I completed a 1031 Exchange in 2023 in which the relinquished property was replaced by 3 replacement properties. One of the replacement properties is a convenience store/fuel center. The other two properties are really mineral rights which generate royalty payments - in which there is no physical land. Please note, I am using the "2 schedule" method, which addresses each property separately versus combining all 3 - from a tax filing perspective. From speaking with other Turbo Tax experts I believe the following is true:Royalty Properties, as in the case of oil and gas mineral rights, cannot be allocated any land tied to the relinquished property’s original basis or any replacement property’s additional basis.I’m interpreting that into 100% of the land value tied to both basis numbers gets assigned to the convenience store. Is that correct?While you cannot depreciate a basis amount assigned to a Royalty Property, you must assign a reasonable value to it as it was also a property received in the trade. It can be used when and if I sell those rights to reduce any gain in the future. Is this correct?Seeing the 2 Royalty Properties represent 74% of the total replacement value, I’ve assigned 74% of the original and additional basis values to these 2 properties. Once assigned, that 74% will remain untouched until the mineral rights are sold.The remaining 26% of the basis numbers have been assigned to the convenience store. The negative basis number assigned to the convenience store is just a matter of subtracting 100% of the land from only 26% of the remaining basis that has yet to be depreciated. Here are how the numbers played out between the relinquished property and the convenience store replacement property. Relinquished Property:$320k cost$64k land value$166k prior depreciation$89k remaining basis Convenience Store Replacement Property:$84k apportioned cost$64k apportioned land value$44k apportioned prior depreciationCalculation = $ Apportioned Remaining Depreciable Basis = (Apportioned Cost minus (Apportioned Land Value from Relinquished Prop + Apportioned Prior Depreciation from Relinquished Prop)$84k – ($64k + $44k) = -24k To note, the additional basis coming from the convenience store (which has a structure that can be depreciated), after factoring in the relinquished property's loan/debt, AND after being allocated across all 3 properties, is not enough to offset the negative basis coming from the Relinquished property to the convenience store replacement property. MAIN QUESTION:What do I do when it is a negative basis value? Do I enter the -24k, or the value $0? How is this usually handled? Any guidance here will be greatly appreciated! Thanks! As a reference, TurboTax experts that assisted me last year, just in case they can address this question@DianeW777@AmyC

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Question

How do you treat a negative basis value assigned to a replacement property as the result of a 1031 Exchange?

Forum|Forum|2 years ago
February 9, 2024
3 replies
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I completed a 1031 Exchange in 2023 in which the relinquished property was replaced by 3 replacement properties. One of the replacement properties is a convenience store/fuel center. The other two properties are really mineral rights which generate royalty payments - in which there is no physical land.

Please note, I am using the "2 schedule" method, which addresses each property separately versus combining all 3 - from a tax filing perspective.

From speaking with other Turbo Tax experts I believe the following is true:

Royalty Properties, as in the case of oil and gas mineral rights, cannot be allocated any land tied to the relinquished property’s original basis or any replacement property’s additional basis.
1. I’m interpreting that into 100% of the land value tied to both basis numbers gets assigned to the convenience store. Is that correct?
While you cannot depreciate a basis amount assigned to a Royalty Property, you must assign a reasonable value to it as it was also a property received in the trade. It can be used when and if I sell those rights to reduce any gain in the future. Is this correct?

Seeing the 2 Royalty Properties represent 74% of the total replacement value, I’ve assigned 74% of the original and additional basis values to these 2 properties. Once assigned, that 74% will remain untouched until the mineral rights are sold.
The remaining 26% of the basis numbers have been assigned to the convenience store.

The negative basis number assigned to the convenience store is just a matter of subtracting 100% of the land from only 26% of the remaining basis that has yet to be depreciated.

Here are how the numbers played out between the relinquished property and the convenience store replacement property.

Relinquished Property:

$320k cost
$64k land value
$166k prior depreciation
$89k remaining basis

Convenience Store Replacement Property:

$84k apportioned cost
$64k apportioned land value
$44k apportioned prior depreciation
Calculation = $ Apportioned Remaining Depreciable Basis = (Apportioned Cost minus (Apportioned Land Value from Relinquished Prop + Apportioned Prior Depreciation from Relinquished Prop)
$84k – ($64k + $44k) = -24k

To note, the additional basis coming from the convenience store (which has a structure that can be depreciated), after factoring in the relinquished property's loan/debt, AND after being allocated across all 3 properties, is not enough to offset the negative basis coming from the Relinquished property to the convenience store replacement property.

MAIN QUESTION:

What do I do when it is a negative basis value? Do I enter the -24k, or the value $0? How is this usually handled?

Any guidance here will be greatly appreciated!

Thanks!

As a reference, TurboTax experts that assisted me last year, just in case they can address this question

@DianeW777

@AmyC

DianeW777

Let's simplify the best way to handle this. Keep the original property in tact and change the name to the new store. Split all the up charges (additional money you paid including loan you took over minus any loan given up on the old property) and split it between the new mineral properties. This could make it all much simpler and there should be no negative basis. This would be the amounts that are not depreciated and remain with the mineral property until sold. A paper tracking for a future sale.

The land is causing the issue, however, there should be no negative basis in the equation.

Let me know if this makes more sense to you.

@jamie-m-todd

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jamie-m-toddAuthor

@DianeW777

Hello Diane. Great to hear from you! Thank you for your response.

I'll need a little more guidance to be truly grounded in your recommendation. However, before I ask follow-up questions on that front, can you please tell me if this approach strays away from the "2 schedule" method that you recommended and we applied for my 1031 event last year? What I like about the 2 schedule approach is that each replacement property is truly broken out and tracked separately, which makes future exchanges between each respective property/entity much easier to apply. It can also possibly be beneficial when the different replacement properties have different depreciation terms. Please let me know your thoughts here. Ideally, it would be nice if each of my 1031 exchange events followed the same structure.

