Question

Taxpayer T owns an office building worth $950,000, encumbered by a mortgage of $710,000. His original cost was $830,000, and he has taken depreciation deductions of $185,000 on the building. T wants to exchange his building for another office building worth $800,000. He will assume the existing mortgage of $580,000 on the new building.

1) As state, would this be a fair arms-length exchange? If not, who should be required to pay cash boot, and how much? Explain.

2) Assume the exchange is made under the terms of your answer to #1, compute the following for T, showing all calculations.

a) Realized Gain.

b) Recognized Gain.

c) Basis in the new building.

Answer 1

Ans 1,

Current market value of existing office building - $ 950,000

Original Cost of Building - $ 830,000

Depreciation - $185,000

Existing mortgage - $ 710,000

New Building - $ 800,000

Mortgage carry over - $ 580,000, therefore mortgage to the tune of $ 130,000 (710,000-580,000= 130,000) is extinguished by discharge of similar liability.

To arrive at the fair arm's length price we have to consider the market value of the existing building and adjustment for liabilities taken over

Market Value - $ 950,000

Less: Mortgage extinguished - $ 130,000

Net Fair price for Old building $ 820,000

Under the above circumstances, T has to receive $ 20,000 for the above transaction.

Ans 2.

a. Realized Gain

Fair Transfer Price, being Market value of the building - $ 950,000

Less: Cost of original Building    - $ 830,000

Realized Gain - $ 120,000

b Recognized Profit

Fair Transfer Price, being Market value of the building - $ 950,000

Less: Book value of building

Cost of original Building - $ 830,000

Less: Depreciation - $ 185,0000

Book value - $ 645,000

Recognized Profit - $ 305,000

c. Basis in the new Building

Book value of New Building - $ 800,000

Mortgage on New Building - $ 580,000