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

[jamie-m-todd]

@DianeW777 

Good morning Diane,

First off, I'd like to say thank you for investing your time with me.  I so greatly appreciate your insight and how you take the time to break things down for me to better understand.

As a follow-up, I think we are on the same page.  The total cost I allocated to Property 1 in the example was supposed to be $45,000 and not $54,000.  I probably wasn't making that clear in my example.  At this point, if you could please simply verify that the equation to calculate the additional basis (up charge) in my example is correct, I'd greatly appreciate it.  It covers these 3 line items in the example:

1. Replacement Properties' New Loan Amount = $250,000
2. Relinquished Property's Remaining Loan Amount = $100,000
3. Additional Basis or Up Charge to allocate across Replacement Properties = $150,000

I went ahead and created an Amended version of the 2022 TurboTax file.  After I made all of the corrections that we've been discussing, it nets out to only about $100 due to me from the Fed/State.  With that, I'd prefer not to formally file an amended tax return.  However, I do want to have these corrections made moving forward.  With that, I have the following questions I'd greatly appreciate your feedback on:

1. Can a 2022 Amended TurboTax file that has not been filed/returned be pulled into a 2023 TurboTax file to be used as the baseline for the 2023 tax return?
2. Seeing the 2022 tax difference with and without the corrections is negligible ($100 due to me), does an Amendment really need to be filed if I choose to use the corrected 2022 tax file as my baseline for my 2023 tax return?  Would there be any red flags if I do not file the Amendment?

Your insight would be so greatly appreciated.

Thanks so much!

Jamie

[DianeW777]

Yes, the calculation for the up charge is correct in your example.

1. No, you can make the entries yourself with the correct numbers.  
2. No, it's not necessary to amend unless you choose to do so. this would not be a red flag item. Keep the information to show how you started the asset information with the 2023 tax return.  

@jamie-m-todd 

[jamie-m-todd]

@DianeW777 

Good afternoon Diane,

Thank you for the additional input.  Sorry it took me a few days to get back to you; I've been out-of-pocket.  All your answers make sense.

I do have what I hope is a quick question.  It is in respect to my relinquished property from my 2022 tax filing.  That property needed to exist in the 2022 tax return as a rental property with its own line item as I was still using it in that capacity for the month of January.  Then as we discussed, once exchanged in February I portioned it out across the 3 replacement properties.  However, for 2023, there is absolutely no activity associated with that relinquished property line item; no income, no expenses, no depreciation, etc.  Everything has moved on in the form of the replacement properties.  With that, to me it makes sense to delete this line item in the 2023 tax return.  Do you agree?

Thanks so much!
Jamie

[DianeW777]

Yes, I agree.  As long as you have all the replacement figures in place for 2023, and you have your cost basis set aside for the mineral properties (and you do) you can delete that line item that represents the old property.

Note Record Keeping Information: It's important to be clear about the documentation and tax returns that must be kept.  Until you fully dispose of the current properties or any future traded property the tax returns will not be obsolete.  The original property is connected to the new property received in the trade and if that property gets traded all properties are still related to the original property. In other words until a final property received in a trade is completely disposed up your tax returns are permanent records and a statute of limitations does not apply to them until a final property is sold.

@jamie-m-todd 

[jamie-m-todd]

@DianeW777 

Good morning Diane,

Thank you for the confirmation in terms of removing the original asset line item.  I also appreciate your notes around safekeeping the tax returns and supporting documentation - from the original relinquished property up until the final replacement property that is sold instead of being exchanged.

I do have another 1031 exchange question in regards to the relinquished property.  Because the property is "exchanged" and not "sold", any remaining dollars tied to that property from loan refinance fees being expensed as an amortized line item are not released - at least not automatically.  How best would it be to capture these expenses in the return?

Thanks,

Jamie

[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 

[jamie-m-todd]

@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

[DianeW777]

You can add the $1,000 to the current year's cost basis and, as discussed previously, you can decide if an amendment is the best action for last year.

According to IRS Publication 946, retail properties that sell gasoline, such as gas station convenience stores, can be depreciated over a 15-year period under the Modified Accelerated Cost Recovery System (MACRS)

• Publication 946 (review pages 28 & 30 to see if your property qualifies).

The steps to arrive at 15 year property for rentals are as follows:

1. Sign into your return > Search > Type rentals > Click the Jump to... link
2. Continue to Rental and Royalty Summary > Edit beside your property
3. Select Assets/Depreciation to Update > Yes I want to go to my asset summary
4. Add an Asset or Edit beside your Asset > Select Intangibles, Other Property > Select Other Asset Type > Continue to enter your information
5. Continue > Select the appropriate information on Tell us more about this asset > Continue > Select 15 year > Select I used the half year convention (most common if the original purchase date is before the last quarter of the year).
6. Depreciation method would be 150 % Declining Balance > Continue to follow the prompts/screens to complete your entry.

