After the real estate transactions in a 1031 exchange have been completed, there is a final step to report the exchange to the IRS so that the deferral is recognized. Filing form 8824 is not simply "another" tax form. It is a critical step to appropriately document that a like-kind exchange has occurred. Once those financial statements are complete, accountants can utilize this information to prepare related tax returns. For owners who have completed a 1031 like-kind exchange, Form 8824 will need to be prepared and filed with the Internal Revenue Service (IRS).
What is Form 8824?
Titled, “Like-Kind The transfer of the relinquished property to the Qualified Intermediary, and the receipt of the replacement property from the Qualified Intermediary is considered an exchange. To be compliant with IRC Section 1031, the transaction must be properly structured, rather than being a sale to one party followed by a purchase from another party. Exchange s (and section 1043 conflict-of-interest sales)," Form 8824 serves two primary purposes:
- To allow business owners to report the deferral of gains through Section 1031 tax deferred exchange transactions
- To allow certain members of the Federal Government to report the deferral of gain through conflict-of-interest sales
The form is divided into four distinct parts, including:
- Part I – Information on the like-kind exchange
- Part II – Related Party The transfer of the relinquished property to the Qualified Intermediary, and the receipt of the replacement property from the Qualified Intermediary is considered an exchange. To be compliant with IRC Section 1031, the transaction must be properly structured, rather than being a sale to one party followed by a purchase from another party. Exchange Information
- Part III - Realized Gain or (Loss), Recognized Gain, and The value of the taxpayer's investment in a property. Basis of Like-Kind Property Received
- Part IV – Deferral is accomplished by substituting, or carrying over, the basis of the taxpayer’s relinquished property to the replacement property, making any necessary adjustment for additional consideration paid. The tax on an exchange transaction is not paid at the time of the transaction. Rather, it is deferred, and paid at the time the replacement property is ultimately sold. Deferral of Gain From Section 1043 Conflict-of-Interest Sales
Part I – Information on the Like-Kind Exchange
This section covers the basics of the 1031 exchange, including:
- Description of the like-kind property (given up)
- Description of the like-kind property (received)
- Date the given-up property was originally acquired
- Date the received property was actually received
Part one also asks if any like-kind property was either sold to or purchased from a related party. If the answer is yes, then the form’s preparer must complete Part II. If the answer is no, then the preparer may skip Part II and move on to complete Part III.
Part II – Related Party Information
It’s interesting to note, this section does not require any calculations. It simply asks for some basic information about the related party transaction, including:
- The related party’s name, address and relationship
- Timing of any dispositions (by the related party) of the property received from property owner
- Timing of dispositions related to the property acquired
Background on Related Parties
Part II addresses very specific concerns regarding what is known as basis shifting. In these transactions, related parties were working together by exchanging low basis property for high basis property with the immediate plans to sell, at a gain, the lower basis property. By following this strategy, related taxpayers were effectively reducing the gain on the sale of the low basis property. For like-kind exchange purposes, related parties are defined under Internal Revenue Code (IRC). The comprehensive set of tax laws created by the Internal Revenue Service (IRS). This code was enacted as Title 26 of the United States Code by Congress, and is sometimes also referred to as the Internal Revenue Title. The code is organized according to topic, and covers all relevant rules pertaining to income, gift, estate, sales, payroll and excise taxes. Internal Revenue Code Section 267(b) or 707(b)(1) and can include:
- Family members, including brothers and sisters, husbands and wives, lineal descendants, ancestors
- Individuals and corporations, where more than 50% of the value of the stock is owned directly or indirectly by or for the individual
- A corporation and a partnership if the same persons own more than 50% in the value of the outstanding stock of the corporation and more than 50% of the capital interest or profits interest in the partnership.
Part III – Realized Gain or Loss, Recognized Gain, and Basis of Like-Kind Property Received
This entire section is dedicated to determining the results of the like-kind exchange. Of the 14 total lines contained within this section, eight are simple addition and subtraction fields. This leaves the form’s preparer with some additional work to gather the data for the remaining six fields. It’s critical to avoid being fooled by the form’s apparent simplicity. The tax preparer must understand the precise meaning of this section’s terminology and each line’s requirement in order to complete the form correctly. Amongst other things, Part III will require the following:
- Fair market value and adjusted basis of other property given up
- Cash received and fair market value of other property received
- Net liabilities received by the other party
Part IV – Deferral of Gain From 1043 Conflicts-of-Interest Sales.
This section, although provides a reporting requirement for a deferral of The amount received for a property, minus the property’s adjusted basis and transaction costs. Regardless of the adjusted basis of a property, there is no gain until the property is transferred. There are two types of gain: “realized gain” and “recognized gain.” Realized gain is the difference between the total consideration (cash and anything else of value) received for a piece of property and the adjusted basis. Realized gain is not taxable until it is recognized. Gain is usually, but not always, recognized in the year in which it is realized. If gain is not recognized in the year it is realized, it is said to be deferred. In an exchange under Section 1031, realized gain is recognized in part or in full to the extent that boot is received. See Boot. Where only like kind property is received, no gain is recognized at the time of the exchange. Gain , has little to do with a like-kind exchange. Part IV requires reporting on capital gains deferral on the sale of the property that would cause a conflict for those serving as an officer or employee of the executive branch of the federal government. Congress enacted section 1043 to further the collective good by eliminating a tax-based barrier for entry into public service. Interesting, but not relevant to 1031s.
For the vast majority of property owners, part IV of Form 8824 will simply not apply, and as such it can be ignored. However, property owners should carefully report each and every exchange of like-kind property using the first three parts of this form. In doing so, property owners can effectively communicate to the IRS why the disposition(s) of their real estate, should not trigger any income taxation.
Accruit is a 1031 Exchange Qualified Intermediary and facilitates 1031 exchanges. Always consult your CPA or tax advisor for advice pertaining to your specific tax situation. For more information, visit www.accruit.com or call (800) 237-1031.