Liabilities Assumed or Taken Subject To

The term comes from section 1031(d) and two regulations that net debt against debt.

The last sentence of section 1031(d) says that where another party to the exchange assumed a liability of the taxpayer, as determined under section 357(d), the assumption is considered money received on the exchange. Reg. section 1.1031(d)-2 gives the same treatment to liabilities to which the property you transfer is subject, so no one has to sign an assumption agreement for the rule to apply.

Reg. section 1.1031(b)-1(c) then nets the two sides. Consideration you give by assuming a liability, or by receiving property subject to one, is offset against consideration you receive in that same form. Example 2 of Reg. section 1.1031(d)-2 shows the limit: cash you pay can offset liabilities you are relieved of, but liabilities you take on cannot offset cash or other property you receive.

The Instructions for Form 8824 explain who is treated as assuming a debt. A recourse liability is treated as assumed by the party that has agreed to pay it and is expected to, whether or not the lender released the transferor. A nonrecourse liability is generally treated as assumed by whoever takes the property subject to it. Net liabilities assumed by the other party go on line 15; a net amount you paid goes on line 18.

A hypothetical: the mortgage you retire is matched by the mortgage you take on.

Hypothetical figures: you sell a rental for $1,000,000 with a $400,000 mortgage that is paid off at closing, and $600,000 reaches your qualified intermediary. You buy a $1,200,000 replacement with the $600,000 and a new $600,000 loan. You shed $400,000 of debt and took on $600,000, so the new debt fully offsets the old and no net debt relief is left over to tax.

Change one fact: the replacement costs $900,000, bought with the $600,000 of exchange funds and a $300,000 loan. The $400,000 shed now exceeds the $300,000 taken on by $100,000, and that excess is treated as money received, the same pattern as Example 5 in Reg. section 1.1031(k)-1(j)(3), where a $30,000 mortgage assumed by the other side is offset by a $20,000 mortgage the taxpayer assumes, leaving $10,000 of gain. Adding $100,000 of your own cash at the replacement closing would close the gap. Run your own numbers with your CPA.

It bites with seller financing, DST allocated debt and cash taken out at closing.

A purchase-money note you give the seller of the replacement, secured by that property, leaves you holding property subject to a liability, so it sits on the debt side like a bank loan would. The mirror image, a note you take back from your own buyer, is not debt relief at all but a separate problem covered in carrying a note for your buyer.

A Delaware statutory trust interest brings its share of the trust's loan with it. In Rev. Rul. 2004-86 the trust assumed a 10-year nonrecourse loan taken out by the person who formed it, and how that allocated debt counts against the loan you retired is worked through in does a DST loan count as replacement debt.

The one-way rule is the usual trap. If you take cash out of the sale closing and plan to borrow more on the replacement to make up for it, the extra debt does not cancel the cash; see can more debt offset cash taken out and the overview of what counts as boot.