1031 question

[Margaret CPA in OH]

New client had a 1031 exchange in 2022.  Rental property in OR was fully depreciated and sold for nearly $700K.  Client went through proper intermediaries but paid tax on about half the gain and selected a replacement property for about half.  I was puzzled when I saw no assets listed or depreciation on one property until client explained about the 1031.  So there is no asset listed for either the replacement rental, even as fully depreciated, or the land.  What happens if client sells this replacement as some point?  I've never seen one of these but don't feel comfortable having nothing listed.  The prior preparer put in land for $1 I guess so it would make sense to the real estate tax paid.

The only results of my research so far mention the tax deferral even to death not replacing with a non-depreciable property.  Ideas?

(Yes, I get them.  This is the guy with 7 rentals in 5 states who bought and sold an AirBnB within a year but over two tax years.)

[jklcpa]

I've done 1031s, including with partial gain taxable, but never one where absolutely everything was fully depreciated. What about the land value from the original property sold?  

[jklcpa]

I had a thought on the land.  Was this a condo where no amount was assigned to land?

Other than that thought, concerning future sale and gain: as you know, the premise of the 1031 is that the basis of the new carries over from the old property given up so that any gain is deferred to the future, so -0- basis would be possible if every bit of the property given up has been depreciated, but there is still my question about the land.  It is possible that the full amount of proceeds of a sale in future, net of exps of sale, would be the amount of gain from that future sale if the property truly has -0- basis.  Then again, the TP will have additional basis for any capitalized costs incurred after the 1031 exchange occurred.

[DANRVAN]

4 hours ago, Margaret CPA in OH said:

So there is no asset listed for either the replacement rental, even as fully depreciated, or the land. 

It is possible that the deferred gain was equal to the replacement property, and therefore zero basis.  For example the fmv of property given up could have been $100,000 with a fully depreciated building (zero basis) and land with $10,000 basis = tentative gain of $90,000.  If client received in exchange cash of $10,000 and property with FMV of $90,000,  then deferred gain = $90,000 and basis in new = zero. 

The 8824 form year of sale will tell you what the basis should be.  

The zero basis should be listed in your asset detail and carried forward.  I would put a description that indicates it was 1031 exchange property.

Also I would scrutinize the 8824 to make sure the exchange was properly accounted for by prior tax preparer. 

[DANRVAN]

Also, if there is deferred gain attributed to unrecaptured 1250, you should keep track of it for a potential 25%  max capital gain rate if the property is sold.

[DANRVAN]

7 hours ago, jklcpa said:

so -0- basis would be possible if every bit of the property given up has been depreciated

Basis of property received is zero whenever FMV of property received is equal to or less then deferred gain.

Or look at this way; basis in new equals basis in old less recognized gain.  So in my example $10,000 less $10,000 = zero basis.

[DANRVAN]

I am retracting my previous post(s) after giving it some more thought.

In my example the deferred gain would be $80,000, recognized gain $10,000 and basis in the new property $10,000.

So it appears that in order to have zero basis in the new property the taxpayer would to have zero basis in the old property as Judy mentioned.

 

[Margaret CPA in OH]

Thanks so much for all this valuable input.  I will review the documents again with better understanding.

The recognized gain was $386,321 and unrecaptured Sec. 1250 was $96,025.  On Form 8824 Part III line 18, adjusted basis of property given up, $6352 (I see this on the asset report for mostly appliances not fully depreciated).  Line 16 is FMV of property and it's blank.  The sale price was $679,900.  Cash received $392,698,lots of commission expense and other selling expenses and $217,000 to and Exchange group who 'purchased' the replacement property.  The closing statement for the replacement property shows a purchase price of $212,000.  I haven't found where the $5000 difference between the $217,000 the exchange group received and the $212,000 of the cost of the replacement property might be, probably some fee.

So I am comfortable that the replacement property has 0 basis.  But what of the land?  It seems client paid gain on the sale of the original land but doesn't the replacement property have land valued at ?  Sold property was a 2 family rental purchased in 1993 so fully depreciated. Replacement may be a condo as it has HOA fees.  I have to ask so maybe no land.  Does this $217,000 equal the deferred gain?  There seem to be some missing numbers here.  Does the client have an expense of $5000 between what the exchange received and what it spent for the replacement property?  On that closing document I see title and closing charges to client of $500.  Shouldn't that have been amortized?  If so, over what time period as there is no  mortgage?  Or does it go to basis and depreciated?  But there is no basis.

