Question

Rufus Inc. and Hardy Company are negotiating a nontaxable exchange of business properties. Rufus’s property has a $50,000 tax basis and a $77,500 FMV. Hardy’s property has a $60,000 tax basis and a $90,000 FMV. Which party to the exchange must pay boot to make the exchange work? How much boot must be paid? Assuming the boot payment is made, how much gain or loss will Rufus realize and recognize on the exchange, and what tax basis will Rufus take in the property acquired? Assuming the boot payment is made, how much gain or loss will Hardy realize and recognize on the exchange and what tax basis will Hardy take in the property acquired?

Answer 1

Rufus must pay $12,500 as boot to Hardy to equalize the FMVs of their exchanged properties. Rufus will realize no gain or loss and his tax basis in the new property will be $62,500. Hardy will realize a gain of $12,500 but recognize no gain, and his tax basis in the new property will be $47,500.

Step-by-step explanation:

In a nontaxable exchange of properties with different fair market values (FMVs), boot is sometimes used to even out the trade. Boot is an additional cash payment or other consideration that makes up for the difference in value between the two properties being exchanged.

In this case, Rufus's property has a FMV of $77,500, while Hardy's property is valued at $90,000. To balance the exchange, Rufus should pay boot to Hardy.

To calculate the amount of boot Rufus must pay, we subtract Rufus's FMV from Hardy's FMV:

Boot = Hardy's FMV - Rufus's FMV
Boot = $90,000 - $77,500
Boot = $12,500

Rufus would, therefore, need to pay $12,500 as boot. Rufus will realize and recognize no gain or loss, since this is a nontaxable exchange and the boot paid ($12,500) is less than the gain ($27,500). Rufus's tax basis in the new property will be his original basis plus the boot paid: $50,000 + $12,500 = $62,500.

Hardy will realize a gain of $12,500, but since this is a like-kind exchange and the boot received is not greater than the gain, Hardy will recognize no gain. Hardy's tax basis in the new property will be his original basis less the boot received: $60,000 - $12,500 = $47,500.