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FAILED 1031 THAT CROSSES TAX YEARS

Forum|Forum|4 years ago
March 20, 2022
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We sold a single family rental property in mid July 2021 that we purchased in 2015. . We attempted to do a 1031 exchange but weren't able to identify a property until the 11th hour of the 45 day window and in the end the deal did not close due to issues identified during inspection. Our funds were held by the QI until January of 2022. I am trying to use TT Premier to handle the capital gains as an installment to defer that tax til 2022. But it is my understanding that i need to pay the depreciation recapture for the sale on my 2021 taxes. Turbo tax either wants to include both the gain and the depreciation or neither., I have tried to work through this in multiple ways including completing both the Installment Sale and Like Kind Exchange options. Can anyone tell me if it's possible to do this with the online version of TT?

If i move to the desktop version will i have to re-enter all my data on the rental property that has been in Turbotax since 2015? Does the desktop version use an interview like process or is it the tedium of going through every line on every form required by the IRS (8824, 4794, 6252, Schedule E etc. ) Would i be better off getting the online version of TT that includes live support? Or having TT do all the work including filing. After 2 days of struggling trying to figure out how to make this worI am frustrated and exhausted and I just want to get my taxes filed and paid on time. Thanks for any guidance/insights.

TurboTax Premier Online

Best answer by Anonymous_

Robert-

I don’t believe that is correct as we did not receive the funds until 2022. The 180 day period for the 1031 exchange crossed tax years.

I believe you can use the Section 453 installment sale rules for this transaction (which would defer recognition of the gain to the subsequent year).

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Anonymous_

You can probably use the installment sale rules for this (failed) transaction, but I am sure I would not attempt to enter this transaction into any online version of TurboTax.

You do not have to re-enter all of your data from 2015 if you switch to a desktop version, but I would highly recommend that you either use TurboTax Live or Full Service or have this year's return prepared by a tax professional.

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focoAuthor

Thanks for your reply. I will probably try TT Live. I'm concerned that this late in the tax season I won't find a tax professional that will get this done in a timely fashion and will want to file an extension which I would prefer not to do. I feel like I have a good understanding of the laws that govern this transaction but didn't anticipate that this would be so challenging for the TT program to handle.

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DavidD66

I'll start by answering your questions about TurboTax Desktop. You can save all of your information from TurboTax Onlne as a .tax20XX file and then import in to TurboTax Desktop. You won't lose any of the information you have entered this year, or your historical information. As for an interview process like TurboTax Online, Yes, it has one. It also has a "Forms" view. This allows you to see, and enter data directly on to the tax forms you are working on, but also the underlying schedules. This functionality may give you the ability to accomplish what you are trying to do.

One way you might be able to accomplish what you are trying to do is to split the sale into two transactions. Sell the structure and the land separately. Apply a portion of the proceeds to the sale of the structure that results in a gain that covers the depreciation recapture, and then sell the land as an installment sale using the remainder of the proceeds, which should be the remaining gain.

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focoAuthor

Thanks for the reply. If I were to try the option of splitting the sale could I attribute the bulk of the transaction to the land sale so that the bulk of the gain is deferred to 2022? Or would i need to split it in the same percentages it was split to determine the depreciation schedule?

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AmeliesUncle

@foco wrote:
But it is my understanding that i need to pay the depreciation recapture for the sale on my 2021 taxes. Turbo tax either wants to include both the gain and the depreciation or neither.,

It is unlikely that you have any "recapture" that is required to be reported in the year of the sale.

For real estate, "recapture" is based on depreciation in excess of straight line.

But almost all real estate depreciation is straight line depreciation, so that results in "Unrecaptured Section 1250 Gain". That is NOT immediately taxed in the year of the sale of an Installment Sale.

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focoAuthor

Thanks for pointing out that the depreciation that I need to pay is "unrecaptured Sec 1250 GAIN" as opposed to depreciation "recapture". My assumption regarding the need to pay the tax related to the depreciation stemmed from "warnings" found on multiple sites related to 1031 exchanges. Given the distinction you have provided I have re-read those sources and realize they all refer to depreciation "recapture" which is not applicable in my situation as you have pointed out. Thanks for the clarification.