Why, oh why, did I take this client?

 

[DANRVAN]

4 hours ago, Margaret CPA in OH said:

Line 16 is FMV of property and it's blank

Line 16 blank???!!!   FMV of like kind property received is a critical part of the computation.  

4 hours ago, Margaret CPA in OH said:

The closing statement for the replacement property shows a purchase price of $212,000

The FMV of the replacement property.

4 hours ago, Margaret CPA in OH said:

So I am comfortable that the replacement property has 0 basis.

As I see it,  I would not be comfortable with anything provided by prior preparer.

Did client happened to mention why the change in preparer?

[BulldogTom]

6 hours ago, DANRVAN said:

Line 16 blank???!!!   FMV of like kind property received is a critical part of the computation.  

The FMV of the replacement property.

As I see it,  I would not be comfortable with anything provided by prior preparer.

Did client happened to mention why the change in preparer?

^^^^^^   ???????  

Tom
Longview, TX

[DANRVAN]

13 hours ago, Margaret CPA in OH said:

Does the client have an expense of $5000 between what the exchange received

Exchange fee is a reduction on line 15.

13 hours ago, Margaret CPA in OH said:

On Form 8824 Part III line 18, adjusted basis of property given up, $6352 (I see this on the asset report for mostly appliances not fully depreciated)

Appliances are not actually like kind property so they should go on lines 12 and 13.

No basis for the original land?  Maybe it was never allocated and was depreciated as building cost.

[jklcpa]

Margaret, that 8824 definitely has problems and shouldn't be relied on, and I think you are going to have to rework the numbers to arrive at the proper deferral.

In a general and simplified discussion, the deferred gain should be the difference between recognized gain and the realized gain. Maybe think of it as a reconciling exercise where that deferral reduces the basis of the new property back down to that of the old (new property as if purchased outright minus the deferred gain = basis of the new). It's not unlike the very old personal residence rules where the basis was reduced when gain was deferred.

In a very simplified example, I've created an 8824 with your facts. I'm not sure where some of the former preparer's figures come from, and I don't have the selling expenses or other costs that you mentioned, so below is a very basic 8824 with your fact pattern to use as an example. You'll see that the deferral on line 24 is the difference between the recognized and realized gains (line 19 minus 23), and that amount is the exact reduction applied against the new property, and that brings you back to the basis of the old.  Also, keep in mind that "cash received" on line 15 isn't the cash received at settlement of selling the old; it is the cash that the seller didn't reinvest, so my starting point was $679,900 - 212,000 reinvested. The use of $212K accounts for the $5K of fees.

Maybe this will help you sort this out.  And if I'm all wrong here, Dan will straighten me out.

8824.pdf

 

Edited January 18 by jklcpa
deleted blank pg in attachment

[jklcpa]

Sorry if that pdf isn't working. It has been an ongoing issue since the upgrade. Here's a photo that may work

[Margaret CPA in OH]

Thanks so much, DANRVAN and Judy, for these additional comments.  I still have the client's folder with all the exchange documentation in it and a pdf of the 2022 return.  I will review with the 8824 Judy most kindly provided and see what next.

Client changed preparers because prior person was hard to reach and didn't answer questions (I also think client really didn't know what to ask).  I think client wants to better understand and manage his properties now that he is retired from Delta.  That's why there are so many different states for the rentals as he was stationed in different places.  First, though, I have to better understand the 1031 situation in 2022 flowing to 2023 so I feel more confident in 2024.  Thanks to this amazing board and generous folks chiming in, I think it is possible.

[DANRVAN]

1 hour ago, jklcpa said:

Also, keep in mind that "cash received" on line 15 isn't the cash received at settlement of selling the old; it is the cash that the seller didn't reinvest, so my starting point was $679,900 - 212,000 reinvested. The use of $212K accounts for the $5K of fees.

I believe the starting point for line 15 is the actual amount of cash received at closing instead of the sale price less amount invested, otherwise gain is recognized on closing cost etc..

The $5,000 of exchange fee reduces the amount of boot on line 15.  

[Margaret CPA in OH]

Thanks again.  I will review - again - and plug in what may be different numbers taken from the exchange company documents and the 8824.  Client did receive the $386,000 from the selling price of $679,000.  And paid a lot of taxes to IRS, OR, the municipality and others, I think.  I'll see what I come up with from the original documents.