Like-kind Exchange

A program is arranged so that each investor is treated as owning an undivided interest in the underlying property directly, reporting the income and deductions on his own return rather than receiving an allocated share from an entity. Which entity is described?

1. A.A limited partnershipWrong. A partnership files an informational return and allocates items out to its partners.
2. B.A grantor trustCorrect. The beneficial owner is treated as owning the underlying assets directly.
3. C.An S corporationWrong. Its shareholders own stock and receive allocated items, not the assets themselves.
4. D.A joint ventureWrong. It is an association formed for a single undertaking and is generally taxed as a partnership.

Why: A grantor trust is disregarded for tax purposes, so the beneficial owner is treated as owning the trust assets themselves. That is a different mechanism from entities that file an informational return and allocate items out to their owners, even though the practical result of no entity-level tax looks similar. The distinction matters because direct ownership of the underlying property is what a like-kind exchange structure requires. An entity that merely passes allocated shares through to its owners would not produce that treatment.

Ingrid Solberg owns a rental warehouse with a $400,000 adjusted basis and a $1,100,000 fair market value. Using a qualified intermediary and completing every step within the required time limits, she exchanges it for another rental building worth $1,100,000. She receives no cash and there is no net debt relief. For federal income tax purposes:

1. A.No gain is recognized now; the $700,000 gain is deferred and her basis in the replacement building is a carryover basis of $400,000, so the gain remains embedded in the new property.Correct. Deferral works precisely because basis carries over. The unrecognized gain stays in the replacement property until a later taxable disposition.
2. B.She recognizes a $700,000 long-term capital gain in the year of the exchange.Incorrect. A properly executed like-kind exchange of real property held for business or investment defers recognition. No cash or net debt relief was received, so there is no boot to trigger gain.
3. C.The $700,000 of gain is permanently forgiven, since the exchange qualifies under the like-kind rules.Incorrect. Like-kind treatment defers gain; it does not forgive it. The carryover basis preserves the gain for later recognition.
4. D.Her basis in the replacement building is $1,100,000, its fair market value on the date of the exchange.Incorrect. A fair market value basis would erase the deferred gain entirely. The replacement property takes the $400,000 carryover basis instead.

Why: A like-kind exchange of REAL property held for productive use in a trade or business or for investment defers, rather than forgives, the gain. Ingrid recognizes nothing currently. Her basis in the replacement building is a carryover basis of $400,000, so the entire $700,000 of unrecognized gain remains embedded in the new property and will be recognized whenever she later sells it in a taxable transaction. Personal-use property and, since the current rules took effect, personal property such as equipment or vehicles do not qualify.