I completed a 1031 Exchange in 2023 in which the relinquished property was replaced by 3 replacement properties. One of the replacement properties is a convenience store/fuel center. The other two properties are really mineral rights which generate royalty payments - in which there is no physical land. Please note, I am using the "2 schedule" method, which addresses each property separately versus combining all 3 - from a tax filing perspective. From speaking with other Turbo Tax experts I believe the following is true:Royalty Properties, as in the case of oil and gas mineral rights, cannot be allocated any land tied to the relinquished property’s original basis or any replacement property’s additional basis.I’m interpreting that into 100% of the land value tied to both basis numbers gets assigned to the convenience store. Is that correct?While you cannot depreciate a basis amount assigned to a Royalty Property, you must assign a reasonable value to it as it was also a property received in the trade. It can be used when and if I sell those rights to reduce any gain in the future. Is this correct?Seeing the 2 Royalty Properties represent 74% of the total replacement value, I’ve assigned 74% of the original and additional basis values to these 2 properties. Once assigned, that 74% will remain untouched until the mineral rights are sold.The remaining 26% of the basis numbers have been assigned to the convenience store. The negative basis number assigned to the convenience store is just a matter of subtracting 100% of the land from only 26% of the remaining basis that has yet to be depreciated. Here are how the numbers played out between the relinquished property and the convenience store replacement property. Relinquished Property:$320k cost$64k land value$166k prior depreciation$89k remaining basis Convenience Store Replacement Property:$84k apportioned cost$64k apportioned land value$44k apportioned prior depreciationCalculation = $ Apportioned Remaining Depreciable Basis = (Apportioned Cost minus (Apportioned Land Value from Relinquished Prop + Apportioned Prior Depreciation from Relinquished Prop)$84k – ($64k + $44k) = -24k To note, the additional basis coming from the convenience store (which has a structure that can be depreciated), after factoring in the relinquished property's loan/debt, AND after being allocated across all 3 properties, is not enough to offset the negative basis coming from the Relinquished property to the convenience store replacement property. MAIN QUESTION:What do I do when it is a negative basis value? Do I enter the -24k, or the value $0? How is this usually handled? Any guidance here will be greatly appreciated! Thanks! As a reference, TurboTax experts that assisted me last year, just in case they can address this question@DianeW777@AmyC

Question

How do you treat a negative basis value assigned to a replacement property as the result of a 1031 Exchange?

Forum|Forum|2 years ago
February 9, 2024
3 replies
0 views

I completed a 1031 Exchange in 2023 in which the relinquished property was replaced by 3 replacement properties. One of the replacement properties is a convenience store/fuel center. The other two properties are really mineral rights which generate royalty payments - in which there is no physical land.

Please note, I am using the "2 schedule" method, which addresses each property separately versus combining all 3 - from a tax filing perspective.

From speaking with other Turbo Tax experts I believe the following is true:

Royalty Properties, as in the case of oil and gas mineral rights, cannot be allocated any land tied to the relinquished property’s original basis or any replacement property’s additional basis.
1. I’m interpreting that into 100% of the land value tied to both basis numbers gets assigned to the convenience store. Is that correct?
While you cannot depreciate a basis amount assigned to a Royalty Property, you must assign a reasonable value to it as it was also a property received in the trade. It can be used when and if I sell those rights to reduce any gain in the future. Is this correct?

Seeing the 2 Royalty Properties represent 74% of the total replacement value, I’ve assigned 74% of the original and additional basis values to these 2 properties. Once assigned, that 74% will remain untouched until the mineral rights are sold.
The remaining 26% of the basis numbers have been assigned to the convenience store.

The negative basis number assigned to the convenience store is just a matter of subtracting 100% of the land from only 26% of the remaining basis that has yet to be depreciated.

Here are how the numbers played out between the relinquished property and the convenience store replacement property.

Relinquished Property:

$320k cost
$64k land value
$166k prior depreciation
$89k remaining basis

Convenience Store Replacement Property:

$84k apportioned cost
$64k apportioned land value
$44k apportioned prior depreciation
Calculation = $ Apportioned Remaining Depreciable Basis = (Apportioned Cost minus (Apportioned Land Value from Relinquished Prop + Apportioned Prior Depreciation from Relinquished Prop)
$84k – ($64k + $44k) = -24k

To note, the additional basis coming from the convenience store (which has a structure that can be depreciated), after factoring in the relinquished property's loan/debt, AND after being allocated across all 3 properties, is not enough to offset the negative basis coming from the Relinquished property to the convenience store replacement property.

MAIN QUESTION:

What do I do when it is a negative basis value? Do I enter the -24k, or the value $0? How is this usually handled?

Any guidance here will be greatly appreciated!

Thanks!

As a reference, TurboTax experts that assisted me last year, just in case they can address this question

@DianeW777

@AmyC

D

DianeW777

Let's simplify the best way to handle this. Keep the original property in tact and change the name to the new store. Split all the up charges (additional money you paid including loan you took over minus any loan given up on the old property) and split it between the new mineral properties. This could make it all much simpler and there should be no negative basis. This would be the amounts that are not depreciated and remain with the mineral property until sold. A paper tracking for a future sale.

