Reporting

This chapter sets out the form, the situations that complicate it, and the elections that can still be salvaged after the fact.

53.1 Form 8824 and its schedules

The form has three operative parts and one that applies only to a narrow class of federal officials.

Part I records the descriptions of the relinquished and replacement properties and the dates that drive Chapters 25 and 26.

Part II records related party information, and it is filed in the year of the exchange and in each of the two following years. The taxpayer answers whether the related party disposed of any part of the like-kind property received, and whether the taxpayer disposed of the property received, during the year and before the two year date. Where both answers are no and it is not the year of the exchange, the taxpayer stops.¹ The obligation and its exceptions are developed at 40.3 and 40.5.

Part III performs the computation, and its lines correspond to Chapters 33 through 37 in the following way.

Lines 12 through 14 handle non-like-kind property the taxpayer gave up, with the gain or loss reported as if the exchange had been a sale.

Line 15 is boot: cash received, plus the fair market value of other property received, plus net liabilities assumed by the other party, reduced but not below zero by exchange expenses.²

Line 16 is the fair market value of like-kind property received, and line 17 adds the two.

Line 18 is the adjusted basis of the like-kind property given up, plus net amounts paid to the other party, plus any exchange expenses not used on line 15.

Line 19 is realized gain, being line 17 less line 18.

Line 20 is the smaller of line 15 or line 19, but not less than zero, which is the recognition ceiling of 33.2 expressed arithmetically.

Line 21 is ordinary income under the recapture rules, carried to Form 4797. Line 22 is the remainder, carried to Schedule D or Form 4797 unless the installment method applies. Line 23 is recognized gain, the sum of the two.

Line 24 is deferred gain, being line 19 less line 23.

Line 25 is the basis of the like-kind property received, computed as the sum of lines 18 and 23 less line 15.

Lines 25a through 25c allocate that basis among like-kind section 1250 property, like-kind section 1245, 1252, 1254, and 1255 property, and like-kind intangible property received, and the amounts entered must be proportionate to their fair market values.³

Two cautions.

The form itself directs a taxpayer who transferred and received more than one group of like-kind properties, or who transferred or received cash or other property, to the multi-asset reporting instructions, which implement the exchange group methodology of Chapter 32.

And the caution stated at the opening of Chapter 39 applies to every line above. The form's expense instructions assume the amounts entered have not already been netted. Where the commission, the intermediary's fee, and the settlement charges were paid at the relinquished closing out of the gross price, the cash the intermediary received is already net of them, and subtracting them again on line 15 or adding them again on line 18 understates both realized and recognized gain. The computation should be performed under sections 1001 and 1031 and the form reconciled to it.

53.2 Reporting a straddle-year exchange

An exchange that begins in one taxable year and ends in the next is reported with the return for the year in which the relinquished property was transferred, because that is the year of the disposition.

Three situations complicate it.

Boot received in the following year. Where the intermediary releases residual cash after the replacement closing in year two, the coordination rules of Chapter 44 mean the taxpayer is not treated as having received payment in year one, and the gain may be reported in year two under the installment method.⁴ Line 22 of the form anticipates this, directing the amount to Schedule D or Form 4797 "unless the installment method applies."

A failed exchange. Where the exchange fails and the proceeds are released in year two, the transaction is a sale reportable in year one under section 1001, but payment for purposes of section 453 occurs in year two, so the gain may be reported then.⁵ The bona fide intent requirement examined at 44.2 must be satisfied, and the evidence supporting it should be assembled before the year one return is filed rather than when the position is questioned.

Filing before completion. The extension recommended at 26.2 has a reporting dimension in addition to its effect on the exchange period. A taxpayer who files the return for the year of relinquishment before the exchange has closed must report a transaction that has not yet happened, and the exchange period itself ends on the return due date including extensions. Extending is the ordinary answer to both problems.

53.3 Entity-level reporting

The exchange is reported by the taxpayer, and Chapter 19 determines who that is.

A disregarded entity does not report. Its owner reports, because the entity has no separate existence for income tax purposes and title within a chain of disregarded entities moves without consequence.

