Understanding Synthetic Dispositions – Indebtedness in Exchanges of Property

We continue our Synthetic Dispositions series this week with a look at indebtedness in exchanges of property.

Example: Synthetic Disposition –
Indebtedness in Exchanges of Property

Issue: Corry owns a rental property which he purchased for $175,000 which is now worth $195,000. In 2013 he makes an arrangement with Delores to borrow $200,000 at no interest. This arrangement gives Delores the right to exchange the loan for the property in 2015. How is this arrangement taxed?

Answer: If the arrangement was made before budget day (March 21, 2013), there would be no income tax consequences in 2013. If the debt is exchanged for the property in 2015, Corry would report a capital gain of $200,000 - $175,000 = $25,000 in 2015. 

If the arrangement was made after budget day, then Corry would be deemed to have disposed of the property for its fair market value at the time of the transaction triggering the $195,000 - $175,000 = $20,000 capital gain at that time. He is deemed to have reacquired the property for $195,000. In 2015, if Delores exchanges the loan for the property, Corry will have another disposition, with a further capital gain of $200,000 - $195,000 = $5,000.

Excerpted from EverGreen Explanatory Notes. ©Knowledge Bureau. All rights reserved.

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