Tax Season Issues

Exchangers must report their exchange on the tax return for the year in which the exchange begins. The exchange is reported on Form 8824, “Like-Kind Exchanges.” This form requests dates of the exchange transaction, the date properties were “identified” and financial information obtained from the closing/settlement statement.

For the sale of depreciable rental or business property the Exchanger will also need Form 4797, “Sale of Business Property.” For the sale of non-depreciable investment property, the Exchanger will need Form 1041 Schedule D, “Capital Gains and Losses.”

Refer to Rev. Rul. 72-456 and Treas. Reg. §1.1031(k)-I(g)(7)(H) for tax treatment of closing costs in an exchange. Rev. Rul. 72-456 deals specifically with broker commissions but is considered a guideline for treatment of other closing costs. The basic rule is that closing costs reduce realized gain on the relinquished property, reduce boot received and are added to the basis of the replacement property.

Remember, if the Exchanger relinquished property after October 18th, they actually have less than 180 days in which to complete their exchange unless they file for an extension. The actual deadline for completing an exchange (“the exchange period”) is the earlier of either 180 days from the date on which the Exchanger transfers the relinquised property, or the due date, including extensions filed by the Exchanger, for the Exchanger’s tax return for the year of the transfer of the relinquished property.

Be aware that the IRS generally has three years in which to audit a tax return. However, this statute of limitations is extended if a taxpayer fails to report more than 25% of their gross income. Often the tax savings generated by an exchange will be significant enough to activate this extension of the three year audit period.