How to Report a 1031 Exchange on Your Tax Return

A 1031 exchange is the exchange of so-called “like-kind” property; the 1031 exchange tax can result as long-term gains, short-term capital gains or ordinary income. Like-kind property is determined to be property of the same economic use, no matter the value. Note: financial securities and inventory do not qualify for like-kind exchanges. In effect, 1031 exchanges defer the paying of gains tax to a future date instead of paying immediately.

IRS tax rules call for filing forms 8824 and 4797, and any capital gains will be reported on schedule D of the capital gains return. Any short-term gains from the like-kind exchange will be reported on line 4, and any long term gains will be reported on line 11 of the schedule D attachment for the 1040 tax form.

Use form 4797 to report the gain or loss from the exchange. Fill out form 8824 to report any gains from property given up, any cash received, the dates on which the property was exchanged, the adjusted basis from the property received, and any gains including non-recaptured gains.

Tax Basis and Realized Gain for 1031 Like-Kind Property

The adjusted tax basis is denoted by the property being given up plus any expenses that were incurred during the exchange. To compute the realized gain or loss, you subtract the adjusted tax basis from the sum of the fair market value of the property received and any cash, net liabilities and fair market value of any other property received in relation to the like-kind exchange.

Computing Recognized Gain

The recognized gain is line item 23 on the 8824 form and would additionally be reported on the schedule D of the 1040 if above zero. In order to compute recognized gain, you first must know whether you have recaptured ordinary income, which is computed on form 4797. This recaptured ordinary income is subtracted from the lesser of either the cash received from the like-kind exchange or the realized gains. The recognized gain is then the addition of the result of the last subtraction adding back in the ordinary income recaptured. In effect, the income recaptured lessens the realized gain but is still accounted for in the recognized gain.

The IRS tax rules don’t allow the exchanging of domestic property with property overseas to qualify for 1031 like-kind exchanges. And although real property and personal property are eligible for like-kind exchanges, there can’t be a simultaneous swapping of real property for personal property. Additionally, know that employees or spouses of employees who work for the federal government will have to file an additional form as parties of a conflict of interest. Normally, like-kind exchanges occur with real estate investments and properties that pertain to office buildings. To know for sure when to file the tax forms, you simply file in the year the property was exchanged.