@jamie-m-todd

[jamie-m-todd]

@DianeW777 

@RobertB4444 

Good morning Diane,

Thank you for those detailed comments.  I do have a few follow-up questions:

Loan Fees:

1. For any basis associated with depreciable items such as loan fees from the relinquished properties, can I track them as a separate depreciable asset for each replacement property?  For my own sanity, I think it will be easier to track/maintain.  Of course, for the oil and mineral rights properties, the portion of the loan fees that I assign to each of them will be tracked outside of TurboTax.
2. For those loan fees, is it correct that the depreciation schedule will be the same as the replacement property's depreciation schedule used for both the original basis and the additional basis - e.g., 39 years for commercial property?

Convenience Store/ Fuel Center - Changing depreciation schedule:

I tried to follow your steps that you outlined, and then made a few guesses on some sections/questions that you did not mention.  I must have done something wrong, as the depreciation amount went from $1000 (using a 39 year depreciation schedule) to about $0.  Some items I guessed on include:  1) chose 15 years for the Recovery Period, 2) chose 15 years for Asset class, 3) for MCARS Convention, the outcome didn't change whether I picked Mid-quarter convention or Half-year convention.  I believe the correct answer is Mid-quarter convention because I owned the property for less than 3 months of 2023 (actually owned it for only a few days of 2023).   I did not know if I needed to do anything in regards to the "Special Depreciation Allowance" section.  Any  thoughts here?  It might be easier to just use the standard 39 year schedule as a commercial property.  At least that gives me a depreciation amount to deduct.

(Totally new question)

Partnership LLC:

I was a member of an partnership LLC in 2023 in which we worked with a builder to build and sell a spec house.  The house was sold in 2023.  While I live in California, the LLC was established in Colorado, as the spec house was built in Colorado.  The forms I received from the LLC's CPA were a Colorado K-1 and a Colorado Nonresident Partner or Shareholder Agreement form.   On the K-1 form, only item 7 "Net capital gain" was populated with my portion of the proceeds made from the sale of the home.  No other line items were populated.  My questions are as follows:

1. Would the capital gain on the sale of a spec house typically be considered a "short-term" or "long-term" gain?  The LLC owned the lot and had the construction loan for greater than 1 year.
2. In TurboTax, under the "Choose Type of Activity" section, box 7 equates to Royalties, which does not seem suitable.  Instead, box 8 (short-term gain) or box 9a (long-term gain) seems like a better fit.  Please advise.
3. In TurboTax, I do not plan on populating anything for the "Percentage of Your Share" section or "Liability Share" section, as it says this is not necessary.  Is that ok?
4. Is it ok not to populate the Capital Account Information?  Nothing was specified on the K-1.
5. Under the first "Describe Partnership" section (includes checkboxes for items such as "publicly traded partnership", "partnership ended in 2023", etc), can I choose the "None of these apply" checkbox?
6. Under the second "Describe Partnership" section, would I choose "All of my investment in this activity is at risk"?  There was no guaranteed buyer for the spec house.

Your thoughts on any of those comments/questions would be so greatly appreciated!

Thanks so much!

Jamie

[jamie-m-todd]

@DianeW777 

@RobertB4444 

Hello Diane and Robert.  I just wanted to follow-up with my most recent message.  Are either of you able to answer any of those questions?  I'd greatly appreciate your insight.

Thanks so much!

Jamie

[DianeW777]

Yes, here is the advice for each question.

Loan Fees:

1. Yes, you can track them separately. It can be easier with a like kind exchange, you want the easiest method that works for you and still maintains the integrity of the assets cost basis. 
2. Yes the refinance costs are being amortized over the life of the loan (not the asset recovery period of 39 years) from the date of refinance and it is the correct action to retain the amortization. These will NOT be included as part of the cost basis, but will continue on as though you never exchanged the property.

Partnership LLC:

1. Holding period dictates the gain as either ordinary or capital gain.  From the date the property was acquired until the date of sale would make the determination.  The land would be long term, while the spec house would likely be short term.  The spec house would have to be completed and held for more than one year to have a long term holding period.
2. You must determine the holding periods and then enter each portion appropriately in short term or long term.
3. Yes.
4. Yes.
5. Yes.
6. Yes.  The only time you would answer 'No' is if you had funds you used that you were not responsible for such as money from a parent or sibling that you were not obligated to repay.

@jamie-m-todd 

[jamie-m-todd]

@DianeW777 

@RobertB4444 

Good morning Diane,

Sorry it has taken me a few days to get back to you.  As usual, I greatly appreciate your feedback!

I do have a few follow-up questions:

Loan Fees:

1. In general for a 1031 Exchange, for the relinquished property, under the Property Profile section, you do NOT say that you Sold the property, because you really exchanged it.  I believe we've already talked about this point, but please confirm.
2. However, under "Assets/ Depreciation" section for that relinquished property, I believe you DO indicate that you "Stopped Using this Asset in 2023"...and then enter in the "Date of Sale or Disposition" with the "Date Acquired" date?  I believe you would answer Yes whether that is for the actual house depreciation line item, or for the depreciation of any loan fees.  To me this step is necessary to turn off these line items before creating new line items for the same depreciable assets under the respective replacement properties (after remaining values are apportioned) for the remainder of the original depreciation schedules.  Please confirm.

