain. If you recognize the gain, you want to increase your basis. Why? Because you already recognize this gain. You want to increase your basis. So because your basis go up, your future tax, your future tax will be lower. But when you defer the gain, your basis go down, your future tax is higher. Very important concept. I would say if you're taking the regulation section of the exam and you mess up on section 1031, and they gave you a lot of questions of those. And what the software does is it seems, it appears that they know what you are weak with. And if they can, if they deduct the, detect this weakness, you'll pay dearly for the exam. So don't, don't take your chances. You have your CPA review course. That's great. Keep it. But if you want more detailed explanation, go to farhatlectures.com. Again, I don't replace your course. Do it. It's worth it. The CPA exam is an investment for life. You only study for it once. Take it seriously. Good luck. Study hard. And of course, stay safe.