Congratulations! You have successfully followed all the rules and completed your exchange on time. You utilized the services of a Qualified Intermediary (QI) so you are in full compliance with IRC §1031.
February 19, 2023
By Al DiNicola, AIF®, CEPA ™
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC
You purchased a property equal to or in excess of the property you sold. You used all the cash proceeds and replaced the debt that was paid off on the property you sold. Now it is time to report the details of the exchange as required by the IRS. SO, exactly what does the IRS want to know about the exchange. Maybe not everything but there are key elements of your exchange you need to submit.
CPAs for Complete Answers
We are not CPAs and would suggest consulting your CPA for full compliance. This may serve as an overview on what to expect.
The Internal Revenue Service provides several forms that need to be completed reflecting your exchange details. Everything starts with form 8824. Real estate investors who have utilized the 1031 exchange are required to fill out this form. This reflects the transactions from the previous tax reporting period. There is a complication that occurs when the sale of the relinquished property and the acquisition of the replacement property does not occur during the same tax reporting year. For example, if you sold your property in August 2022 and completed your exchange in December 2022 the process is straight forward. However, if you sold your property in August 2022 (identified your replacement properties with the prescribed 45 days) and are waiting to close in February 2023 there is an extra step required. You would need to fill out form 8824 and attached to your 2022 tax returns. You would complete the reporting when filing your 2023 returns.
Fill in the Blanks- Correctly
- To avoid any unnecessary penalties or liabilities for taxes the forms need to be filled out correctly. The IRS typically may want answers to Who, What, Where, When, how much, and more questions that will be on Form 8824!
- What was the property exchanged or a description?
- Did you make any money (gain) or lose money (loss) on sale of other property you sold or gave up that was not part of the exchange?
- What was the dates of the replacement properties identified and when the property was closed, or title transferred?
- What were the proceeds from the sale, was there a mortgage paid off, or any other Cash received or any other relief of liabilities?
- Were there any related parties to the transaction.
- What was the adjusted basis on the property that was relinquished. And what was the gain.
- What was the fair market value of the property that was acquired.
There are four section to Form 8824.
- Part I Information on the Like-Kind Exchange
- Part II- Related Party Exchange Information
- Part III- Realized Gain or (Loss), Recognized Gain, and Basis of Like-Kind Property Received
- Part IV- Deferral of Gain from Section 1043 Conflict of Interest Sales
Part I (lines 1-7) as stated includes information on the exchange. This would include description of the relinquished property which is a full address or other acceptable description (occasionally referenced as the down-leg), the date you transferred title to buyer, when you identified your potential replacement properties (45-day replacement notification) to your Qualified Intermediary (QI), and finally the date you closed on one or more of the identified properties on your list (occasionally referenced as the up-leg).
Part II (lines 8-11) addresses any related party exchange information. If you had an interest in or stake in a property with a related party translated as any family member, spouse, grandparents, sister, brother, a partnership, etc. would need to be reported. There a few noted exception including death of related party. As always consult your tax advisor.
Part III (lines 12-25) focuses on the financial numbers related to the exchange. This is how the IRS tracks the financial details of your exchange. Topics and questions include references to fair market value, adjusted basis of relinquished property, gain on property, cash received, adjusted basis of like kind property, realized gain and other financial related questions.
Part IV (lines 26-38). This would be a special situation and used only by officers or employees of the executive branch of the federal government or judicial officers of the federal government (including certain spouses, minor or dependent children, and trustees as described in section 1043) for reporting nonrecognition of gain under section 1043 on the sale of property to comply with the conflict-of-interest requirements. This part can be used only if the cost of the replacement property is more than the basis of the divested property.
Understanding and Execution
Many CPAs and especially tax advisors understand the process especially those who handle 1031 exchanges on an ongoing basis. The execution of filling out Form 8824 should be very easy for those professionals. CPAs who are engaging with an investor for the first time may need to ask a lot of question of the investors. A big part of the solution will come back to the individual investor understanding the relinquished property details when acquired (typically found on the closing documents) as well as all cost involved during the ownerships that may add to the basis in the property.
Standing by to assist
We deal with 1031 exchanges all the time and are happy to engage with CPAs on the initial question for your exchange. We have engage with CPA on clarifying the acquisitions of Delaware Statutory Trusts (DSTs). DSTs have been utilized by investors for about 20 years. However, many CPAs do not see as many exchanges involving DSTs as compared with traditional real estate. There are a few more details when a DST is acquired or relinquished. Typically, those details may be in the description and percentage of ownership.
There are occasions when investors engage in a partial exchange. This is either by design or by one or more of the properties identified falling out or a failed exchange. We will address partial exchanges in an upcoming post.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email firstname.lastname@example.org.
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