I would prefer to pay the depreciation gain on my 2021 and the rest of the gain in 2022 but don't see any way to split it up that way without showing some gain in 2021. I also don't believe that the option of showing the sale of land and structures as separate transactions is an option that is available to me as one respondent suggested.

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focoAuthor

Unfortunately, as an expert, you have given incorrect advice. It's not unusual, I had to convince a cpa who specialized in real estate that he was wrong. In the end, he agreed this is allowed. In a failed exchange, nothing changes except you receive cash in the second year that must be reported as income, instead of a replacemnt property that does not. As long as you can show intent that you planned to do the exchange and not just use it as a tax reduction tool, it will stand. The taxpayer also has the option of choosing whether to file it as an installment sale or to take all of the prodeeds in the first year. Here is an article I saved to a doc for myself. I don't have the link, but still have the text. It's long...

When an Exchange Straddles Two Tax Years

As we approach year end, many Exchangors will find themselves with an exchange that straddles two tax years. That situation usually leads to one of two questions:

My exchange was a success, but what year do I use to report the transaction?
My exchange failed. I got my money back, but when do I report the gain?

The first question is easy. The exchange is reported on IRS form 8824, for the tax year in which the relinquished property was transferred. So, for an exchange that begins in 2023 and concludes in 2024, the transaction is reported on the Exchangor’s 2023 tax return. If there are unused exchange funds, or “boot”, disbursed to the Exchangor at the completion of the exchange in 2024, the receipt of such funds can be reported on the 2024 tax return, using IRS form 6252.

As for the second question, the IRS Regulations provide an option that gives Exchangors some welcome flexibility. A failed exchange which straddles two tax years may be treated as an installment sale under IRC §453. Reg. §1.1031(k)-1(j)(2). In most years, Exchangors would jump at the opportunity to push any gain into the next tax year. However, given the potential uncertainty over capital gains rates, Exchangors should consult with their tax advisors about any potential benefits from opting out of installment treatment and recognizing the gain in 2023. Of course, each 1031 exchange transaction is different, and Exchangors should always discuss the particulars of their exchange with their tax advisor.

An exchange will fail if no replacement properties are identified within the 45-day identification period. In that instance, installment treatment is available if the identification period had extended over two tax years. The exchange will also fail if the Exchangor was unable to acquire any of the identified replacement properties before the end of the exchange period.

To qualify for installment treatment, the Exchangor must demonstrate that there was a bona fide Intent to complete the exchange. Installment treatment will be denied if the IRS determines that the exchange was a sham, used solely to obtain installment sale treatment for the gain. To establish bona fide intent the Exchangors must show that there was a reasonable belief, based on facts and circumstances at the beginning of the exchange, that like-kind property would be acquired before the end of the exchange period. Reg. §1.1031(k)-1(j)(2)(iv).

The IRS challenged the Exchangor’s intent in Smalley v. C.I.R., 116 T.C. 450, 2001 WL 667858 (2001). The Exchangor had exchanged the right to cut timber growing on 3 timberland parcels during a two-year period. The exchange began in 1994 and was completed in 1995. The IRS assessed a deficiency for 1994, on the grounds that the exchange did not involve like kind property and that it was not reasonable to believe that the properties were like kind. The Court held for the Exchangor, finding that the Exchangor clearly showed a bona fide intent through the use of an exchange agreement, a qualified escrow, and by obtaining expert advice on the issue of like kind property.

In another ruling that favored the Exchangor, the IRS granted a limited liability company's request to revoke its election out of the installment sale method after a failed exchange. Apparently the accountant did not recognize that the property sale qualified for installment treatment, resulting in an inadvertent election out of §453. As a consequence, the proceeds were reported in the year the Relinquished Property was transferred. Once made, the election out could only be revoked with the consent of the IRS. Fortunately, in this case the IRS allowed the Exchangor to undo the mistake and use the installment method. Be aware that a revocation is not allowed if one of its purposes is to avoid federal income tax. PLR200813019.

The ability to control the timing of tax payments is a powerful tool, so remember that all is not lost if your exchange fails. You may benefit from reporting the gain using the installment sale rules. As with any tax reporting issue, you should consult with your accountant or tax advisor to determine the best way to meet your investment objectives.

The original question was never about the tax law related to the issues. The original question was always about the turbo tax software glitch that was giving me errors and how to input the information so I could resolve the errors and file.