Partial 1031 Exchange of Business Property and 1250 Designation

[midwesttaxinc]

Client sold arena and storage units (all business real property) on 12/31/19, purchased replacement property on 2/28/20. Issue is with calculations of the gain since the replacement property wasn't as much value as the sold property. All other 1031 requirements were met. I am either misunderstanding how the calculations work OR I've entered something incorrectly into the worksheets because I believe the gain is being calculated too high. Any help is appreciated; amounts to follow below.

Sold property value: $1,089,906

Received property value: $284,600

Basis of Sold property: $669,352

Shouldn't taxpayer only have to pay capital gains on sold property value minus sold property basis minus received property value? System is currently calculating capital gains on sold property value minus basis. Thinking I might have mucked something up in keying in the amounts. Also, total amount of gain would qualify as 1250 property since everything sold was real estate...right?? 😞

Thanks all!

[TaxGuyBill]

Are you saying that he received $800,000-ish in cash?

If so, the first $800,000-ish of the gain is taxable.  Only any gain after that is deferred.  When the taxpayer receives any non-like-kind property (such as cash), that part of the gain is taxed first.

Does that solve it for you?

[midwesttaxinc]

So, shouldn't he get to recover the basis tax free? I think that's where I'm getting hung up. Seems like if the value of the received property qualifies as a partial 1031, the $284,600 shouldn't be taxed and the remaining basis of the original property shouldn't be taxed, leaving a total of about $129k capital gains taxed. The system is showing me $413,601 as capital gains taxable (sold property value minus sold property basis).

Thanks for the help!

[TaxGuyBill · Accepted solution]

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@midwesttaxinc wrote:

Seems like if the value of the received property qualifies as a partial 1031, the $284,600 shouldn't be taxed

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That is where you are mistaken.  Because the taxpayer received non-like-kind property (money), that is taxed first.  And because the non-like-kind property (money) is over $284,600, all of the $284,600 is taxed.

[rbynaker]

Yeah, the whole concept is based on "trading up".  If I sell a property and have to pay taxes on it, then I don't have as much money to invest in a comparable property, so the taxes are forcing me to "trade down" to a property with a lesser value.  To fix this, Congress created 1031 which allows me to swap a property for something comparable and defer the taxes until later, keeping the money in the real estate market.

In this case though, there's $800K in the bank, so plenty of money available to pay taxes.  I'm surprised the 1031 intermediary didn't mention that an exchange wasn't necessary.

[TaxGuyBill]

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@rbynaker wrote:

I'm surprised the 1031 intermediary didn't mention that an exchange wasn't necessary.

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They didn't want to turn down their commission/fee.   

[midwesttaxinc]

One would think, except $800k went to pay off loans on the property being sold, which doesn't help any of this situation at all. And you're absolutely right about the intermediary - should have been upfront with him but...

Thanks for the assistance!

[d-walker1]

I have a similar situation of a partial 1031 that also straddles two tax years, as the replacement property (FMV 142,972 subject to 65,000 liabilities) wasn't purchased until 2021.  The relinquished property had a FMV of 213,500 (adjusted basis 92,149) and liabilities 71,333.  I know the realized gain is 105,297 (and the 8824 Smart Worksheet gives me this correct answer).  However the recognized gain should be the change in equity 48,141 (213,500-77,333) less (142,972-65,000).  I haven't checked the smart worksheet box T to report the partial sale (vs exchange) in 2021 when the final proceeds were disbursed by the intermediary and the replacement property closed, because I wanted to see if the program would come up with the correct amount of the "recognized gain."  It doesn't and I'm confused as to how to actually enter the amounts into the program to get the correct recognized gain and excess basis in the replacement property.  I've looked at many other threads and everyone seems to stop short of actually explaining what amounts to put in which lines of the smart worksheet.  I'm guessing I'll have to work it manually into the form?