A, who is not a dealer in real estate, exchanges Parcel A — investment real estate purchased in 1940 for $5,000 and now worth $8,000 — for Parcel B (to be held for productive use in a trade or business), which has a fair market value of $6,000, plus $2,000 in cash. The initial structure shows A holding Parcel A (FMV 8,000, basis 5,000) and X holding Parcel B (FMV 6,000) and 2,000 of cash.
In the exchange step, A transfers Parcel A to X, and X transfers Parcel B together with 2,000 of cash to A. Because the properties are of like kind, section 1031 applies, but the cash A receives is “other property or money” — boot — under section 1031(b).
A’s realized gain is 3,000 (amount realized of 8,000, being Parcel B’s 6,000 value plus 2,000 cash, less A’s 5,000 basis in Parcel A). Under section 1031(b) that gain is recognized only to the extent of the 2,000 of cash boot. The remaining 1,000 of gain is not recognized and stays deferred in A’s carryover basis in Parcel B.
When a like-kind exchange includes cash or other non-like-kind property, section 1031(b) forces the taxpayer to recognize realized gain up to the amount of boot received.
A’s 3,000 realized gain is recognized only to the extent of the 2,000 cash received; the excess 1,000 of gain is deferred rather than taxed currently.
The unrecognized 1,000 of gain is preserved through A’s substituted basis in the newly acquired Parcel B, so it is taxed on a later disposition.
Both parcels must be held for investment or productive use in a trade or business; only that real property qualifies for nonrecognition, while the cash is treated as boot.
