1031 Exchange - Apartment Complexes & Boot?

I'm struggling with a 1031 calculation. I'm simplifying the data to make it sound like homework, but I assure you this is actual client data. I'd appreciate some guidance on the proper treatments.

Taxpayer owns apartment complex for 3 years. Original cost of the relinquished property is as follows:

Land $250K
Building $1,500K
Land Imp $100K
(1245) Appliances, etc $200K
Deprec (1250) ($200K)
Deprec (1245) ($150K)

Net Book Value of Property = $1.7MM

Property sells in 2018 for $3MM. Commissions/Closing Costs of $200K.

Debt of $1.4MM is paid off in the process, and the remaining $1.4MM of net proceeds are received by a qualified 1031 intermediary.

New property is identified and purchased in the proper time frame.

Purchase price is $3.3MM, but a $200K credit is given to the buyer per the contract for needed improvements. In the succeeding months, in excess of $200K was spent on those improvements.

$1.4MM from Intermediary is applied and $2MM of bank debt is incurred. As a result, $300K of cash is received by the taxpayer on the closing of the replacement property.

So, I should have a realized gain on the sale of the relinquished property of $1.1MM ($3MM less $1.7MM NBV less $200K closing costs).

What gain is recognized? I guess that's a lot of detail to ask the real question - do I have boot? Specifically, is the cash received at closing taxable even though Taxpayer used the funds for improvements as specified in the contract and shown as a credit on the closing statement.

I believe the answer is yes, but wondering if I"m missing something.

Is this an improvement exchange (meaning that the $200K was held by the QI and paid out to the contractors within the 180 days?)

Any allocation in the purchase price to §1245 property?

So, let's assume I have $300K of boot. How do I fill out the 8824?

Box 15 is the $300K of cash received (boot).

Box 16 is the FMV of replacement property received - $3.1MM

Box 17 (15 + 16) would therefore be $3.4MM

Box 18, the adjust basis of the relinquished property would be $1.7MM.

But that gives me a realized gain of $1.7MM on Box 19. (note above my realized gain should be $1.1MM, right?)

Box 20 = $300K

Box 23 = $300K

Box 24 = $1.4MM of deferred gain

Box 25 = $1.7MM Basis of like-kind property received.

Is this an improvement exchange (meaning that the $200K was held by the QI and paid out to the contractors within the 180 days?)

Any allocation in the purchase price to §1245 property?

$200K was paid out to the owner, not held by the QI.... Taxpayer paid contractors directly.
Yes, let's say $150K was allocated towards 1245.

Here are my results:

Box 15 is the $300K of cash received (boot). Correct.
Box 16 is the FMV of replacement property received - $3.1MM Correct
Box 17 (15 + 16) would therefore be $3.4MM Correct
Box 18, the adjust basis of the relinquished property would be $1.7MM. No, $2.3MM. You need to add the additional debt assumed ($2.0MM new debt minus $1.4MM debt paid off), see instructions for line 18 of the form
But that gives me a realized gain of $1.7MM on Box 19. (note above my realized gain should be $1.1MM, right?) It's now $1.1MM
Box 20 = $300K Correct
Box 23 = $300K Correct
Box 24 = $1.4MM of deferred gain No, $800K
Box 25 = $1.7MM Basis of like-kind property received. No, $2.3MM

Line 15 states cash received less any incurred exchange expenses (closing costs) on both the sale and purchase of the replacement property but just do not duplicate in Line 18. So with your numbers Line 15 would report $100k.

Line 15 states cash received less any incurred exchange expenses (closing costs) on both the sale and purchase of the replacement property but just do not duplicate in Line 18. So with your numbers Line 15 would report $100k.

If you put $100k on line 15, then you are duplicating the exchange expenses. The exchange expenses have already been offset against the cash received:

Selling price of relinquished property - $3,000,000
Less: debt paid off – (1,400,000)
Less: exchange expenses – (200,000)
Net proceeds - $1,400,000
Less: proceeds used to purchase replacement property – (1,100,000)
Proceeds to taxpayer - $300,000 (boot)

1031 currently does not apply to 1245 property correct??

1031 currently does not apply to 1245 property correct??. Not exactly. It does not apply to personal property, but some real property is section 1245 property. See section 1245(a)(3). And https://www.aicpastore.com/Content/medi ... on1245.jsp

Nilodop is correct, but i'm not sure I"m applying this correctly. In my case, the 1245 property is not spelled out in great detail but I believe it's mostly dishwashers and washers and dryers. I assume these would be considered detachable from the 1250 property and thus not be eligible for 1031 treatment, right?

Line 15 states cash received less any incurred exchange expenses (closing costs) on both the sale and purchase of the replacement property but just do not duplicate in Line 18. So with your numbers Line 15 would report $100k.

