How to Report a §1031 Exchange on Your Tax Return?

Investors who have or will com­plete a §1031 exchange this year may already have an eye on prepar­ing for report­ing the exchange. Hope­ful­ly tax pre­par­ers, CPAs, and indi­vid­u­als under­stand the process of enter­ing into and suc­cess­ful­ly com­plet­ing an exchange.

Sep­tem­ber 4, 2024

By Al DiNi­co­la, AIF®, CEPA™
DST 1031 & OZ Spe­cial­ist 
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC Mem­ber of FINRA/SIPC

Sim­pli­fy­ing the Process of Report­ing a §1031 Exchange for Tax Pur­pos­es

The sig­nif­i­cant tax ben­e­fits of defer­ring cap­i­tal gains are well doc­u­ment­ed. Your exchange must be report­ed cor­rect­ly, and the dev­il may be in the details. We have writ­ten on the process over the years and con­tin­ue to have requests for a review.  We are not CPAs but are mem­bers of the Flori­da Insti­tute of CPAs and inter­face often with mem­bers and pro­fes­sion­als.  We have offered con­tin­u­ing edu­ca­tion ses­sions for the mem­bers.

§1031 Tax Deferred Basics.

The IRC (Inter­nal Rev­enue Code) con­tains numer­ous sec­tions. Sec­tion 1031 address­es the abil­i­ty for indi­vid­ual investors to defer cap­i­tal gains. There are numer­ous require­ments to com­ply includ­ing rein­vest­ing the pro­ceeds from the sale of the prop­er­ty into a like kind prop­er­ty. under­stand­ing the rules for com­pli­ance becomes crit­i­cal enabling the defer­ral of pay­ing tax­es on the cap­i­tal gains. This does not mean elim­i­na­tion of cap­i­tal gains tax­es. Once the exchange is com­plet­ed report­ing the exchange is just as impor­tant.

The Paper Trail

Years ago, retain­ing records of the sale and replace­ment of invest­ment prop­er­ty was very stress­ful. The paper trail (actu­al paper records) became sub­ject to becom­ing lost, mis­placed or even destroyed.  With the dig­i­tal age reten­tion of records has become eas­i­er but still some­what stress­ful, espe­cial­ly if the investor has entered into mul­ti­ple exchanges.

Here is an overview of the report­ing process for the §1031 Exchange

1. Form 8824

The IRS has vol­umes of doc­u­ments and hun­dreds of forms. Investors need to track all the prop­er­ties involved as well as dates and time­lines. Form 8824 address­es the “Like Kind Exchanges”. Over the years, espe­cial­ly with the 2017 Tax and JOBS Act, cer­tain assets have been elim­i­nat­ed from the list of assets to exchange. Basi­cal­ly it is now real estate

2. Part I: Sum­ma­ry Infor­ma­tion on the Like-Kind Exchange

There are basic require­ments on Form 8824 Part 1. This will report the infor­ma­tion (some­what in detail) on the prop­er­ties exchanged. It is impor­tant to main­tain the same prop­er­ty iden­ti­fi­ca­tion espe­cial­ly if the investors have been involved in mul­ti­ple exchanges.

Can you prop­er­ly iden­ti­fy the prop­er­ties? This includes the prop­er­ty sold (relin­quished prop­er­ty) and the prop­er­ty pur­chased (replace­ment prop­er­ty). The dates become crit­i­cal when you sell (actu­al­ly trans­ferred title) the prop­er­ty as well as the date you have closed on the replace­ment prop­er­ty. These must be in com­pli­ance with the IRC §1031 exchange require­ments.

3. Beware of relat­ed par­ties.

Part 2 address­es the Relat­ed Par­ty Exchange Infor­ma­tion. The IRS is espe­cial­ly con­cerned with any relat­ed par­ty involve­ments. Occa­sion­al­ly investors may (know­ing­ly or unknow­ing­ly) enter into a trans­ac­tion that appears to cir­cum­vent the tax rules. All names, address­es and tax­pay­er infor­ma­tion of the relat­ed par­ties must be report­ed.

4. Cal­cu­la­tions Real­ized and Rec­og­nized Gains

The next sec­tion to be com­plet­ed will address real­iz­ing and rec­og­niz­ing gains on the trans­ac­tion. Form 8824 Part 3 is where the cal­cu­la­tions will be report­ed. The prof­it from the sale of the relin­quished prop­er­ty is known as the real­ized gain. How­ev­er, the amount sub­ject to cap­i­tal gains tax is known as the rec­og­nized gain.

These two terms may become a lit­tle con­fus­ing. There are a few oth­er items that will assist in the cal­cu­la­tions. The investor must know the fair mar­ket val­ue of both prop­er­ties involved. There is also anoth­er term called the adjust­ed basis. The adjust­ed basis is arrived at by tak­ing the orig­i­nal cost of the relin­quished prop­er­ty and adjust­ing (adding to the basis) for any improve­ments to the prop­er­ty that was made over the time as well as depre­ci­a­tion that was assumed to be tak­en dur­ing the course of own­er­ship (reduc­ing the basis). Improve­ments to the prop­er­ty do not include gen­er­al main­te­nance of the prop­er­ty. Depre­ci­a­tion whether tak­en or not on the indi­vid­u­als tax forms must be cal­cu­lat­ed.

