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"Beware
if you are closing after October 17, 2002" FORM
8824 - REPORTING THE EXCHANGE Form
#8824, Like-Kind Exchanges, is filed to reflect the exchange on the Exchanger's
tax return in the year the transaction began (i.e. the year the relinquished
property was sold to a buyer.) Form #8824 requires the Exchanger to provide the
following information:
1)
Description of like-kind property given up; 2)
Description of like-kind property received; 3)
Date like-kind property given up was acquired; 4)
Date property was transferred to other party; 5)
Date like-kind property was identified; 6)
Date like-kind replacement property was received. Part
II -
Related Party Exchange Information Part
III -
Realized Gain or (Loss), Recognized Gain, Basis Part
IV -
Deferral of Gain from Section 1043 Sales FORM
4797/SCHEDULE D - REPORTING THE GAIN Form
#4797 or Schedule D is filed to report the taxable gain. The gain must be
allocated between capital gain, ordinary income depreciation recapture, Section
1231 gain and unrecaptured Section 1250 gain. FORM
6252 - REPORTING AN INSTALLMENT SALE Form
#6252, Installment Sale Income, must be filed if the Exchanger carries back a
note to a buyer on the sale of the relinquished and is able to report the
taxable gain under the installment sale rules. CONSULT
WITH YOUR TAX ADVISOR This
is a brief summary. Every Exchanger should consult with a tax advisor to review
their specific situation and tax filing requirements. DUE
DATE OF THE TAX RETURN
An
Exchanger has to complete their exchange within 180 calendar days, or the date
their tax return is due - whichever
is earlier. For
2002, if an Exchanger closes an exchange: 1)
Between October 18 and December 31; 2)
Files their tax return on April 15, 2003; 3)
Desires the ability to have up to 180 calendar days to complete their
exchange by purchasing one or more replacement properties; then
the Exchanger must: File
an extension by April 15, 2003, using Form #4868, which would extend the date
the Exchanger's tax return is due until August 15, 2003. If
the tax extension is not filed by their tax filing date, the Exchanger's
"exchange period" is shortened to the actual date their tax return is
due and filed.
BENEFITS
OF A REVERSE EXCHANGE
The
need for a §1031 reverse exchange arises when circumstances require that the
replacement property be acquired before closing on the relinquished property.
Often Exchangers may need to perform a reverse exchange in a "sellers
market" where recently listed properties are quickly under contract with a
buyer. Revenue Procedure 2000-37 provides guidelines for the Exchanger to
perform a "parking arrangement" exchange within 180 calendar days from
the Exchange Accommodation Titleholder's (EAT) purchase of the replacement
property. "REPLACEMENT
PROPERTY PARKED"
The
EAT acquires title to the replacement property with funds the Exchanger causes
to be loaned to the EAT. Within 180
days, the Exchanger sells the relinquished property through the "delayed
exchange" format and the EAT transfers the replacement property to the
Exchanger. Positives
of the "Replacement Property Parked"
·
Exchange
equity need not be present. ·
A
deferred exchange may follow this format. ·
Allows
for multiple relinquished properties. Negatives
of the "Replacement Property Parked" ·
Lender
may have issues lending to the EAT. ·
High
costs - potential double transfer taxes and title insurance fees. "RELINQUISHED
PROPERTY PARKED" The
Exchanger conveys the relinquished property to the EAT and then the Exchanger
acquires the replacement property under a "simultaneous exchange"
format. During the 180 days, the
EAT remains on title to the relinquished property until it is sold to a
purchaser. Positives
of the "Relinquished Property Parked" ·
Loan
and purchase of replacement property
easier since the loan is directly to the Exchanger. ·
Possibly
less expensive on transfer tax for
relinquished property. ·
Safer
for EAT and Exchanger to hold title. Negatives
of the "Relinquished Property Parked" ·
Equity
and debt should match to avoid "boot" ·
Transfer
to EAT may increase county property tax basis. ·
Lender
issues on relinquished property (due on sale clause and prepayment penalties).
Calculating
the Depreciation Deduction: "It's
more complicated when acquiring replacement property" By
Asset Preservation, Inc. Kennen
S. Cohen Although
tax deferred exchanges provide many benefits to investors, the annual cost
recovery deduction (commonly called "depreciation") in the replacement
property is not as high as if acquired in a typical purchase. The reason for
this is that the basis from the relinquished (sold) property is carried forward
into the replacement (new) property. Assume
the following: ·
The
relinquished property is sold for $250,000; ·
The
replacement property is purchased for $550,000; ·
The
land-to-improvement ratio for both is 80%; ·
The
carried forward depreciation deduction is $5,025/year; ·
Properties
are depreciated over a useful life of 27.5 years. DEPRECIATION
DEDUCTION IN A PURCHASE If
the investor purchased the property, the depreciation deduction would be
calculated against the full value of the depreciable improvements as reflected
below:
Price of the Relinquished Property
$550,000 x
Percentage of Improvements
x .80
Depreciable Improvements $440,000 The
calculation for the annual depreciation deduction of a single family house is
the depreciable improvements divided by the useful life as shown below:
Depreciable
Improvements
= Annual Depreciation
Useful Life
Deduction $440,000
= $16,000 Annual Depreciation Deduction
27.5
With
an exchange, the depreciation schedule from the relinquished property is carried
forward into the replacement property and the investor is only allowed to
calculate a new depreciation schedule on a portion of the new purchase. DEPRECIATION
DEDUCTION IN AN EXCHANGE
Purchase Price
$550,000
- Value Transferred
-$250,000
New Cost Basis
$300,000
New
Cost Basis
$300,000 x
Percentage of Improvements
x .80
Depreciable Improvements
$240,000
Depreciable Improvements:$240,000=
$8,727 Annual
Useful Life of 27.5 Years
Dep.
Deduction To
calculate the total deduction, add the old and new depreciation schedules as
shown below:
Prior Annual Deduction $5,025
+ New Annual Deduction +
$8,727
Total Annual Deduction
$13,752
With an exchange, the investor loses $2,248 in the annual depreciation deduction ($16,000 - $13,752 = $2,248). Although the loss of some depreciation benefits is a consequence of an exchange into replacement property, most investors feel the benefits of capital preservation, greater leverage, diversification and consolidation are far more significant factors.
******Information provided
by a reliable 3rd party, please discuss your personal situation with your
own legal/tax counsel.************
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