Assigning 1031 basis in a subdivided property used as a home

1031 Exchanges
5yFollow

Assigning 1031 basis in a subdivided property used as a home

Braath Waate
Member since 2021 · 5 posts · 0 votes
25 years ago I bought an income producing farm with land and a house.  I used a 1031 exchange from another business property to pay for it partially.  I lived in the house.

Skip ahead to today.  I subdivided the house off from the land.  But how to assign the original 1031 exchange basis to prepare for sale?

Do I have the freedom to assign the 1031 exchange basis between properties as I determine? If so, I think I should assign the entire 1031 basis to the house, and the rest of the money I spent to the the subdivided land.  Because I lived in the house for more than 5 years, the IRS rules seem to allow the 1031 exchange capital gain to disappear in the home sale capital gains exclusion ($250,000/$500,000), which is a nice loophole.

Or would the IRS require me to allocate the original 1031 exchange basis between both properties?  If so, how?

Caveat.  The sale of the subdivided land and the house will probably not occur within 2 years of each other, so the IRS will not consider the appreciated land as part of the home sale.

0Reply
55 views

Most Popular Reply

Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
5y

@Braath Waate, You'll had some flexibility when you purchased the property.  But you probably wont skate free on the land sale.  All of the real estate has to have a basis.  When you bought the property in the 1031 your basis in the old property was carried forward into the new property and it would have been allocated between land (not depreciable) and building (depreciable) by your accountant.  That land basis will be divided now between the land under the house and the rest of the land.  

That will be your starting basis.  And your gain will be the difference between the net sales price of the land and the adjusted cost basis of the land.

Your tax returns will have already reflected this.

The 1031 Investor5137 Reviews
WebsiteView Page
1Reply
See this reply in the discussion

4 Replies

Jump to latestLatest
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Braath Waate, You'll had some flexibility when you purchased the property.  But you probably wont skate free on the land sale.  All of the real estate has to have a basis.  When you bought the property in the 1031 your basis in the old property was carried forward into the new property and it would have been allocated between land (not depreciable) and building (depreciable) by your accountant.  That land basis will be divided now between the land under the house and the rest of the land.  

    That will be your starting basis.  And your gain will be the difference between the net sales price of the land and the adjusted cost basis of the land.

    Your tax returns will have already reflected this.

    The 1031 Investor5137 Reviews
    WebsiteView Page
    1Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    5y

    @Dave Foster

    Can correct my guesses but….

    Either the house was also a rental for some time before it became your home or it probably couldn’t have been part of the the 1031 exchange. In which case all of the 1031 had to be for the land. And, if it was a rental before it was your primary you only get the percent of time it was your primary tax free. (Say a rental for 2 years and then your primary for 5 years then about 70% capital gains tax free but you still owe the depreciation recapture.) 

    1Reply
  • Braath Waate
    OP
    Member since 2021 · 5 posts · 0 votes
    5y
    Great thought that the basis should have been already established because the house was correctly a depreciable asset.  But I elected not to claim depreciation on the house and never declared it as a depreciable asset on any business tax forms.  (That would have been a mistake had the asset actually depreciated, precluding any claim for loss, but it didn't.)  Thus there will be no depreciation recapture on its sale.  There will be a capital gain.

    The house was not a prior rental. The local tax authority considered it integral to the farming operations as a management residence and taxed the entire property as agriculture.  The contract verbiage of the original 1031 exchange specified the property in whole, not any portion.

    Going forward, it would appear to me that now I need to retroactively establish the basis in the respective property, now subdivided. And determine how to allocate the amount from original 1031 exchange and the amount added to complete the sale.  If accounting rules permit flexibility, I will allocate the amount from the 1031 exchange to the house so that its capital gain will disappear under the home sale exclusion rule.   (Although not pertinent to the discussion, the future sale of the subdivided land will continue its basis in a further 1031 exchange).
    0Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    5y

    That MAY lead you to another problem. depreciation is claimed even on properties that double or triple in value. “Farming operations” depreciate every single thing they can. They certainly should have been depreciating any buildings or equipment. I don’t believe you can choose not to depreciate an investment property unless this property is in Canada where I believe they do have the option. (But then I don’t think they offer a 1031 exchange equivalent.) As far as I know the IRS will just assume you took the depreciation and tax you on it’s recapture, this is certainly true of rental properties. 

    I would probably look at my county tax records. They should break out building value as a percent of total value and use that if they have old enough records dating back to your time fo purchase. But this is something your cpa/accountant should have done at purchase time when they determined how much the buildings were worth and started depreciating them. 

    If it’s like a MN farm it will be a tiny percent if it’s only housing or a section (640 acres) but a much larger percent if it’s housing plus grain or machinery storage on a quarter (160 acres) usually 3-10 acres can be included with the buildings if it isn’t production land. 

    None of my arguments will stand up in court or against the IRS. So I would explain all this to a representative willing to defend their determinations in an audit and cover all fees/fines/interest. 

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free