Depreciating Property Acquired Under Code Secs. 1031 or 1033
As a taxpayer involved in a like-kind exchange or who replaced property after a casualty loss, regulations concerning the annual depreciation allowance for the replacement property may be of interest to you.
Under a typical like-kind exchange, a taxpayer sells property to be exchanged to a buyer, the proceeds are transferred to and held by an intermediary, and the taxpayer acquires replacement property from an unrelated seller using the funds held by the intermediary. Like-kind exchanges offer enormous tax planning opportunities by allowing the taxpayer to reinvest proceeds from the sale of qualified business or investment property without recognizing gain. Although a like-kind exchange is often referred to as being tax free, the exchange is more appropriately tax deferred because the basis of the relinquished property is carried over to the replacement property.
Similarly, nonrecognition of gain from property is mandatory if the old property is converted directly into similar property, and elective if the taxpayer receives money, such as insurance proceeds, or other nonqualified property, and acquires qualified replacement property within the prescribed time period. If the old property is exchanged for replacement property, the basis of the old property carries over to the replacement property, thereby deferring unrecognized gain until the disposition of the replacement property.
Until its disposition, the replacement property must be depreciated according to regulations. The computation of the depreciation allowance depends, in part, on whether the recovery period and depreciation method of the relinquished property and replacement property are the same. In some cases, application of the regulations has an adverse tax effect. Fortunately, a taxpayer may elect out of the regulations. This election should be considered if the recovery period of the replacement property is shorter than the remaining recovery period of the relinquished property, or the depreciation method of the replacement property is more accelerated than the depreciation method of the relinquished property.
The most beneficial method for depreciation should be determined and applied to your replacement property. Even if the replacement property was acquired in a prior tax year, it may be to your advantage to amend the return and elect out of the regulations if the property can be depreciated more quickly. We can prepare the computations and discuss your options. Please give our office a call at your earliest convenience.
Like-Kind Exchanges
We have reviewed your tax information and would like to take this opportunity to describe a very important tax planning arrangement approved by the IRS for property owners. This planning arrangement is commonly called a "like-kind exchange." You may have also heard this arrangement referred to as a “tax-free exchange” or a “Starker exchange.” The tax savings from participating in a like-kind exchange can be very substantial.
A like-kind exchange provides a wonderful alternative to selling property. The sale of property may cause you to recognize a gain on the sale, requiring you to pay taxes on this gain. A like-kind exchange, on the other hand, allows you to avoid gain recognition through the exchange of qualifying like-kind properties. The gain on the exchange of like-kind property is effectively deferred until you sell or otherwise dispose of the property you receive. The IRS allows this tax-deferred transaction because it recognizes that because your economic position remains the same (i.e., you have merely exchanged one property for another), you should not have to incur taxable gains. You will, however, have to recognize gain on any money or unlike property that you receive in the exchange.
Only qualifying property may receive like-kind treatment. To qualify, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. Buildings, rental houses, land, trucks, and machinery are examples of property that may qualify.
Like-kind exchanges provide a valuable tax planning opportunity if:
1.You wish to avoid recognizing taxable gain on the sale of property that you will replace with like-kind property;
2. You wish to diversify your real estate portfolio without tax consequence by acquiring different types of properties with the exchange proceeds;
3. You wish to participate in a very useful estate planning technique (continued like-kind exchanges allow you to permanently avoid recognition of gain); or
4. You would generate an alternative minimum tax liability upon recognition of a large capital gain in a situation where the gain would not otherwise be taxed. (The like-kind exchange shelters other income from the alternative minimum tax.)
If you would like more information on like-kind exchanges, or if you feel that you may benefit from a like-kind exchange, please contact our office at your convenience so that we may discuss this in greater detail.
Sincerely yours,
Frank’s Tax and Business Service
120 York Rd
Kings Mountain, NC28086-3151
(704) 739-4039 Fax: (704) 739-3934
e-mail: [email protected]
Web Site: File Your Return Online
Franklin Katz, ATP, PA, PB,
Providing Professional Accounting, Bookkeeping,
Payroll and Income Tax Preparation Services
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Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL60015.