1031 Exchange Tax Filing Requirements
By: Dennis Young, CPA
Young, Craig and Co., CPAs
REPORTING THE EXCHANGE
A 1031 exchange is reported on the tax return for the year in which the exchange begins, i.e. the year the relinquished property is transferred, using Form 8824, Like-Kind Exchanges. Form 8824 requires a description of the relinquished and replacement properties, purchase date of the relinquished property and the date it was transferred, the date the replacement property was identified and the date it was acquired by the Taxpayer. Note these last two items are to insure the Taxpayer meets the 45-day replacement property identification rule and 180-day replacement property acquisition date rule*. Form 8824 also requests related party information since, if the relinquished property is exchanged with a related party, directly or indirectly, who disposes of it within 2 years after the exchange, the Taxpayer must report the deferred exchange gain. There are a few exceptions to this related party rule and your tax advisor should be consulted. Part III of Form 8824 is used to calculate the gain on the transaction and the basis of the replacement property. The form also requires the fair market value of the exchange properties, liabilities given up and received, sales expenses, cash received and given up, tax basis of relinquished property and unlike property given up, and fair market value of unlike properties received and given up.
REPORTING THE GAIN
Taxable gain is then reported on Form 4797 or Schedule D, depending on the character of the property given up. Gain must be allocated between ordinary income depreciation recapture, unrecaptured 1250 gain, Section 1231 gain, and capital gain. If the exchange does not close until the next year, or if the Taxpayer takes back a note from the buyer, he may be able to report the taxable gain on the installment basis using Form 6252, Installment Sale Income. There are several circumstances when installment sale reporting is limited or not allowed, such as when the relinquished property has a mortgage in excess of basis. If you are considering seller financing, consult with your tax advisor for the tax effects on your transaction.
DUE DATE OF THE RETURN
*If the Taxpayer has not acquired his replacement property by the due date of his tax return, typically April 15th, he must file an extension using Form 4868 which extends the due date of his tax return until August 15th. This will enable those Taxpayers, who began the exchange late in their tax year, the full 180 days allowed them to complete the exchange. When filing an extension to complete the exchange, income tax which is projected to be due on the extended tax return should be paid with the extension. The IRS can deny an extension to a Taxpayer who does not pay or provide for his projected tax liability by the due date of the return. This would invalidate a 1031 exchange not finalized by that date.
STATUTE OF LIMITATIONS
The IRS has 3 years after the return is filed to audit the return. If the return is filed before the due date, the due date is considered the filing date. If the income not reported exceeds 25% of Taxpayer's gross income, the period for audit, (statute of limitations), is extended to 6 years. Because the gain excluded on a 1031 exchange may exceed 25% of Taxpayer's gross income, the 1031 exchange may trigger the 6 year statute of limitations.
By: Dennis Young, CPA
Young, Craig and Co., CPAs