A partnership or S corporation reports at the entity level, and the related party questions in Part II are answered at that level. The two year monitoring obligation of 40.3 belongs to the entity, and it survives changes in the entity's advisors.

A drop and swap produces returns that do not obviously match. The partnership reports a distribution, and each former partner reports an exchange of an undivided interest. Nothing on the face of either return states that the properties were held by a partnership weeks earlier, and nothing conceals it either. The structure's exposure is examined at 20.4 and Chapter 42; the reporting point is simply that the returns should be prepared with the knowledge that they will be read together.

One election is entity-level by its terms. The depreciation election examined at 36.3 is made by the common parent for a consolidated group member, by the partnership rather than by the partners, and by the S corporation rather than by the shareholders, and a separate election is required for each exchange.⁶

53.4 Amended returns and late elections

Begin with what is not an election. Section 1031 is not elective. A transaction that satisfies its requirements produces nonrecognition whether or not the taxpayer prefers it, as 35.3 develops in connection with loss property. There is no section 1031 election to make late, and a taxpayer who wanted a taxable sale had to structure one.

The elections that do exist, and the relief available for each.

The depreciation election of 36.3 must be made by the due date, including extensions, of the return for the year of replacement, in the manner provided on Form 4562, and may not be made in any other manner, including through a request to change a method of accounting.⁷

Because its due date is prescribed by regulation rather than by statute, it is a regulatory election.⁸ That characterization matters, because two forms of relief follow from it.

An automatic six month extension from the due date of the return excluding extensions is granted for regulatory or statutory elections whose due date is the due date of the return, provided the taxpayer timely filed the return for the year the election should have been made and takes corrective action within the six month period.⁹ Corrective action includes filing an amended return for that year with the appropriate form attached.¹⁰

Beyond that window, discretionary relief is available where the taxpayer establishes to the satisfaction of the Commissioner that it acted reasonably and in good faith and that relief will not prejudice the interests of the Government.¹¹ A taxpayer is deemed to have acted reasonably and in good faith where, among other circumstances, relief is requested before the failure is discovered by the Service, where the failure resulted from intervening events beyond the taxpayer's control, or where the taxpayer reasonably relied on a qualified tax professional who failed to make, or to advise the taxpayer to make, the election.¹²

The section 754 election examined at 50.4 is on the list of regulatory elections eligible for an automatic twelve month extension, provided corrective action is taken within that period.¹³ A partnership that discovers after a partner's death that the election was never in place is not necessarily out of time, and the possibility should be checked before the loss is treated as permanent.

The election out of the installment method must be made by the due date including extensions of the return for the year of the disposition and is revocable only with consent.¹⁴

The involuntary conversion election of Chapter 45 is made at the time and in the manner the Secretary prescribes,¹⁵ and the assessment period for the year of realization stays open until the Service is notified of the replacement or of an intention not to replace.¹⁶

Amended returns arise in three recurring situations.

Where a taxpayer reported an exchange of a dwelling unit expecting the replacement property to satisfy the vacation home safe harbor, and later determines it does not, the Service directs the taxpayer to file an amended return and not report the transaction as an exchange.¹⁷ That obligation arises two years after the original return was filed and should be disclosed to the client at the outset.

Where a related party disposition triggers retroactive recognition under Chapter 40, the deferred gain is reported on the current year's return rather than by amending the year of the exchange, because the statute takes the gain into account as of the date the disposition occurs.¹⁸

And where the economic substance penalty of 42.3 is in play, an amendment or supplement to a return is not taken into account for the disclosure purpose if filed after the earlier of the date the taxpayer is first contacted by the Secretary regarding the examination or such other date as the Secretary specifies.¹⁹ Disclosure that comes after the letter is worth nothing.

The closing instruction for this chapter is that the reporting file should be assembled at closing rather than at filing. The settlement statements, the exchange agreement, the assignment and notices, the identification, the depreciation allocation between land and improvements, and the calendar for the two related party years are all easier to produce in the week of the transaction than in the month the return is due, and far easier than in the year it is examined.