Successfully completing a 1031 exchange and deferring your capital gains taxes is certainly a reason to celebrate. However, you’re not quite done yet. Although you may not owe any taxes, the IRS still wants a detailed recording of your transaction.
This is a critical step, as failing to file the form correctly could result in a reversal of your 1031 exchange and potential tax penalties. Luckily, reporting a 1031 exchange is fairly easy to do. You’ll just need to complete IRS Form 8824 when you file your taxes. Here’s what you need to know.
As with all tax issues, there are some important deadlines you need to know. First, you must complete and file IRS form 8824 along with your tax returns at the end of the year in which you sold the relinquished property and began the 1031 exchange process. This is true whether you’ve actually completed the 1031 exchange or not.
If you’ve initiated and completed your 1031 exchange in the same tax year, you’re in luck. You can file your tax return as normal, making sure to include form 8824 in your filing.
If you’ve initiated your 1031 exchange in one tax year but don’t finalize it until the following year, your form 8824 isn’t considered final until the exchange is complete. In this case, you’ll need to file for an extension using IRS form 4868.
To get started, you’ll want to download IRS Form 8824 from the IRS website. When completing the form, make sure you have the closing statements from both of your property transactions. These documents will contain the bulk of the information you need.
Upon review, you'll notice that the form has four parts. Here is a brief overview and some tips for completing each section.
Part I – Information on the Like-Kind Exchange
When completing Part I of the form, you’ll need to describe the relinquished and replacement properties. This is also where you’ll provide important dates including when you sold and transferred your original property, when the replacement property was identified, and when you closed on the replacement property.
The last question in this section asks whether a related party was involved in the exchange. If you answered “yes," you’ll need to complete Part II. Otherwise, you can skip to Part III.
Part II – Related Party Exchange Information
If a related party was involved in any of the exchange transactions, you’ll need to complete Part II of form 8824. Otherwise, your 1031 exchange will be deemed invalid.
Under IRS rules, a “related party” is the taxpayer’s spouse, child, parent, grandparent, or sibling. Note that in this case, “relation” applies to blood relatives only, so a relationship by marriage is not a concern. A corporation or trust in which the taxpayer has more than 50% ownership is also considered a related party.
If the 1031 exchange occurred between related parties, it must meet one of the IRS exceptions to qualify. Since related party exchanges can be tricky, this warrants a discussion with your tax advisor.
Part III – Realized Gail or Loss
In Part III, you’ll provide the basis of the like-kind property received in the exchange and account for any realized or recognized gains. This may include a reduction in debt and/or cash received above the amount of cash spent. Either of these circumstances will result in taxable income.
Part IV – Conflict-of-Interest Sales
Finally, Part IV is exclusively for use by specific members of the Federal government’s judicial and executive branches. This won’t be relevant for most U.S. taxpayers, so you can likely ignore this section.
While it is possible to complete this form on your own, it’s always a great idea to consult with a qualified tax advisor. This is particularly true when dealing with potentially complex transactions like a 1031 exchange. This overview is not intended to be a substitute for specific tax advice.
If you have any general questions regarding 1031 exchanges or you would like a referral to a tax advisor, please contact us to schedule a consultation.
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