Depreciation Cost Basis for 1031 real estate exchange

[rhmaron1942]

I paid $115000 for House 1 and sold 16 years later for $390000. I bought House 2 using 1031 exchange for $452000, $30000 land and $422000 for dwelling. Cash paid was $452000 less $390000, or $62000.

Is the cost basis for depreciation:

A. $62000

B. $452000

C. $115000 + $62000????

Richard

[Anonymous_]

I have to presume that when you say you "sold" House 1 and "bought" House 2 that you meant you "exchanged" House 1 and House 2 (hopefully using a qualified intermediary). 

Regardless, your total basis would be C, but do not forget that you have 16 years worth of accumulated depreciation that does not simply disappear. 

In sum, you have $115,000 in exchanged basis and $62,000 in excess basis (and note that land is not depreciable so that needs to be subtracted out of the calculation).

[Think57]

I have a similar question regarding my 1031 exchange.  Did I do this correctly? 

- Line 25 of Form 8824, Basis of like-kind property received, is 505,273.  This takes into account all of the depreciation and improvements of the relinquished property, as well exchange & closing expenses for both the relinquished and received propertes

- The building of the relinquished property still has 37,345 of basis to depreciate.  I continue to depreciate this over its remaining life on the received property's depreciation schedule as carryover depreciation.

- The received property's building is valued at 538,629.  Its Excess Basis is 538,629 less 37,345 of carryover depreciation basis from the relinquished property for a value of 501,285.  I depreciate 501,285 for the received property as Excess Basis over 27.5 year on the received property's depreciation schedule.  Thanks for your help!

[Vic_R]

@Think57 , @Anonymous_ 

I'm not an expert, but that doesn't sound correct, as you seem to be ignoring the calculation from form 8824.  Using the approach to continue the current depreciation schedule forward it seems you would subtract that from the new adjusted basis of the like-kind property calculated on form 8824.

I just want to clarify 100% before I file that you do use this new adjusted basis calculation from 8824 not just in the future when you sell the new property, but also to figure the new depreciation schedules (by percentage) for the structure, land improvements, etc.  This makes a really big difference in long term strategy if you can only depreciate what is essentially the adjusted basis from the replaced property plus added basis from the new property.  For example, selling a property after 30 years with a huge gain and trading  up a little to multiple properties doesn't leave anything close to the actual cost basis of the new properties.

[Think57]

Hello Vic-R and thank you for your post.  I am not clear about the number on Line 25 of Form 8824, the Basis of like-kind property received.  Seems to me that it is the basis only to be used for determining the capital gain of the replacement property if you sell the replacement property.   I am confused on how we can use this number on Line 25 of Form 8824 for depreciation purposes because it is derived from Fair Market Value (FMV) numbers for both relinquished and replacement properties, and the FMV includes land which is not depreciated.  And confused I am, after doing some internet research. 

My thinking is leading me down the path of continuing the depreciation schedule of the building of the relinquished property as carryover depreciation as if the property was never sold and separately depreciating the building of the replacement property over 27.5 years.  Where I am stuck is how to calculate the "Excess Basis" to depreciate for the building of the replacement building.  Do I subtract from the value of the building of the replacement property the remaining un-depreciated basis of the building of the relinquished property, or do I subtract the value (cost) of the relinquished property's building at the time I bought the property?

Getting to the point of giving up and handing over my tax preparation to someone who professionally does tax returns that include real estate and 1031 exchanges.

Thanks again for your post.

[Think57]

Hello Vic_R.  After doing some more research on the internet, and working through some examples on the internet, this is how it seems to work.  Hope this helps. 

The new adjusted basis number on line 25 is the "cost" of the received property to determine the capital gain if you sell the received property.  Regarding depreciation:

A. Carry forward the depreciation of the relinquished property as if the relinquished property had not been sold. 

B.  To determine the "excess basis" of the received property to depreciate:  1)  First calculate what percentage the building is of the total basis of the received property, which I took to mean the building value divided by the total of purchase price of the received property plus any exchange expenses.  ;  2)  Then take this percentage and multiply it by the amount of Line 25 on form 8824, the new adjusted basis of the received property.  This backs out un-depreciable assets included in the new adjusted basis such as land ;  3)  Depreciate the building over 27.5 years as you normally would.

