Using a Like-Kind Exchange
to Avoid Gain Recognition

Editor:
Albert B. Ellentuck, Esq.
Of Counsel
King & Nordlinger, L.L.P.
Arlington, VA

Editors note: This case study has been adapted from Tax Planning for High Income Individuals, 4th Edition, by Anthony J. DeChellis, Douglas L. Weinbrenner, Catherine A. Roeder and Patrick L. Young, published by Practitioners Publishing Company, Ft. Worth, TX, 2003 ((800) 323-8724; www.ppcnet.com).

Facts: John Henderson owns real property consisting of a building, a parking lot and three acres of land, which he acquired in 1989 for $1.6 million. The propertys current fair market value (FMV) is $1.9 million, with a $1.2 million mortgage and a $1.3 million adjusted basis. John leases part of the building to his solely owned corporation (his medical practice) at fair rental value. The rest of the building is leased to a medical clinic.

Because of his growing practice, John needs to double the existing facilitys size. Unfortunately, renovating the building is not feasible, nor is there any available land near the present building. Thus, John will have to replace the existing property with a larger, more expensive facility.

He is worried that if he purchases a new facility, he will end up with both properties and their mortgages for a long period. He is afraid of not being able to meet the debt service on both properties. Additionally, he does not believe he can pay the tax on the anticipated $600,000 gain from the sale of the existing facility and still be able to purchase a building large enough to meet his business needs. Issue: How can John meet his goals and avoid gain recognition?

Analysis

Johns tax adviser tells him that if he can acquire another property in a like-kind exchange without receiving any boot, he can meet his desired results without triggering gain.

John locates the property he wants to acquire. The owner is willing to take the existing facility in exchange, provided John makes a cash payment to equalize the properties equity values. The existing facility has a $1.9 million FMV and a $1.2 million mortgage. The new facility has a $3 million FMV and a $2 million mortgage. John will give the owner $300,000 cash. Each party will assume the mortgage secured by the property received in the exchange.

Although John receives relief from liabilities in the exchange, he also pays cash and assumes a mortgage. The following computes the boot John paid/received:

Thus, John does not receive any boot in the deal, so none of his realized gain ($600,000) is recognized. His basis in the new property is computed as follows:

Exhibit 1 provides a like-kind exchange worksheet.