Like-Kind exchange combined with Sec 121 exclusion - reporting questions

[Kate Lavery]

I converted my primary residence into a rental property three years ago. Last year, I completed a 1031 exchange, where I exchanged that rental property for two new residential rental properties. The overall gain on the sale of the original property was over $500K, and I received $500K in cash. I turned around and contributed over $500K to close the purchase of the two replacement rental properties. I am also eligible for the Section 121 exclusion for this transaction.

I received two 1099-S forms from the title company: one reporting the cash proceeds (box 2 for Gross Proceeds) and the other showing no amount in box 2 but with box 4 checked, indicating the transaction involved a 1031 exchange. I completed Form 8824 in TurboTax as a combined transaction.

From my understanding, this transaction is tax-free, and the gain is deferred. I want to ensure the reporting is accurate. Based on my reading of IRS Publication 523 (Selling Your Home), it appears that I must report the sale of the original property on Form 8949 and Schedule D, given that I received a 1099-S. However, this doesn’t seem right to me because there is no taxable gain or depreciation recapture. Additionally, I don't believe Form 4797 should be generated for this transaction.

Please confirm that, for reporting a 1031 exchange from one residential rental to two residential rentals, I need to prepare a separate statement and only complete lines 19 through 25 on Form 8824. It appears TurboTax (downloaded version/Forms) doesn't have the capability to report an exchange of one residential rental for two residential rentals.

I am entering this transaction myself through TurboTax, but I would appreciate feedback from the community on the correct forms that need to be filed. Thank you!

[Ashish Acharya]

@Kate Lavery For your 1031 exchange combined with the Section 121 exclusion, here's a simplified breakdown of what you need to do:

1. Form 8824: Yes, you're correct in using Form 8824 to report the 1031 exchange. Since you exchanged one rental for two, you’ll need to provide a separate statement for each of the replacement properties and report lines 19-25.

2. Section 121 Exclusion: You’re also eligible for the $500K exclusion (if filing jointly) under Section 121 since it was your primary residence for two of the last five years. This exclusion covers your capital gain on the portion of the sale that’s not part of the exchange.

3. Form 8949 and Schedule D: Even though you received a 1099-S, you don't need to report the entire gain as taxable because of the combined Section 121 exclusion and 1031 exchange. Instead, you’ll use Form 8949 and Schedule D to report the sale, but the gain should be reduced by the Section 121 exclusion. The rest is deferred under the 1031 exchange.

4. Depreciation Recapture: You’re right, you don’t need Form 4797, as the gain is not taxable due to the exchange and exclusion.

*This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.