The land is causing the issue, however, there should be no negative basis in the equation.

Let me know if this makes more sense to you.

@jamie-m-todd

**Say "Thanks" by clicking the thumb icon in a post**Mark the post that answers your question by clicking on "Mark as Best Answer"

J

jamie-m-toddAuthor

@DianeW777

Hello Diane. Great to hear from you! Thank you for your response.

I'll need a little more guidance to be truly grounded in your recommendation. However, before I ask follow-up questions on that front, can you please tell me if this approach strays away from the "2 schedule" method that you recommended and we applied for my 1031 event last year? What I like about the 2 schedule approach is that each replacement property is truly broken out and tracked separately, which makes future exchanges between each respective property/entity much easier to apply. It can also possibly be beneficial when the different replacement properties have different depreciation terms. Please let me know your thoughts here. Ideally, it would be nice if each of my 1031 exchange events followed the same structure.

Thanks so much!

Jamie

D

DianeW777

The '2 schedule' approach is fine, however the confusion begins because there is no negative value based on the overall 1031 exchange.

As noted last year, the information was provided when it was not yet clear with respect to receiving only one building in the trade for three properties when only one building (convenience store) was actually received. See a portion of last year's notes:

'Part 2: All fees with the exception of marketing would be added to the cost basis as part of the buy up charges. Add those fees to the assets mentioned above before apportioning it.'
You did not acquire another building: 'When you enter the new properties (Add another property for each building), you will select as noted above and they will be depreciated using the correct 39 year recovery.'

NOTE: **** Although the actual trade did include mineral property, the land must be a factor that must be used in the formula to arrive at the correct amount for purchase of the mineral property regardless of the fact it cannot be depreciated or be called land.
This will actually reduce the land value associated with the convenience store as it should. There is no negative amount in the exchange.

The added up-charge we originally calculated of $118,000 which requires a portion assigned to the mineral properties. This, as you noted, is not depreciable so it stays on-hold until you trade or sell the mineral properties. It doesn't have to be the entire amount that is assigned to the mineral properties, however the formula must work out in a positive result. You did NOT have a section 1031 trade that resulted in a loss.

If you believe the full land value should remain with the new convenience store, then you would simply leave the original building in tact as it was and continue to depreciate it even if you enter it again to rename it. Keep in mind this retains the same character as if it was never traded. The purpose is to defer any gain until you fully dispose of the replacement property.

As stated earlier, then the $118,000 would be split between the two mineral properties and suspended until sold.

@jamie-m-todd

**Say "Thanks" by clicking the thumb icon in a post**Mark the post that answers your question by clicking on "Mark as Best Answer"

J

jamie-m-toddAuthor

@DianeW777

Hello Diane,

Thank you so much for your follow-up!

I'm now finding these 2 recommendations in conflict:

From last year's correspondence:
1. "No, if you do not own the land and only the mineral rights then no amount of the assets should be applied to land for the oil & mineral property. It was not previously clear there was no land ownership with this property."
From this year's correspondence:
1. "NOTE: **** Although the actual trade did include mineral property, the land must be a factor that must be used in the formula to arrive at the correct amount for purchase of the mineral property regardless of the fact it cannot be depreciated or be called land."

I agree, if I can allocate a good portion of the $64k from the relinquished property to the 2 oil and gas properties it will solve for the negative depreciable basis for the convenience store. I could use each replacement properties value as a percentage of the entire replacement cost to apportion that land. In the case of the convenience store, its value is only 26% of the whole. Thus only 26% of the $64k land value of the relinquished property would be tied to the convenience store; or $16.6k. Please let me if I misunderstood you last year, and this is possible.

Last year I did not have to apportion any land to the single oil and gas property to have a positive depreciable basis for each of the 3 replacement properties. More-than-likely this is due to having assets and land on 2 out of the 3 properties which accounted for about 72% of the overall replacement value. Based on your most recent reply, please let me know if this wasn't the correct (or best) decision. Allocating some of the land value to the single oil and gas property would provide more depreciable basis to the 2 other properties with assets that can be depreciated.

Thanks again Diane for your great insight!

Jamie

D

DianeW777

Yes, allocating all of the cost basis (including land) of the assets traded along with the additional added funds would be the appropriate action which will include the land from the original property. The new property in total must be represented with a basis that makes sense.

I agree there was much detail last year that could be confusing. You should do as you indicate here: 'I could use each replacement properties value as a percentage of the entire replacement cost to apportion that land.'

@jamie-m-todd

**Say "Thanks" by clicking the thumb icon in a post**Mark the post that answers your question by clicking on "Mark as Best Answer"

R

RobertB4444

Any expenses associated with the relinquished property are rolled up and included in the basis for the property received in the exchange. You'll depreciate them over time as part of the new property basis.

@jamie-m-todd

**Say "Thanks" by clicking the thumb icon in a post**Mark the post that answers your question by clicking on "Mark as Best Answer"

J

jamie-m-toddAuthor

@RobertB4444

@DianeW777

Thank you Robert for that input!