If you put $100k on line 15, then you are duplicating the exchange expenses. The exchange expenses have already been offset against the cash received:

Selling price of relinquished property - $3,000,000
Less: debt paid off – (1,400,000)
Less: exchange expenses – (200,000)
Net proceeds - $1,400,000
Less: proceeds used to purchase replacement property – (1,100,000)
Proceeds to taxpayer - $300,000 (boot)

Not sure of the mechanics, but I think boot has to be $300K, which matches Dave's description.

So I think I need to treat the sale of the Dishwashers/Washers/Dryers as a taxable sale, followed by a bonus depreciable purchase of the new appliances.

The land/building would obviously be 1250, eligible for 1031 treatment.

Land Improvements I believe are also 1250 property:

https://www.journalofaccountancy.com/issues/2005/aug/thebestofbothworlds.html

So I think I need to treat the sale of the Dishwashers/Washers/Dryers as a taxable sale

Depends on what they were sold for.

I always advise my clients entering a 1031 exchange with 1245 property on the depreciation schedule that they should allocate part of the sales price to the 1245 property, and if possible, the portion allocated should be the adjusted basis of the 1245 property so that there is no gain on the sale of such property.

In your example, if the portion of the $3MM sales price allocated to the appliances was less than $50K (the adjusted basis), then there was no 1245 recapture.

Understood, though in this case we're dealing with large operating losses, plus boot, so 1245 recapture won't have a huge impact.

I'm on day 3 of this project and am struggling with the journal entry. Let me provide some simplified data (that may not agree with the original data) so someone can hopefully tell me where the hole in my brain is because frustration is growing .

Relinquished Property - Cost $1.8MM, A/D $200K (NBV = $1.6MM)
Old Debt - $1.4MM

FMV of Replacement Property = $3MM,
New Debt - $2MM
Security Deposits assumed - $20K
Closing Costs on purchase - $40K
Cash received on exchange - $300K

My 8824 would look as follows:
Line 15...........300,000
Line 16...........3,000,000
Line 17...........3,300,000
Line 18...........2,180,000 ($1.6MM NBV + $600K increase in debt + 20K liability assumed - $40K closing costs)
Line 19...........1,120,000
Line 20/22/23.....300,000
Line 24..............820,000
Line 25...........2,180,000

Here's the journal entry I'm trying to make on the books based on this data:
Cash...........300,000
Building.....2,180,000 (assume this is where the problem lies....)
Loan.........1,400,000
A/D............200,000
.......Building (old)..........1,800,000
.......Deferred Gain............820,000
.......Recognized Gain.........300,000
.......Deposits....................20,000
.......Loan....................2,000,000

That entry is out of balance by $860,000 - I assume not coincidentally the deferred gain + closing costs.

What am I missing?

TIA

Is the sales price still $3MM?

What am I missing?

TIA

The building should booked at the full 3,000,000, and there should be a 40,000 expense (debit) for the closing costs.

If you are preparing tax-basis books, then 2,180,000 would be correct, but deferred gain would not be an entry at all.

That's helpful. Would the $40K not be added to the basis of the building? I'm trying to think what I would call that expense.

I'm thinking more for tax basis here....

Wait, line 18 should be 2,220,000. Don't subtract the 40,000 selling expenses here.

You should have (in thousands)

Line 18: 2,220
Line 19: 1,080
Line 24: 780
Line 25: 2,220

Your JE should have either:

Tax basis:

Code: Select all

Cash          300
Building    2,220
Loan        1,400
A/D           200
     Old building      1,800
     Recognized gain     300
     Deferred gain         0
     Deposits             20
     Loan              2,000

Totals      6,700      6,700


Or

Non-tax basis

Code: Select all

Cash          300
Building    3,000
Loan        1,400
A/D           200
     Old building      1,800
     Recognized gain     300
     Deferred gain       780
     Deposits             20
     Loan              2,000

Totals      4,900      4,900


I would like to address the $200,000 spent on improvements. This is from the following article.

https://www.thetaxadviser.com/issues/20 ... y2014.html

Given those definitions, the conclusion in Field Attorney Advice (FAA) 20124801F that the taxpayer did not engage in a like-kind exchange even though it used a QI was not surprising. In this FAA, the funds from the disposition of the relinquished property were placed in an account that the taxpayer could control by using them to acquire property or pay for other items. The fact that the acquired property could qualify as replacement property was immaterial. The QI must control the funds and use them to acquire the replacement property, which is transferred to the taxpayer. The taxpayer cannot have access, control, or benefit of the funds from the relinquished property for the transaction to qualify under Sec. 1031.

So, unless the $200K is eligible for bonus depreciation, I don't thnk the gain is $300K

You have a good point. My reply is based on the assumption that the building was sold "as-is" and the improvements were made after the fact. In this case, the 200,000+ spent on improvements add to the basis of the building as it is spent.

If the improvements were made with exchange funds and the 300,000 held by the QI during the process, then that changes the amount of boot and the FMV of the building received.