Form 8824 - 1031 Exchange Flow

[rfk]

I know that all of you are particularly busy, but if you can find the time to do a cursory look and comment:

Client bought a piece of property (CA) that was being developed by company. It closed on 10/12/04, an investment property. The Basis was approximately $351,492.

It was refi'd again, closing date of 5/26/05, approx. $360,716.28. It was exchanged through a QI, (Oakland, CA), a large, national firm finalized 07/25/05. The total was about $525,000; under additional disbursements category it showed (seller proceeds to T/P show (TP) of $50,000 and Balance Due YOU, to T/P of $85,210).

An accounting statement from QI shows various Wires ins / outs where "check out" was to Franchise Tax Board" of 3.333& and amount subject to W/H of $15,486.90; so the amt to FTB was $515.71.

Two props were exchanged to in NV, one where TP is living in the residence and the other is a vacation rental for people coming to NV and wanting to rent the place out nightly. The cumulative combined values (Basis/Purchase) of two props are approx. $766,843.37.

I am using a an Excel W/S but want to make sure form 8824 is going to be filed correctly by me. Can someone offer input on the "best" direction I should take to finish this form. I know that it has been mentioned not to consider mortgages; it it shows on settlement statements paid on behalf of borrower or something like this.

If someone can get me started, I can finish it up on paper / Excel. I just need to know whether the numbers I will be inputting and the source of the numbers makes sense from an exchange point of view.

I hope this flow of numbers makes sense.

Thank you very much for your help.

Ray

[jainen]

boot received

There are several items of non-like-kind property (boot) received. The first was in the refinance a few months prior to the exchange. If you look at the payoff amount you will probably see that it was quite a bit below the new loan amount of $360,000. Unless that money was used to complete the construction, it is not eligible to be exchanged and is taxable on the disposition of property. The exchangor knew he was trading down (into a personal residence) and would have a substantial tax hit. He attempted to pull value out ahead of time so it wouldn't show in the exchange documents. The IRS calls this a "step transaction." He hopes it will appear that the refinance was not related to the exchange, but in reality it was so close in time that they must be considered consecutive steps in a single transaction.

The money withheld by FTB is taxable boot, as is any other item on the settlement statement not directly related to the transaction. Look for things like taxes, creditor liens, and partner buyouts.

I didn't follow the explanation of the two cash out amounts, but it seems that the two new properties were worth less than the one old one, so the difference is cash boot. This is in addition to the money withdrawn from equity in the May refinance.

Finally, the FMV of the property occupied as a personal residence is non-like-kind, treated as boot received. It would seem the taxpayer had a healthy profit in a short time, and that most of it will be recognized and taxed in 2005.

The mortgages will confuse you because money was pulled out of this investment along the way. Nevertheless, there is no mortgage boot because he paid off the old balance in full and took out new loans. He neither transferred nor received property subject to prior loans. Therefore, do not consider that exchange proceeds were used to pay the mortgage or that his new loans may be larger than necessary. Just look at the FMV of the three properties and ignore the source of funds.

[rfk]

Jainen,

Thanks for your reply. I don't work with these issues at all pretty much. The TP, in looking at the paperwork, seems to have touched some of the money, just based on a "feeling" w/o my not knowing a lot about 1031's. However, I do know some stuff; but this one just does not seem right and I have been going back and forth with it.

* The title company does have a caption labeled ADDITIONAL DISBURSEMENTS of which two line items say Seller Proceeds TP $ 50,000
BALANCE DUE YOU $ 85,210

* This was from an Amended Final statement. The Original showed
Seller Proceeds: TP
BALANCE DUE YOU $135,210.73

So it seems that the title comapny had provided paperwork that showed the seller being the QI and buyer being another individual, but why would my client have proceeds to him of $135,210.73? Is this some sort of misnomer on the paerwork or...?

The paperwork flows with the QI having taken position and selling, but I am not sure if this was a legitimate 1031 though. A CA form 593-B, RE W/H Tax Statement was also included in his paperwork which shows the Escrow info -- Date of Transfer, Total Sale Price ($525,000), amount Subject to W/H $15,486.90 and corresponding Amount Withheld from Seller of $515.71. It is a little confusing, if in essence, this was supposed to be an Exchange.

I know I am rambling on; I am sorry, but something is not right.

Ray

[jainen]

under his pillow

This setup obviously had taxable boot so withholding of some amount was appropriate. Don't be confused by the terminology in the escrow documents; they have as much jargon as any other business. Just make a little chart showing what was transferred and what was received, using fair market values (contract prices) and ignoring the way the mortgage was paid off and the way proceeds from the new mortgages were applied.

It will take you about an hour to sort through all the deeds and contracts, another hour to figure out the new basis and the taxable gain (using pencil and paper), and another hour or three to figure out how to get it all into the computer.

The client himself is knowledgeable and should be able to help explain things. He appears to have pulled off a pretty sophisticated exchange exactly the way he wanted to. Of course, he is trying to hide the full amount of gain and characterize his personal residence as 1031 property, so you will have to verify everything he says. To do that you need the complete escrow file, which he has safely tucked under his pillow.