Tax Guru – Ker$tetter Letter

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Carryover Cost Basis

Posted by taxguru on September 7, 2006



Subject: 1031 Cost Basis vs. Actual Price – Accounting Question
Dear Guru:
I would appreciate ANY help you could spare!  My question is this:
My corproation bought “Vacant Lot A” in 2003 for $5,000.00.  In 2005 my corporation sold “Vacant Lot A” for $40,000.00, using a 1031 Exchange.  With the 1031 Exchange proceeds, my corporation bought another investment property, “Vacant Lot B” for $40,000.00.   What is the “book value” I should show as my corporation’s asset for “Vacant Lot B”?  Would it be the cost basis of $5,000.00 or the actual purchase price of $40,000.00??   
I don’t know who else to ask!  I would greatly appreciate you pointing me in the right direction!


If you’ve ever read any of my blog postings, you should already know in what direction I will be pointing you; into the arms of a professional tax advisor.  It is crazy and downright irresponsible for you to attempt to operate a corporation without the appropriate guidance of trained professionals.  I’m assuming that you are the 100% owner of this corp because any co-owners could bring an action (lawsuit) against you for fiscal malfeasance if you have been risking their investment without proper professional support services.

The terminology in your email also raises some concerns about the validity of your 1031 exchange.  To be valid, your corp should not have actually received any of the proceeds form the first property, but had them held by a neutral third party exchange facilitator.  Hopefully, you had an exchange facilitator and didn’t try to handle the 1031 sale and reinvestment on your own, in which case, there would have been a taxable sale.

Assuming there was a valid 1031 exchange via an appropriate facilitator, there is a tax form (8824) that needs to be attached to your corporate tax return documenting the details of the 1031 exchange.  Part of that form includes a calculation of the cost basis of the new replacement property.  This calculation takes into account the cash given, the cash received, the debt assumed or paid off on the old property, the debt assumed on the new property, as well as the adjusted cost basis of the old property. 

Using simplistic numbers and assuming that you essentially swapped one property for another that was worth $40,000, the adjusted basis of the replacement property on the corp books will be the exact same basis as the old property. In this case, that means it would be $5,000.  A 1031 like kind exchange is technically a tax deferred exchange.  This means that if you were to sell (not exchange) the new replacement property for $40,000, the gain from the original property would pop up and be taxable.

This is a very basic principle which any competent professional tax advisor should have no problem explaining to you.

Good luck.  I hope this helps.

Kerry Kerstetter


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