Partnership LLC:

Earlier this week I received the following items from the LLC's CPA: 

• "Schedule K-1 (Form 1065)"
• "Partner's Basis Worksheet"
• "Analysis of Partner's K-1, Current Year Net Income (Loss) Worksheet"
• "2023 Colorado K-1"
• "2023 Colorado Nonresident Partner or Shareholder Agreement"

The nonresident form applies as I live in California, but the LLC partnership exists in Colorado, as the new home build exists in Colorado. 

After reviewing these forms, and trying to enter all the data into Turbo Tax, these are my questions:

1. The K-1 (Form 1065) I received from the LLC's CPA has a section "M - Did the partner contribute property with a built-in gain (loss)?".  They checked the "No" box.  I'm not sure where this entry exists on the TurboTax form.  Can you please guide me to that location?
2. The LLC's CPA has "Final K-1" as checked, which makes sense because the LLC is no-longer needed as the house was sold in 2023.  However, I want to confirm the choices for the sub-boxes that are in the "Describe the Partnership" section of Turbo Tax:
   1. I chose "This partnership ended in 2023" of the available choices.  Please confirm (there are too many other choices to type them all :-).
   2. Then it asks "Describe Partnership Disposal".  For now I checked the "No entry" box, as the sub-boxes that the other choices lead you to don't seem to apply.  The other choices took you down the path of selling your partnership interest.  Please confirm "No entry" is correct (or at least ok to select). 
3. Do these documents need to be entered into TurboTax or are they just for my reference?  "Partner's Basis Worksheet" and "Analysis of Partner's K-1, Current Year Net Income (Loss) Worksheet".
4. Where do I enter the data from these forms?  "2023 Colorado K-1" (DR106K) and "2023 Colorado Nonresident Partner or Shareholder Agreement" (DR107).  I downloaded the Colorado state file from Turbo Tax.  I imagine the data from these forms goes somewhere in that Colorado section?  Can you please guide me to the right area?  The only data that seems pertinent, at least to the proceeds from the house sale, is the DR106K which has "Non-Resident" checked and my share of the proceeds on line item "7 - Net capital gain".  Everything else is blank.
5. After completing the majority of the Schedules K-1 section (at least entering the gains), while the taxes due did increase as expected, when I close out of that section to the point of the "Business Items" summary section, the Schedules K-1 line item still states a $0 value.  This seems odd not to reflect the additional taxes due from this line item.  Thoughts?

I'd greatly appreciate your kind insight on these items.

Thanks so much!

Jamie

[DianeW777]

Here are the answers to your questions:

Loan Fees:

1. In general for a 1031 Exchange, for the relinquished property, under the Property Profile section, you do NOT say that you Sold the property, because you really exchanged it.  Confirmed - Continue as though it has not been exchanged.  You can choose to divide it if you like (same date, same combined total amount even if divided)
2. However, under "Assets/ Depreciation" section for that relinquished property, I believe you DO indicate that you "Stopped Using this Asset in 2023"...and then enter in the "Date of Sale or Disposition" with the "Date Acquired" date?  Not Exactly - not sold even though you traded property.  This retains the same character. This gets a little confusing - Say it was converted to personal use, then 'yes' to special handling, then enter a new asset EXACTLY the same as indicated in number 1 above). See Notes.

Partnership LLC:

1. This is not an entry on your personal return.
2. The LLC's CPA has "Final K-1" as checked, which makes sense because the LLC is no-longer needed as the house was sold in 2023.  However, I want to confirm the choices for the sub-boxes that are in the "Describe the Partnership" section of Turbo Tax:
   1. I chose "This partnership ended in 2023" of the available choices.  Please confirm. It may be easier to select 'None' and then delete the K1 next year so there are no errors and the 1031 is handling the exchange. Then the next screen will not appear for sales information.
   2. Then it asks "Describe Partnership Disposal".  For now I checked the "No entry" box, as the sub-boxes that the other choices lead you to don't seem to apply.  The other choices took you down the path of selling your partnership interest.  Please confirm "No entry" is correct (or at least ok to select). N/A if you follow instruction in #1 above.
3. Keep them in your files.  You may need them in the future but only the K1 income, etc in Part III needs to be entered.
4.  The K1 income should carry over to the CO tax return.  Once this is entered in the federal return, you should see a section populate in the nonresident CO return to make any adjustments for the CO portion.
5. The question is not clear for me.  Keep in mind if there are capital gains, the tax calculation will be using capital gains tax rates and a worksheet to calculate the tax. Review the tax return after complete to look at the income sections to account for the K1 information.

@jamie-m-todd 

[jamie-m-todd]

@DianeW777 

@RobertB4444 

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.

1. 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.
2. 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:

1. 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?
2. 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?
3. 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

[DianeW777]

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