Exchanging Thoughts

Reporting your 1031 Exchange on Form 8824

Posted by Margo McDonnell on Thu, Oct 11, 2012

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Many that requested an extension are now wrapping up (or maybe just starting) their 2012 tax return.  Those that completed a 1031 exchange must also report the transaction on this return due October 15th.  Therefore, we are using this Thankful Thursday  post to help those now trying to report their 1031 exchange. Following is a line-by-line Instruction for the completion of Form 8824:

Part I:

Lines 1 and 2 – describe the property(s) (e.g. Steel mill) and indicate that the property is located in the USA.

Line 3 – use initial acquisition date regardless of any improvements made at a subsequent date.

Line 4 – use date of sale of the first property relinquished.

Line 5 – This is the 45th day or earlier. Note that the taxpayer and the tax return preparer should have support for this date.

Line 6 This is the 180th day or the due date of the return or the completion of the exchange (if earlier). NB – the taxpayer must file for an extension if the taxpayer is within the 180-Day Exchange Period at the time of the due date of the return.

Line 7 – Note that if either blocks a or b are checked, Form 8824 must be filed for two additional years after the exchange.

Part II:

Line 8 – Do your homework. Make sure the related party issues including the rules of attribution.

Line 9 – The property sold to a related party should not be sold by that party for 730 days or two years following the related party’s acquisition of the property.

Line 10 – What is purchased from a related party should not be sold (by the taxpayer) for 730 days or two years following the completion of the exchange.

Line 11 – If either 9 or 10 have been checked yes, then this line 11 must be completed. Arguably, blocks a and b do not give rise to potential abuse. Proof that involuntary conversion was not a threat at the time of the exchange might be difficult to prove. The facts and circumstances test of box c are going to be difficult to win upon audit. The case must be compellingly in favor of the taxpayer.

Part III:

Lines 12 to 14 are only applicable if other than like kind property is involved in the sale of the relinquished property(s). The gain or loss on the disposition of non- like kind assets is transferred to the appropriate form (usually schedule D or 4797). For example if a furnished rental property was sold and an unfurnished rental property was purchased as the replacement property, this would give rise to reporting on lines 12 through 14.

Line 15 – one of, if not the most complicated line of the form. This is comprised of the following four elements:

      a.     Cash that the taxpayer walked away with from the transaction. (plus)

      b.    The FMV of any non like-kind property received in the exchange (plus)

      c.     Any net reduction in debt (new debt less than old debt). If the taxpayer added additional equity in the course of completing the exchange, this additional equity reduces the net reduction in debt. (less)

      d.    Exchange fees and other transaction costs – use all such costs to reduce line 15 first then use the remainder on line 18.

Line 16 – This is the contract (sale) price of the replacement property. Do not reduce this by any transaction costs.

Line 17 – This is the sum of line 15 and 16.

Line 18 – This is the second most confusing line of the form (behind line 15). This line is comprised of the following three elements:

      a.    Adjusted tax basis of the relinquished property. (plus)

      b.    Net amount of additional equity added to complete the exchange (not otherwise used to offset potential debt boot on line 15). (plus)

      c.    Exchange fees and other transaction costs (not otherwise used on line 15).

Line 19 – This is line 18 less line 17. This is the economic or realized gain and should make some intuitive sense to you. In essence, this is the gain that would be taxed if not for the election under § 1031.

Line 20 – The goal is to minimize the amount on this line. To the extent that you can minimize the amount on line 15 below the realized gain, less than the full gain will be taxed as a result of the election under § 1031.

Line 21 – The instructions are not correct with respect to § 1250 property. A literal interpretation of the instructions for § 1250 property for recapture can result in greater recapture than accumulated depreciation. Otherwise, any gain on line 20 is allocated 100% up to the amount of recapture that would be calculated in a sale at gain for which § 1031 was not elected.

Line 22 – To the extent that there is an excess of line 20 over line 21, this excess is reported on line 22. This amount is carried over to the appropriate form (typically schedule D or form 4797). If an installment sale election were to be made, this gain would be transferred to form 6252.

Line 23 – This is the sum of lines 21 and 22. It cannot exceed line 20 and must also not exceed line 19.

Line 24 This is the difference between line 19 and line 23. The goal is to have line 24 equal line 19. To the extent that there is any amount on line 24, there will be deferral of recognized gain. Note that the form refers the taxpayer to the instructions if a related party is involved in the exchange. If this is the case, and subsequent sale occurs within the prohibited two-year period, the gain is reported in the year of that subsequent sale.

Line 25 – This is the sum of lines 18 and 23 after subtracting line 15. In essence, this is the old basis plus capitalized transaction costs plus additional capital (equity or purchase money debt) less any gain recognized or boot.

Download our 2011 Exchange Reporting Guide for other helpful information.  For questions, please feel free to contact our Exchange Team.

Topics: tax consequences of a 1031 exchange, reporting a 1031 exchange