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@david3 wrote:

The adjusted basis of the property given up was $246K and accumulated depreciation taken was $66K.

Deferred gain is $199K.

The asset entry for the replacement property reports the $246K adjusted basis and depreciation was calculated on this amount.

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@david3 and @gregg1 and @TaxGuyBill First of all, the cost basis for depreciation on the new replacement property should be reduced by the deferred gain or zero in your case, because that is the cost basis of the new replacement property, otherwise how do you capture the deferred gain of $199K?

For completing a sale, you need to two things, the cost basis for the purpose of sale, and the accumulated depreciation. 

The cost basis for the purpose of sale and the cost basis for the purpose of depreciation should be two separate concepts in general (but can be the same) and we have to keep track of them separately, no matter you like it or not. This is because the following three reasons:

(1) The cost basis for depreciation is lower of the cost basis or the fair market value. 
(2) The cost basis for depreciation can be part of the cost basis in the case that the property is rented partially, for example, rented a room.
(3) The cost basis for sale should not be adjusted for depreciation, because that is kept tracked separately, or it is counted twice.

In your case, the cost basis for sale is 66K, and the accumulated depreciation is 66K, and we can just proceed as a normal sale.

You just need to keep track of the depreciation of the given up property separately, or add to the prior depreciation.

Let me provide a simplified but general example:

Given up property: purchase price 20, fully depreciated, sale price 25. No other expenses.
New replacement property: purchase price 40, fully depreciated, sale price 50. No other expenses.

The deferred gain is 25 consisting of 5 capital gain and 20 section 1250 gain.

You enter the cost basis for depreciation as 40 - 25 = 15, and prior depreciation as 20, so the total depreciation is 35.

So the sale data will look like:

cost basis for sale purpose with depreciation adjustment: 15 + 20 = 40 - 5 = 35
accumulated depreciation: 35
sale price 50

So the total gain is 50 consisting of 35 section 1250 gain (unrecaptured depreciation) and 15 capital gain.

In other words, after you transfer the 1031 exchange data, it is just like a regular sale. You need to keep track of the original cost basis of the property before depreciation just as any other property, for example, you rented 50% of the property for one year, and 60% for two years, and then you convert it to primary home for 3 years, then the fair market value dropped, you depreciate at a much lower value than the purchase price. When this property is sold, you have to enter the original cost basis and accumulated depreciation. Same idea here. So what I proposed is a generic solution for any rental properties with a sordid history, but remember you just need two things: original cost basis and accumulated depreciation.