Finding the Adjusted Basis

Problem: Brown Construction, Inc. is in the road construction business. Brown exchanges a grader used in its business and $45,000 in cash for a scraper to be used in its business. The adjusted basis of the grader is $50,000, and the fair market value of the scraper is $102,000. What are the tax consequences to Brown of the exchange?

Tax Issues: There are a few tax issues to consider in this case. The first tax issue to consider is whether this exchange qualifies as a like-kind exchange, and if so, how does the IRS apply the recognition of gains or losses from these exchanges. Another tax issue that needs to be addressed is applying the appropriate rules when exchanging property when there is also cash involved in the exchange. Additionally, the determination of the adjusted basis of the property received must be completed.

The section of the IRS code that addresses the issue of exchanges of property is section 1031. Section 1031 allows tax payers to defer gains and losses from exchanges of like kind property. The tax code specifies which type of property can be tax exempt and the stipulations for qualification to be like kind property, "No gain or loss shall be recognized on the exchange of property held for productive use in the trade or business for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment." The IRS Code, Section 1031 does provide examples of property that does not qualify under Section 1031 and is not allowed to take the tax deferral as a like kind exchange; "Exception. This subsection shall not apply to any exchange of (A) stock in trade or other property held primarily for sale, (B) stocks, bonds, or notes, (C) other securities or evidences of indebtness or interest, (D) interests in partnership, (E) certificates of trust or beneficial interests, or, (F) choses in action. " In this particular scenario, Brown Construction, Inc. is exchanging a grader for a scraper (ignoring the cash given), which are both equipment used in the trade of business. Additionally, this equipment does not fall into any of the exception categories provided by the code.

However, there is more to consider in this research problem. Section 1031 does provide specific regulations regarding exchanges where the presence of cash (boot) is involved. "If an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or of section 1037(a), if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property. Loss from exchanges not solely in kind. If an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or of section 1037(a), if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange shall be recognized. " If Brown Construction, Inc. had been the recipient of cash, the company might have had to recognize a portion of the gain, or take no loss, depending on the amount of the cash received. However,