Like-kind exchanges

A like-kind exchange is a disposal that is being exchanged for a similar asset.

Note: See APB29, Accounting for Nonmonetary Transactions, and EITF86-29, Nonmonetary Transactions: Magnitude of Boot and the Exceptions to the Use of Fair Value for additional information on GAAP requirements.

Under certain circumstances, you might be required to defer a portion of the gain on a disposal that is being exchanged for a similar asset.

If the exchange results in a gain smaller than 25 percent, you must recognize gain proportionally and coordinate the disposal of the original asset and the addition of the new asset.

If the exchange results in a loss, or if the gain from the exchange is greater than 25 percent, follow the standard disposal procedure for the disposed asset, and follow the standard addition procedure for the new asset.

Consult your accounting advisor before you decide on a processing method for like-kind exchanges.

Before you dispose of an exchanged asset, you must gather these information:

  • The total gain or loss incurred because of the exchange

  • The numbers to use for both the old asset disposal and the new asset addition.

    For the old asset disposal

    You must know the asset basis, proceeds amount, accumulated depreciation amount, and gain or loss amount.

    Note: The disposal program calculates these amounts for you, but if you want to use proportional gain recognition, you must move the loss amount to the Deferred Loss field when prompted for gains or losses, and you must verify the journal entries created before you release the disposal.
    For the new asset addition

    To use proportional gain recognition, you must calculate the recognized gain, unrecognized gain, and the new asset basis you must use in the asset addition. Calculations used in a like-kind exchange transaction

    For this type of asset addition, the new asset basis is not the declared value of the new asset.

Calculations used in a like-kind exchange transaction

  • Total gain is the actual gain realized in the exchange. The formula to calculate the total gain is:

    (Old Asset - Accum Deprec) - (New Asset + Proceeds) = Total Gain

  • Recognized gain is the portion of the total gain you must recognize in the asset addition. The formula used to calculate recognized gain is:

    Proceeds / (New Asset + Proceeds) * Total Gain = Recognized Gain

  • Unrecognized gain is the portion of the total gain that you cannot recognize. The formula used to calculate unrecognized gain is:

    Total Gain - Recognized Gain = Unrecognized Gain

  • The new asset basis is the asset basis you must use when you add the asset, in place of the declared value of the asset. The formula used to calculate the new asset basis is:

    New Asset - Unrecognized Gain = New Asset Basis

  • Deferred loss is the temporary loss incurred when you dispose of an exchanged asset. The loss is deferred because it is later offset by the gain from the new asset addition. The disposal program calculates the loss, and you must move the loss to the deferred loss account. The formula used by the program to calculate the loss is:

    Old Asset - (Proceeds + Accum Deprec) = Loss

Differences between like-kind exchanges and regular disposals and additions

If a like-kind exchange results in a gain of less than 25 percent, you must coordinate the old asset disposal and new asset addition in this manner:

  • When you dispose the old asset, you must move the loss incurred to the Deferred Loss account.

  • When you add the new asset, you must use the Differed Loss account as the Asset Clearing account, and the asset basis that you specify must be the calculated new asset basis described in the previous section.

  • When the addition program prompts you to accept the journal entries created, you must adjust the journal entries to clear the Deferred Loss account and add the recognized gain to the Gain account.

Example

Office equipment is exchanged at a gain. This information has been accumulated from the Asset Management application and the new asset purchase documents.

Old Asset Basis 10,000
Accumulated Depreciation 2,000
Net Book Value 8,000
Proceeds 2,000
New Asset 9,000
Total Gain 3,000

Use this formula to determine whether you must recognize gain proportionally:

Proceeds / (New Asset + Proceeds) = <25%

2,000 / (9,000 + 2,000) = 18%

Calculate the recognized gain on the exchange.

Proceeds / (New Asset + Proceeds) * Total Gain = Recognized Gain

2,000 / (9,000 + 2,000) * 3,000 = 545

Calculate the unrecognized gain.

Total Gain - Recognized Gain = Unrecognized Gain

3,000 - 545 = 2,455

Calculate the new asset basis.

New Asset - Unrecognized Gain = New Asset Basis

9,000 - 2,455 = 6,545

These entries are created for the original asset, from addition trough disposal:

Description Source JE # Account Debit Credit
Add original asset through Accounts Payable AP175 1 Asset Clearing 10,000
10,000
Release Asset in Asset Management AM170 2 Office Equipment 10,000
Asset Clearing 10,000
Depreciate asset AM190 3 Depreciation Expense 2,000
Accumulated Depr 2,000
Dispose of asset AM40 4 Cash 2,000
Accum Depr 2,000
Deferred Loss 6,000
Office Equipment 10,000

When you add, the new asset, override the prompted journal entries to clear the deferred loss and record the recognized gain. In this example, the journal entries should be:

Description Source JE # Account Debit Credit
Add new asset AM20 5 Office Equipment 6,545
Deferred Loss 6,000
Release asset in Asset Management AM170 2 Gain 545