See:  https://tax-lawyer-texas.com/2018/05/28/calculation-of-basis-in-new-property-in-a-section-1031-like-... and    the example below which do not know the web address of:

Example: An exchanger has been taking depreciation for 10 years on a residential rental purchased for $150,000. He has taken $4,500 in depreciation annually leaving an exchanged basis of $105,000. If he purchases a residential replacement property with a total new basis of $165,000 (per Line 25 of IRS Form 8824), his depreciation schedules for the replacement property would be as follows: 

A.  Continuation of the Old Schedule for remaining 17.5 years : $4,500 per year for 17.5 years.
B.  New Schedule for amount of Excess Basis for 27.5 years: If the value of the new property depreciab'le improvements were 82.5%, then the $60,000 increase in basis ($165,000 -105,000) would be depreciated as follows: $60,000 X 82.5% = $49,500 divided by 27.5 years. The result would be $1,800 in annual depreciation to be taken for 27.5 years.

The total depreciation to be taken annually henceforth would be $4,500 (old schedule) plus $1,800 (new schedule) for a total amount of $6,300.

[Think57]

Here is the web address of the 2nd example

https://www.1031.us/wp-content/uploads/Form8824Workbookfor2019-Draft.pdf

[Vic_R]

@Think57 

Hi there, I also spent a ton of time reading and thinking about all this and created my own spreadsheets etc. to make sense of it all, and I have finally reached the point where I think it (mostly) makes sense.   Your latest description is closer but not quite right IMO.  I'll summarize and send the best links I could find that helped me (in addition to Pub 527 and the instructions for 8824).

But 1st, note that another detail (which is not discussed in this thread) is the distinction between fundamentally 3 different types of "costs" on your closing statement (which end up in 3 different places): I spent a lot of time on that.  Refer to Pub 527. 

(1)  You have pre-paids (such as insurance and funding an impound account), and pro-rations for taxes and insurance and HOA and things that have to do with owning the property, not selling it: these things are resolved on Schedule E as expenses.

(2) "Costs associated with obtaining a loan".  These costs are anything you would NOT have if you were paying cash, and don't forget the Lender's Title Insurance.  These costs are amortized for the new property or properties in full, under "Intagibles" loan cost, and you put the life of the loan for the amortization period.

(3) Whatever is left are the "Total Exchange Cost" (see examples in Pub 527) and are used on 8824 in the boot calculation (since cash received may be used to cover these costs).  Here is a good link I used:

https://firstexchange.com/closing-costs-in-an-exchange

One of the things I learned is that those basic rules to fully defer your gain are somewhat misleading:

(1) step up in price paid vs. price sold and (2) replace or increase the debt...simple...however, it turns out that if you increase your loan amount which is quite possible if not probable you may only have a partial exchange.  If you increase your debt substantially more then 8824 will quickly tell you that you may have more "equity received" than "equity given", which means you received cash/boot from the exchange.  This happened to me and I put cash into the deal!!  So that's where the expenses come into play and that cash received may be used to cover your "Total Exchange Expenses" which are only the expenses described above (for both properties you sold and purchased).  Here is another link on that subject:

https://homeguides.sfgate.com/can-amortize-rental-property-77587.html

Now, back to depreciation, and if you have a CPA that really understands RE and exchanges I would suggest you use them to review whatever you come up with.  Here is my attempt to summarize and some links that helped me.

1) YES, line 25 on 8824 is the "New Cost Basis for the Replacement Property", which is the starting point on the asset entry, and yes you can start by looking up the tax assessors property information to have a reference for the percentage land vs. Improved.  Then you can use that percentage on the New Cost Basis to divvy up between land and improved.  Then, as many do, you can split the "improved" up between the structure (27.5 years), Land Improvements (15 years) and carpet/appliances (5-years) and often there is a "special" depreciation of 50% the 1st year or even (as we have currently) 100%.  Turbo Tax handles this and I think gives you the option to take it or not.