Thanks so much!

Jamie

DianeW777

The '2 schedule' approach is fine, however the confusion begins because there is no negative value based on the overall 1031 exchange.

As noted last year, the information was provided when it was not yet clear with respect to receiving only one building in the trade for three properties when only one building (convenience store) was actually received. See a portion of last year's notes:

'Part 2: All fees with the exception of marketing would be added to the cost basis as part of the buy up charges. Add those fees to the assets mentioned above before apportioning it.'
You did not acquire another building: 'When you enter the new properties (Add another property for each building), you will select as noted above and they will be depreciated using the correct 39 year recovery.'

NOTE: **** Although the actual trade did include mineral property, the land must be a factor that must be used in the formula to arrive at the correct amount for purchase of the mineral property regardless of the fact it cannot be depreciated or be called land.
This will actually reduce the land value associated with the convenience store as it should. There is no negative amount in the exchange.

The added up-charge we originally calculated of $118,000 which requires a portion assigned to the mineral properties. This, as you noted, is not depreciable so it stays on-hold until you trade or sell the mineral properties. It doesn't have to be the entire amount that is assigned to the mineral properties, however the formula must work out in a positive result. You did NOT have a section 1031 trade that resulted in a loss.

If you believe the full land value should remain with the new convenience store, then you would simply leave the original building in tact as it was and continue to depreciate it even if you enter it again to rename it. Keep in mind this retains the same character as if it was never traded. The purpose is to defer any gain until you fully dispose of the replacement property.

As stated earlier, then the $118,000 would be split between the two mineral properties and suspended until sold.

@jamie-m-todd

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jamie-m-toddAuthor

@DianeW777

Hello Diane,

Thank you so much for your follow-up!

I'm now finding these 2 recommendations in conflict:

From last year's correspondence:
1. "No, if you do not own the land and only the mineral rights then no amount of the assets should be applied to land for the oil & mineral property. It was not previously clear there was no land ownership with this property."
From this year's correspondence:
1. "NOTE: **** Although the actual trade did include mineral property, the land must be a factor that must be used in the formula to arrive at the correct amount for purchase of the mineral property regardless of the fact it cannot be depreciated or be called land."

I agree, if I can allocate a good portion of the $64k from the relinquished property to the 2 oil and gas properties it will solve for the negative depreciable basis for the convenience store. I could use each replacement properties value as a percentage of the entire replacement cost to apportion that land. In the case of the convenience store, its value is only 26% of the whole. Thus only 26% of the $64k land value of the relinquished property would be tied to the convenience store; or $16.6k. Please let me if I misunderstood you last year, and this is possible.

Last year I did not have to apportion any land to the single oil and gas property to have a positive depreciable basis for each of the 3 replacement properties. More-than-likely this is due to having assets and land on 2 out of the 3 properties which accounted for about 72% of the overall replacement value. Based on your most recent reply, please let me know if this wasn't the correct (or best) decision. Allocating some of the land value to the single oil and gas property would provide more depreciable basis to the 2 other properties with assets that can be depreciated.

Thanks again Diane for your great insight!

Jamie

DianeW777

Yes, allocating all of the cost basis (including land) of the assets traded along with the additional added funds would be the appropriate action which will include the land from the original property. The new property in total must be represented with a basis that makes sense.

I agree there was much detail last year that could be confusing. You should do as you indicate here: 'I could use each replacement properties value as a percentage of the entire replacement cost to apportion that land.'

@jamie-m-todd

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RobertB4444

Any expenses associated with the relinquished property are rolled up and included in the basis for the property received in the exchange. You'll depreciate them over time as part of the new property basis.

@jamie-m-todd

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jamie-m-toddAuthor

@RobertB4444

@DianeW777

Thank you Robert for that input!

I had a similar situation in 2022 in which I performed a 1031 Exchange, but I did not think to reassign the remainder of the refinancing expenses to the replacement properties as part of their apportioned original basis number. Is it too late to do that? I had about $1,000 left for these expenses. Maybe it isn't worth readjusting the basis of the replacement properties (3 of them) in their second year?

Additionally, in regards to the 1031 Exchanged that I performed in 2023, one of the replacement properties is a Convenience Store/Fuel Center. I classified it as a Commercial rental property, which for the depreciation section, classified the asset as Nonresidential Real Estate that comes with the 39 year depreciation schedule. My understanding is that an asset that is a fuel center could qualify for a much shorter depreciation schedule - possibly as low as 15 years. Is that true, and can you please tell me what steps I need to go through in Turbotax to reclassify it this way?

Please let me know your thoughts.

Thanks so much!

Jamie

DianeW777

You can add the $1,000 to the current year's cost basis and, as discussed previously, you can decide if an amendment is the best action for last year.

According to IRS Publication 946, retail properties that sell gasoline, such as gas station convenience stores, can be depreciated over a 15-year period under the Modified Accelerated Cost Recovery System (MACRS)

Publication 946 (review pages 28 & 30 to see if your property qualifies).

The steps to arrive at 15 year property for rentals are as follows:

Sign into your return > Search > Type rentals > Click the Jump to... link
Continue to Rental and Royalty Summary > Edit beside your property
Select Assets/Depreciation to Update > Yes I want to go to my asset summary
Add an Asset or Edit beside your Asset > Select Intangibles, Other Property > Select Other Asset Type > Continue to enter your information
Continue > Select the appropriate information on Tell us more about this asset > Continue > Select 15 year > Select I used the half year convention (most common if the original purchase date is before the last quarter of the year).
Depreciation method would be 150 % Declining Balance > Continue to follow the prompts/screens to complete your entry.

@jamie-m-todd

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