I had a similar situation in 2022 in which I performed a 1031 Exchange, but I did not think to reassign the remainder of the refinancing expenses to the replacement properties as part of their apportioned original basis number. Is it too late to do that? I had about $1,000 left for these expenses. Maybe it isn't worth readjusting the basis of the replacement properties (3 of them) in their second year?

Additionally, in regards to the 1031 Exchanged that I performed in 2023, one of the replacement properties is a Convenience Store/Fuel Center. I classified it as a Commercial rental property, which for the depreciation section, classified the asset as Nonresidential Real Estate that comes with the 39 year depreciation schedule. My understanding is that an asset that is a fuel center could qualify for a much shorter depreciation schedule - possibly as low as 15 years. Is that true, and can you please tell me what steps I need to go through in Turbotax to reclassify it this way?

Please let me know your thoughts.

Thanks so much!

Jamie

Hello Diane,

Thank you for those additional comments. Greatly appreciated as usual!

I applied a couple of your suggestions, but need a little more direction on a few others.

Loan Fees:

I still need some clarity on the 2nd bullet - how to treat an Asset/Depreciation line item for a relinquished property. In general, I understand that you are indicating that in an exchange an Asset/Deprecation line item is never really sold, but instead will continue as if you never exchanged the property.

For my first relinquished property that incurred the exchange in 2022, I believe I need to remove this property from my 2023 return (which I believe we discussed), as I am currently receiving errors in the error check as it was used for 0 days as a rental property in 2023. However, this asset still has loan fees/points that can be depreciated. With that it seems like the only choice is to continue that depreciation as a new asset under each of the respective replacement properties. Because I had 3 replacement properties, the loan's remaining depreciation needs to be split up across each of the 3 properties. Therefore, the original loan's cost and prior depreciation would be split up across each of the 3 properties using the original Date of the loan. Please confirm.
For my second relinquished property that incurred the exchange in 2023, this property should remain in my 2023 tax return, as it was rented for a portion of time during 2023. With that, I can keep all of the asset/depreciation line items intact. As it stands now, by not populating an asset sold date, a full years worth of depreciation has been recognized for the relinquished property for that line item, whether that is part of the property depreciation, loan fee/points depreciation, etc. When I setup the replacement properties and apportion to them the remaining original basis (that has already subtracted out the full years worth of depreciation taken by the relinquished property in 2023), those properties are calculating a depreciation expense (at least for the non mineral rights property). With that, I'm left with the question of is there overlap there? If I took 12 months worth of property depreciation as tied to the relinquished property, is it correct that I am taking any deprecation for the replacement properties in the 2023 tax year? Please provide your thoughts.

Partnership LLC:

I've gone ahead and made the updates you recommended for points 1, 2, and 3. I then went onto the State portion of the returns in which I have to file for California (where I reside) and Colorado (where the partner LLC was established). I have a few questions as I navigated through both states:

California state return:
1. Investment Income Adjustment section:
  1. It is referring to the Royalty income from Schedule E. Is that specific to the royalty payments received from the oil and gas mineral rights, or does that include other properties such as a rental house or convenience store?
  2. It states,... If the California amount is more than the federal amount, enter the difference as a positive number. If it is smaller, enter it as a negative number. Right now it is blank, which I guess means there is no adjustment. How would I determine that? Is it ok if I leave it blank?
Colorado State Return:
1. Business Schedule K-1 section: Not sure if I need to populate anything in this section, which contains "State Income Tax Addback", "Increases to Income", and "Decreases to Income". Any guidance here would be so greatly appreciated. This is my first time completing this section.
2. Colorado Portion of Gains or Losses: There is a Federal box which has $130k, and a Colorado box which starts out as blank. Initially I was expecting the Federal box to equal my K-1's capital gain - $133k (all proceeds coming from Colorado). However, it shows $130k, because it also includes gains or losses from my stock market investments. With that, is it correct to enter $133k into the Colorado box as the capital gain attributed to Colorado, even though the Federal box states $130k?
I've included a screen shot to assist with my previous #5 question that was a little confusing. I'm just trying to indicate that after I entered all of the K-1 information, the Schedules K-1 line item in the Business Items section of the Wages and Income root section still shows a $0 value. I'd expect that number to change, as the taxes due did increase once I included that capital gain in that section.

Your insight will be so greatly appreciated Diane.

Thanks so much!

Jamie

Loan Fees:

1. If it makes it easier for you simply enter zero for a sales price for the loan fees and this will easily provide a deduction for the remaining fees or a loss of the same amount remaining.

2. You should show they were converted to personal use on the date of the exchange, then add them back as assets based on the previous discussion in this thread. If you read back through the notes there is an explanation about how to do that.

California:

1. It should be only the mineral rights situated in this state.

2. Review the federal return if necessary. I'm not sure if California has a different depletion allowance.

Colorado: Compare the federal amounts with what shows up on the CO return to see if any adjustments need to be done for income that should be associated with CO. This would be any income derived from CO.

These are just a few steps that may help you reach completion. It may not be a bad idea to check with a tax professional to finish your return.

@jamie-m-todd

**Say "Thanks" by clicking the thumb icon in a post**Mark the post that answers your question by clicking on "Mark as Best Answer"