What it means
Most of the time, realised and recognised gains are the same. You sell a share for more than you paid, and the whole gain is taxed this year.
But some rules allow part or all of the gain to be postponed, so the realised gain is larger than the recognised gain. A well-known case is the exchange of one business or investment property for another of a similar kind, where tax rules in some countries let the gain be deferred.
If you receive only the replacement property, no gain is recognised yet. If you also receive cash or other value, known as boot, the gain is recognised up to the amount of boot.
The deferred part is not forgiven. It is carried forward by giving the new asset a lower tax basis, so the gain appears when that asset is eventually sold.
Tax planning in this area aims to defer tax, not to remove it. Outside tax, the same word is used in accounting.
A gain is recognised in the income statement when it meets the criteria for recording, for example when a sale is complete and the amount can be measured reliably. Some gains, such as certain revaluations, go straight to equity instead of profit.
Because the rules are technical and differ between countries, advice is essential before structuring any exchange. Deadlines, qualifying asset types and documentation rules are strict, and failing them can turn a deferred gain into an immediate tax bill.
For planning, it helps to model both outcomes before agreeing to a deal. Compare the tax paid now under a straight sale with the smaller tax today and the larger tax later under an exchange.
The value of deferral depends on how long the gain stays deferred and what the business can earn on the money it keeps.
In practice
Real-world examples.
Example
A farmer swaps a plot of land worth $800,000, with a basis of $500,000, for neighbouring land worth $800,000. He receives no cash, so the recognised gain is zero. The $300,000 realised gain is deferred into the basis of the new land.
Example
A company sells a delivery truck with a basis of $20,000 for $35,000 in cash. The realised gain of $15,000 is fully recognised in the year of sale. No deferral rules apply because the transaction is an ordinary sale.
Example
An investor exchanges a rental building for a larger one and receives $120,000 in cash along with it. The realised gain is $400,000, so she recognises $120,000 and defers $280,000. Her tax adviser records the lower basis in the new building.
Formula
Calculation
Recognised gain = Lesser of (Realised gain, Boot received)
Suppose a business exchanges a property with a tax basis of $300,000 and a market value of $500,000 for another property worth $450,000 plus $50,000 in cash. The realised gain is 500,000 - 300,000 = $200,000. The boot received is the $50,000 of cash, so the recognised gain is the lesser of $200,000 and $50,000, which is $50,000. The remaining 200,000 - 50,000 = $150,000 is deferred, and the new property's basis is 300,000 + 50,000 - 50,000 = $300,000.Case study
Seen in the real world.
Lakeview Storage is an illustrative, fictional business that owns a warehouse with a tax basis of $900,000 and a market value of $1,500,000. The owners agree to swap it for a bigger warehouse worth $1,400,000, plus $100,000 in cash.
The realised gain is 1,500,000 - 900,000 = $600,000. Because the cash received is $100,000, the recognised gain is the lesser of $600,000 and $100,000, which is $100,000, and $500,000 is deferred.
The finance director budgets for tax on only $100,000 of gain this year and notes that the new warehouse has a basis of 900,000 + 100,000 - 100,000 = $900,000. In this illustrative case, she reminds the board that the deferred $500,000 will be taxed when the new warehouse is eventually sold. She records a note in the tax file showing how the deferred amount links to the basis, so that future advisers can follow the calculation.
Watch out
Common mistakes.
- Treating realised and recognised gains as the same, when special rules can defer part of the gain.
- Assuming a deferred gain disappears, when it usually reappears through a lower basis in the new asset.
- Ignoring cash or other value received in an exchange, which can trigger an immediate recognised gain.
Questions
People also ask.
What is the difference between realised and recognised gain?
A realised gain has actually occurred through a sale or exchange, while a recognised gain is the part that must be counted for tax or reporting now.
What is boot?
Boot is cash or other non-matching value received in an exchange, and it is usually what triggers the recognised gain.
Do these rules apply everywhere?
No, the availability of deferral depends on local law and on the type of asset, so seek professional advice. Some countries restrict deferral to specific kinds of property, while others do not offer it at all.
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