How do I calculate 1250 recapture when a 1031 exchange property is sold?

[david3]

TP sold a 1031 exchange property. The exchange was done in 2016 and I looked at the details on F8824 for that year.

It appears that the accumulated depreciation on the relinquished property was not carried over to the replacement asset. All the instructions appear to have been followed in reported the exchange.

The FMV of property given up was $480K and the FMV of property received was $445K. Boot of $35K was reduced by selling costs of $30K resulting in a taxable gain of $5K.

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. The election to elect out of regs under Sec 1.168(i)-6(i) was not taken.

When the accumulated depreciation from the relinquished asset was entered on the replacement property Asset Entry Wks, an error message stated that no prior depreciation should be entered for the asset. Now this seems to come back to bite me when reporting the sale of the property.

$32K depreciation has been taken on the replacement asset since the 2016 exchange date. The gain from sale only reports $32K as 1250 recapture and ignores the $66K depreciation reported for the relinquished property. 

Shouldn't the 1250 recapture be $32K plus $66K for a total recapture amount of $98K?

How do I get PS to recognize the total amount of $98K 1250 recapture? 

For future 1031s, how can the prior depreciation on relinquished property be accounted for in PS so that it isn't dropped in calculating 1250 recapture?

Thank you. 

[TaxGuyBill]

I'm too tired today to analyze everything you said, but I'll toss out a few thoughts and questions:

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@david3 wrote:

The election to elect out of regs under Sec 1.168(i)-6(i) was not taken.

When the accumulated depreciation from the relinquished asset was entered on the replacement property Asset Entry Wks, an error message stated that no prior depreciation should be entered for the asset.

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If the election out was not taken, you should be depreciating it on two separate Asset Entry Worksheets, right?  One for the depreciation of the 'old' building and one for the additional cost for the 'new' building.   The 'old' building should still have the original "placed in service" date with the prior depreciation.

If that is the case, you can just allocate the sales price between the two Asset Entry Worksheets.

Otherwise, for any situation that entering the sale on the sale on the Asset Entry Worksheets is problematic, you can just enter the sale DATE on the worksheet and leave the sales price BLANK.  That will stop the depreciation.  Then use the "Enterable 4797" to manually enter the sales information.

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@david3 wrote:

Boot of $35K was reduced by selling costs of $30K resulting in a taxable gain of $5K.

Shouldn't the 1250 recapture be $32K plus $66K for a total recapture amount of $98K?

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I didn't look at all of your numbers, but did you factor in the $5000 that was already taxed?  You don't want to tax that again.  I think the $5000 of taxable boot should have been taxed as Unrecaptured Section 1250 Gain, so that will reduce that amount of gain subject to Unrecaptured Section 1250 Gain.

[david3]

Thanks for helping even though you're tired. 🙂

There is no excess basis for the new asset since the FMV of the old property was greater than the FMV of the new property. Therefore, the adjusted basis of the old property was used as the basis of the new property.

Now that I'm reporting the sale of the property I noticed that the $66K accumulated depreciation on the relinquished property has been dropped from the history for the asset. 

I think the problem is because the FMV of the new property was lower than the FMV of the relinquished property. I followed the PS directions and it appears that PS doesn't have a method to handle this situation - unless I missed that.

I guess I'll have to do a work around as you suggest to add the depreciation for the relinquished property to the depreciation on the new property when calculating sec 1250 recapture.

It would be helpful if anyone has a suggestion on how to enter an exchange in PS for this type of situation so that all depreciation is considered in the 1250 recapture amount.

Thanks for your help.

[david3]

Also, I want to make sure I'm not calculating too much to 1250 recapture and PS knows something I don't. 🙂

But it seems as though the 1250 recapture should also include depreciation taken in the past for the relinquished property.

Thanks.

[TaxGuyBill · Accepted solution]

Okay, but you still should have been using the original depreciation asset, right?   Using the original "placed in service" date and the original prior depreciation.  Then it should have just been continuing to depreciate the old asset, and it should be able to be reported as usual.

If that is not how you have it set up, what have you been doing for depreciating?

But as I said before, I think that original $5000 should have been taxed as Unrecaptured Section 1250 Gain.  And I think the only way to manipulate things to factor that in is to manually do things on the "Enterable 4797".

[david3]

I think that's where I messed up. I treated the $246K adjusted basis of the relinquished property as the depreciable value of the new asset and started the depreciation period from the 1031 exchange date.

There should not have been a value for the new asset.

You're correct - I'll have to manually record the sale on the "Enterable 4797".

Thanks so much for clarifying this. 

[TaxGuyBill]

I totally understand.  It always takes me quite a while to wrap my head around for how to deal with a 1031 exchange.

[gregg1]

What if you don't want to carryover prior depreciation from relinquished property and choose to follow the "Simplified Method" thereby not showing two properties being depreciated?  If using the Simplified Method how do you track the amounts from the relinquished property on the Lacerte when you have only setup one new property?  thank you for your comments

[puravidapto]

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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.