One over­looked item is any cash that’s received in the exchange which may be tax­able. This is known as Boot.

5. Defer­ral of gain or loss will be com­plet­ed in Part 4.

There are sev­er­al steps to cal­cu­late the gain or loss of the §1031 exchange. There are many tools that are avail­able, includ­ing some of our tools on our web­site that can pro­vide investors with a gen­er­al under­stand­ing of the cal­cu­la­tion of the gain or loss. 1031 Tax Esti­ma­tor — (dst.investments). Investors must under­stand there are IRS require­ments for the exchange in order for these cal­cu­la­tions to be valid.

Time­lines pro­vide the rules of the road

The report­ing of the trans­ac­tion on your indi­vid­ual tax returns may be void­ed if you have not com­plied with the IRS §1031 dates. The strict time­line set by the IRS includes the iden­ti­fi­ca­tion of the replace­ment prop­er­ties with­in 45 days and the clos­ing of iden­ti­fied prop­er­ties with­in 180 days of the relin­quished prop­er­ty being trans­ferred to anoth­er investor or own­er. If the investor has not com­plied with these dead­lines there will be no tax defer­ral of cap­i­tal gains.

A qual­i­fied inter­me­di­ary is extreme­ly impor­tant.

The investor must not take con­struc­tive receipts of any of the pro­ceeds from the sale of the relin­quished prop­er­ty. A qual­i­fied inter­me­di­ary or QI is manda­to­ry. The QI will hold the funds from the relin­quished prop­er­ty and trans­fer those funds upon the sale or acqui­si­tion of replace­ment prop­er­ty.

Mul­ti­ple Prop­er­ties

Occa­sion­al­ly investors who own mul­ti­ple prop­er­ty will sell those prop­er­ties and acquire a sin­gle prop­er­ty. Alter­na­tive­ly, investors sell­ing a sin­gle prop­er­ty may acquire mul­ti­ple prop­er­ties. Investors need to ensure and dou­ble check all the math and com­bined val­ues of the relin­quished and all replace­ment prop­er­ties so that they com­ply with the IRS require­ments.  This is also required on the 45- day iden­ti­fi­ca­tion day form the QI will pro­vide to the investor. Delaware Statu­to­ry Trusts (DST) that are prepack­ages may assist investors with iden­ti­fy­ing mul­ti­ple prop­er­ties espe­cial­ly when debt replace­ment is required.  DST by design have non-recourse debt which may appeal to investors.

Accu­rate report­ing can­not be over­stat­ed.

The IRS pro­vides an overview of the rules and reg­u­la­tions. Investors need to main­tain and be able to show doc­u­men­ta­tion of their exchange process. This becomes crit­i­cal if the investor wants to avoid penal­ties, dis­qual­i­fi­ca­tion of their exchange and obtain max­i­mum tax defer­ral ben­e­fits. Investors who have the prop­er doc­u­men­ta­tion may be in a bet­ter posi­tion in the event of an audit.

We always advise seek­ing pro­fes­sion­al assis­tance when enter­ing into and com­plet­ing a 1031 exchange. In our deal­ing with CPA’s, we have found cer­tain CPA’s do not han­dle 1031 exchanges on a recur­ring basis. How­ev­er, many CPA’s can pro­vide advice for investors pri­or to endur­ing the §1031 exchange process.

Investors who under­stand how the report­ing process of a 1031 exchange is required we’ll enjoy a cer­tain lev­el of Peace of Mind even if they are not fill­ing in the forms them­selves.

We are not pro­vid­ing an opin­ion on whether or not enter­ing into a §1031 tax deferred exchange will enable you as an investor to achieve your invest­ment objec­tives. Each investor must iden­ti­fy their real estate strat­e­gy when enter­ing into a §1031 exchange. Over the years the gov­ern­ment may change tax brack­ets that will affect investors on a dif­fer­ent lev­el.

Real estate invest­ing does con­tain a cer­tain amount of risk. Real estate that is financed also has the pos­si­bil­i­ty of being fore­closed. Real estate that is sub­ject to unex­pect­ed dis­rup­tion may also sus­pend cash flow to the investors. §1031 exchanges that uti­lize Delaware Statu­to­ry Trusts as replace­ment prop­er­ties also are illiq­uid invest­ments.

Investor Restric­tion:

DST’s (Delaware Statu­to­ry Trusts) are for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your §1031 Exchange and com­pli­ment your finan­cial objec­tives. 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 adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus.  Invest­ing in secu­ri­ties, real estate, or any invest­ment, in any form, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor.   NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion). Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 8215 SW Tualatin ‑Sher­wood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed. 

SOCIAL MEDIA

Social Media plat­forms are sole­ly for infor­ma­tion­al pur­pos­es. Advi­so­ry ser­vices are only offered to clients or prospec­tive clients where the advi­so­ry firm and its rep­re­sen­ta­tives are prop­er­ly licensed or exempt from licen­sure. Past per­for­mance is no guar­an­tee of future returns. Invest­ing involves risk and pos­si­ble loss of prin­ci­pal cap­i­tal. No advice may be ren­dered by NAMCOA unless a client ser­vice agree­ment is in place.