Definitions
Carryover Basis: In a tax-deferred exchange, the adjusted tax basis of the property given up is used to determine the tax basis of the property acquired. This approach defers the realization of capital gains and consequently the capital gains taxes until a subsequent taxable sale or exchange of the final property.
Key Characteristics
- Adjusted Tax Basis: The value used for tax purposes to determine gain or loss on the sale of property, adjusted for depreciation and improvements.
- Tax-Deferred Exchange: Often known as a 1031 exchange, it allows you to defer capital gains taxes by reinvesting proceeds from a sold property into a similar type of property.
Examples
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Example 1 - Land Exchange:
- Abel exchanges land with Baker in a tax-deferred exchange.
- Abel’s adjusted tax basis in the land he gives up is $10,000.
- The carryover basis for the new property Abel receives becomes $10,000, excluding any boot (additional money or property that may affect tax calculations).
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Example 2 - Commercial Property Swap:
- Sarah exchanges her commercial building for another commercial property.
- Her adjusted tax basis in her original building is $150,000.
- In the absence of boot, the carryover basis for the new commercial property becomes $150,000.
Frequently Asked Questions (FAQs)
What is the significance of a carryover basis?
The carryover basis allows property owners to defer paying capital gains taxes until the final sale or exchange of the property. This deferral can enhance cash flow for real estate investors by reducing immediate tax obligations.
How does the adjusted tax basis affect the carryover basis?
The adjusted tax basis, which may be altered by additions or depreciation, becomes the carryover basis for the newly acquired property in a tax-deferred exchange.
Can carryover basis apply in inheritances?
No, in the context of inheritances, the term “step-up basis” is used, where the property basis is reset to its current market value at the time of the owner’s death.
What happens if I receive boot in an exchange?
Boot received in a tax-deferred exchange can partially trigger capital gains taxation. The carryover basis must also be adjusted to account for the boot.
Is carryover basis applicable in personal property exchanges?
No, carryover basis primarily applies to real estate and certain business assets considered under the Internal Revenue Code Section 1031.
Related Terms
Basis (Tax)
The value used for tax purposes to determine gain or loss upon selling or exchanging property. Adjusted basis accounts for property improvements, deductions, and depreciation.
Boot
In a 1031 exchange, any additional value (cash, other property) received to balance out an unequal property exchange, potentially liable for tax.
1031 Exchange
A tax-deferred exchange of like-kind properties under Internal Revenue Code Section 1031, designed to defer capital gains taxes.
Capital Gains Tax
A tax on the profit realized from the sale of non-inventory assets, such as real estate, which are categorized as capital assets.
Online Resources
- Internal Revenue Service (IRS) 1031 Exchange Information
- Investment Properties: IRS Guidelines for Property Exchange
- National Association of Realtors: Guide to Like-Kind Exchanges
References
- “Tax-Free Exchanges Under §1031” by Prof. Gerald J. Robinson
- “Practical Guide to Real Estate Taxation” by David F. Windish
Suggested Books
- Real Estate and Taxes! What Every Agent Should Know by Sandy Botkin
- The Book on Tax Strategies for the Savvy Real Estate Investor by Amanda Han and Matthew MacFarland
- Like-Kind Exchanges Under Code Section 1031 by Alan G Coral.
