Realized Gain vs. Recongized Gain
Last week, I started a series of blogs on the Internal Revenue Code Section 1031 tax deferred exchange. The blog covered the concept of "like-kind" exchanges and defined the time constraints involved when conducting a 1031 exchange.
Today, we'll explore the difference between "recognized gain" and "realized gain." While they sound a lot alike, knowing the difference can give the real estate investor an interest-free loan from the IRS! Additionally, we will define the concept of "boot." So, what do these three terms mean?
Realized Gain - This is the amount of gain that the investor made during ownership of the property. The owner calculates this by determining the net sales price (sales price of the property less closing costs) and then subtracts the adjusted tax basis of the property (the formula is relatively simple and your accountant can help you with this).
Boot - Any non "like-kind" benefit received by the Seller after the sale. If the Seller receives cash, this is referred to as "cash boot" and is taxable. If the Seller has a mortgage paid or reduced at closing (and does not acquire an equal amount of mortgage on the new property), the Seller is seen to have gained "mortgage boot," and is taxed the same as if he/she received cash. Any other non "like-kind" benefit would be seen as boot as well. For example, if the Seller received a car as part of the trade, the car would be seen as boot and would be taxed, at its value, as a gain.
Recognized Gain - This is the taxable portion of the above "realized gain." Typically, the only taxable portion of realized gain is the boot received after the sale.
So, to summarize, the key to using a 1031 exchange is to take a realized gain and reinvest it into another property. Done correctly, there will be no boot, and therefore no recognized gain to be taxed!
So, when then does the property owner finally pay these taxes? The answer might surprise you.... NEVER is a valid option. So long as the Seller never takes any boot, then no taxes are paid! The Seller can refinance the property to pull cash-out without having to recognize this as boot, so the cycle can continue for the rest of the investors life.
About The Author
As Broker and Co-Owner of Century 21 First Realty, a Tallahassee Real Estate Brokerage business, Joe Manausa utilizes his MBA and 17 years of Tallahassee Real Estate experience in order to help clients with large investment opportunities while also taking the lead in growing the Century 21 First Realty operation. Additionally, he heads an experienced team of fellow West Point and Annapolis Graduates who run Tallahassee Real Estate Holdings and other entrepreneurial ventures. He contributes to a daily Web Blog which focuses on the Tallahassee Real Estate Market, as well as other topics important to Tallahassee, Florida. For more information on Joe and Century 21 First Realty, please visit his company website at www.manausa.com
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Joe Manausa, MBA, CRB, CRS | Broker / Owner | Century 21 First Realty
2365 Centerville Road | Tallahassee, Florida 32308 | (850) 386-2001 | http://www.manausa.com