You’ve successfully completed a 1031 like-kind exchange and deferred your capital gains tax on the sale of your former investment property - congratulations! The IRS still wants a report of every single exchange where you may have deferred your tax liability.
Reporting a like-kind exchange on your federal income tax is a step you cannot miss and should be viewed as part of the entire exchange process. Almost all states recognized 1031 exchanges and whether or not you need to report capital gains on your state report depends on where you live and where the exchange took place.
When to File Your 1031 Exchange
If you’re unsure of when to file, here are some basic rules:
- Your exchange was initiated and completed within the same calendar year. File your tax return as normal.
- Your exchange has been initiated but is not completed. You need to acquire your replacement property before filing. If the 180-day exchange period is before the April filing date, your return will be on time. If it’s after, you need to file for an extension using IRS Form 4868.
You’ll need to fill out specific tax forms and provide information about the properties for the IRS.
IRS Form 8824: Like-Kind Exchange
All 1031 exchanges are reported on IRS Form 8824. This is where you describe the relinquished and replacement property, the dates the relinquished property was acquired and transferred, the dates the replacement property was identified and received, and information about related parties. Providing this information also shows that these dates are within the 45-day identification period and the 180-day exchange period.
On Part III, you’ll calculate and record the realized gain or loss and the recognized gain or loss on the relinquished property as well as the adjusted cost basis of the like-kind replacement property.
IRS Form 4797: Reporting Taxable Gain
IRS Form 4797 or Schedule D is used to report gains from the sale or exchange of business property. Taxable gain must be disbursed between capital gain, ordinary income depreciation recapture, Section 1231 gain, and unrecaptured Section 1250 gain.
IRS Form 6252: Installment Sale Income
IRS Form 6252 is used to report installment sale income from a 1031 exchange that spills over into multiple tax years. Form 6252 must also be filed if the taxpayer accepts a carry back note from the seller from the relinquished property and is able to report taxable gain according to installment sale rules.
Recording in Failed Exchange
If your 1031 exchange falls through, it might not be taxed immediately, and you may still be able to defer your capital gains. It depends on your situation, but you may have a partial tax-deferred exchange or be able to push income tax on the failed 1031 exchange into the following tax year.
It’s critical that you file all necessary forms with accurate information. The federal statute of limitations for audits from the IRS related to income tax is three years from the date your income tax return was filed. Filing Form 8824 with your income tax return notifies the IRS of an exchange on a sale, which may have deferred your tax liability for that taxable year.
The 1031 Investor's Guidebook
Tackle the art and science of completing your 1031 exchange.