NOTE:  This approach ENDs the depreciation schedules on the property given up.  In fact you edit that asset and say you are taking it out of service and enter the date (you sold the property) and Turbo Tax will pro-rate the amount for 2019.

This is a pretty summary of how to do that: (see the procedure from @Husam22)

https://ttlc.intuit.com/community/taxes/discussion/re-1031-exchange-for-rental-property-end-to-end-q...

Now, maybe when you mentioned carrying the existing depreciation schedule forward (?) you were referring to more complicated approach, where you split up the "new cost basis" between the "Adjusted Basis of the relinquished property", which is up to you to calculate, and....(continued below)

--------- 

Adjusted Basis

The adjusted basis of property is usually the original cost of the property, adjusted for various items after you acquired it. Additions to basis include improvements you made to the property and nondeductible assessments for improvements (sidewalks, utilities, etc.). Decreases to basis include casualty and theft losses deducted. Depreciation claimed and section 179 deductions taken also decrease your basis. In general, calculate adjusted basis in this manner:

  1. Original cost, including sales tax, purchase expenses, etc.
  PLUS
  2. Improvements (with a useful life of more than one year)
  3. Nondeductible assessments for improvements (sidewalks, utilities,
  etc.)
  MINUS
  4. Depreciation claimed
  5. Section 179 deduction taken

-----------

and the "added basis" from "stepping up" assuming a full deferment of your gain.  These values are on 8824.  It's not 100% clear to me the advantage of doing this, but here is an explanation of how you do it:

Note: I did not take this approach: I'm splitting everything up into 3 new replacement properties so I don't need to make it any more complicated.

https://proconnect.intuit.com/community/help-articles/help/1040-completing-a-like-kind-exchange-of-b...

Here is another question that could come up, if you have carry-forward passive losses.  YES, these are carried forward to the replacement property:  https://ttlc.intuit.com/community/investments-and-rental-properties/discussion/we-sold-a-rental-prop...

That's all I have for now, after about a weeks worth of research.

Good Luck,

Victor

[Think57]

Hey Vic_R.  Thank you for your detailed and informative post.

1) Mea Culpa ... found an error in my description of how to compute Excess Basis:  before multiplying by the percentage the building is of the purchase price plus exchange expenses, need to subtract the Adjusted Basis of the relinquished property from the New Basis of the Replacement property (8824 Line 25).  That is how it is done in the examples

2) Thanks for the notes on the different types of costs

3)  Agree with you that it is simpler to depreciate all assets going forward as new assets with new life.  And yes, I have taken the more complicated approach of splitting up the New Basis of the Replacement Property between the remaining depreciation of the relinquished property and the now "Excess Basis" of the replacement property.  IMO, this seems to give me higher depreciation deduction for the remaining basis of the relinquished property over its remaining life versus treating as a new asset reset to year 1 of its depreciation schedule.  And yes, also splitting out different assets types to get appropriate asset life.

4)  Regarding the Like-Kind Exchange tax reporting calculations (8824) to fully defer capital gain, found the worksheet included in the workbook at  https://www.1031.us/wp-content/uploads/Form8824Workbookfor2019-Draft.pdf   most helpful. 

5)  Regarding Like-Kind Exchange rules, in general, have done the following that seems to avoid the pitfalls

a) Purchase price in total of replacement property(ies) greater than selling price of relinquished property

b) Loan amount(s) in total of replacement property(ies) greater than loan amount of relinquished property

c) Take no cash out

d) Adhere to all timelines for property identification and purchase

5) That's good advice to have a CPA or Tax Preparer review my work.  Have already been working on lining someone up to do this.

6) Not taking advantage of Fed Special Depreciation rules as my state does not allow this and prefer to keep my Fed and State returns consistent, so opt out of it when TT presents the option to choose.

7) Doing the same as you are and leveraging Turbo Tax to do the depreciation calculations by inputting the values it needs.  Took a bit of effort to figure out how to do this without having to use "override" feature for some of the automatically calculated fields.

😎 Learned about the  validity of carrying forward of passive activity losses in our previous Like-Kind Exchange five years ago.  Thanks for reminding me.

Thanks again for your detailed and informative post.  Good luck to us all and be safe.