A BUG in TurboTax re: 1031 Exchange? And, need some help in understanding what, if any, profit to recognize.

[TomYoung]

@Carl 

I'm helping my daughter with her Starker exchange (Sec 1031). This is an area where I'd say I have a general understanding of the tax concepts but have never actually prepared a Form 8824. To a large extent the instructions for Form 8824 are vague and somewhat contradictory to what you see presented on the form itself.

She asked for my help because the program, on the page "Different property received", was asking for what seems to be a "balancing" amount of "other (not like-kind) property."

There was none. My daughter got a new house and a new mortgage, and that's it. Of course you can't go forward in the interview until you put $14,804 in a box on that page, which immediately increases taxable income because it's considered "boot."

The interview is dealing with the following input:

OLD Property
Adjusted basis of property given up $160,980
FMV of property given up 219,000
Loan assumed by buyer 161,196

NEW Property

FMV of property acquired $215,000
Loan assumed by buyer of new property 172,000

so it looks like the "shortfall" TurboTax is looking for is comprised of:

1. Excess of new mortgage assumed by buyer over seller's $10,804
2. Shortfall of FMV of buyer's new property over FMV of property given up 4,000

Essentially, it's the difference between the exchange of equity.

It's not clear to me if the $4,000 should be taxed as gain since the FMV of the property acquired was slightly less than the FMV of the property relinquished.

The $10,804 amount was a little more difficult to narrow down. It seems to be a BUG in TurboTax's calculation of line 15 of the Form 8824:

-------------------------------------------------------------------------------------------------------------------------------------------

-------------------------------------------------------------------------------------------------------------------------------------------

EDIT: upon further review the TurboTax programming here does appear to be correct based on the IRS instructions.  In their typical ponderous fashion the instructions refer to THE EXCESS, IF ANY of liabilities assumed by the other party over the liabilities assumed by you.  The Smart Worksheet has left out "cannot be a negative number."

If I enter  $14,804 on the "Different property received" then having the correct math here on the "Smart Worksheet" would reduce the gain down to $4,000, though I'm not sure if that's even correct.

I can override TurboTax to get to the position I'm guessing is correct after filling out Form 8824 by hand, but maybe I'm missing something completely.

Questions:

1. Is the prompt for $14,804 on the "Different property received" page an error of some sort, or is it somehow "legitimate" due to the differences in equity?
2. Does the fact that she received a property with a FMV $4,000 less than the FMV of the property she gave up trigger a recognizable gain?  The property given up and the property acquired were pretty much as "like kind" as possible, both single family homes used as rentals.

Thanks.

[Carl]

When it comes to 1031 exchanges, I'm dumber than a rock. I just don't have any experience in this or any knowledge about 1031 exchanges.

[TomYoung]

Sorry, for some reason I thought you'd gone through one of those.

Any other SUs (CHAMPIONS!) I might name-drop on this?

Could you ask in the lounge if this is a bug, or not?

Thanks

[Anonymous_]

@TomYoung I believe it seems fairly clear she received boot. 

1) The FMV of the replacement property is ($4k) less than the FMV of the relinquished property, plus

2) The debt on the replacement property is less than the debt on the relinquished property.

There are a ton of examples online, for example:

https://1031x.com/like-kind-exchange-boot/

[TomYoung]

@Anonymous_ 

"2) The debt on the replacement property is less than the debt on the relinquished property."

It's the other way around.  The debt is higher on the replacement property.

In my vague understanding of these things, if both the debt on the new property and the FMV of the new property are more than those items on the relinquished property then there's no recognized gain.  That's why I sort of figured the difference (downward) on the new property's FMV might cause a small gain.

I'll look at the link you've provided to see if this becomes clearer.

[Anonymous_]

It almost looks as if the figures are entered backwards. If they are reversed, the boot is limited to $4k.

[TomYoung]

That was my seat of the pants impression, that the boot would be $4K.  I've added Old and New to the basic input information in my original post, as well as acknowledging that the line 15 Smart Worksheet is operating correctly.

Any boot calculations simply has to come out of the program based on the input, it can't be coming from the user.  That "Different property received" page, to my mind, is very clearly asking about "other property" (not like-kind) that a user is able to identify and there simply isn't any.  But you can't proceed through the interview until you put something in there.  That, to me, is a BUG.

[Anonymous_]

---

@TomYoung wrote:

But you can't proceed through the interview until you put something in there.  That, to me, is a BUG.

---

The language and guidance are both miserably unlcear -- totally ambiguous. Frankly, that section (if you can even call it that) needs a total rewrite. 

For that matter, another "bug" is that there is a checkbox where a user can link an exchange to a business or a rental but checking that box actually does next to nothing.

[TomYoung]

I saw this similar one

https://ttlc.intuit.com/community/investments-and-rental-properties/discussion/1031-exchange-glitch-...

and it's clearly not as issue where the replacement property has a lower FMV than the original property, it's keyed to the net equity difference.  A replacement property with a higher FMV than the original property will trigger this page if the new property indicates lower equity.

Did you happen to float this one up to the lounge?  If you did, did you get any response?

[jfrakes007]

Hi Tom, 

I am ran into this issue for 2021.  This is a complicated tax area, but I think Turbo Tax has it correct.   

In this case, the reason you are running into a problem is because TurboTax is comparing the equity of the relinquished property with the equity of the replacement property; a reduction in equity is considered "boot"  and is taxable.

In your example, the equity she had in the relinquished property was $57,804 and the equity she has in the new property is  $43,000.  The difference of $14,804 is the amount TurboTax is requiring to be added as some type of cash or property receipt.  This is the amount of boot she received and should be entered as cash received.  Much of this was probably spent on various exchange expenses (realtor commission, etc.) which are entered later and will offset the amount of boot.    

My suggestion is to enter the $14,804 as cash received and her exchange expenses should reduce any additional taxes owed. 

James