Depreciating property following a like-kind exchange. (Case Study).Facts: In February 1990, Jim and Ann Hall acquired real property for $500,000 ($100,000 allocated to the land and $400,000 to a commercial building that they lease). Consistent with the rules that applied to nonresidential real property acquired after Dec. 31, 1986 and before May 13, 1993, the Halls have been depreciating de·pre·ci·ate v. de·pre·ci·at·ed, de·pre·ci·at·ing, de·pre·ci·ates v.tr. 1. To lessen the price or value of. 2. To think or speak of as being of little worth; belittle. the building's $400,000 cost over 31.5 years. Thus, at the end of the 2000 tax year, the Halls had a $261,896 adjusted basis in the building ($400,000 cost - $138,104 depreciation). * In February 2001, the Halls exchanged the land (now worth $150,000), building (worth $550,000) and a $300,000 note, for a larger building and land worth $1 million ($200,000 for the land and $800,000 for the building). The Halls have a realized gain Realized Gain A gain resulting from selling an asset at a price higher than the original purchase price. Notes: There may be tax consequences for a realized profit. of $338,104 ($1 million value of property received -- $261,896 building basis -- $100,000 land -- $300,000 boot (cash) given). However, none of this gain is realized because the Halls received only like-kind property Like-Kind Property Investment or business land/properties that are considered to be the same type and exchanging them is therefore tax-free. Notes: For example, you can exchange a car for another car tax-free, but not a car for a piece of land. (and no boot) in the transaction. Issue: How do the Halls depreciate depreciate v. in accounting, to reduce the value of an asset each year theoretically on the basis that the assets (such as equipment, vehicles or structures) will eventually become obsolete, worn out and of little value. (See: depreciation) the like-kind property received in the exchange after Notice 2000-4? Analysis According to Notice 2000-4, the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. plans to issue regulations that basically provide carryover basis and depreciation for property received in a like-kind exchange, to the extent of the basis of the property given up. If the basis of the newly acquired property is greater than the old property's, the difference becomes new modified accelerated cost recovery system Modified Accelerated Cost Recovery System (MACRS) A 1986 act that set out rules for the depreciation of qualifying assets, allowing for greater acceleration over longer periods of time. (MACRS See Modified Accelerated Cost Recovery System. MACRS See Modified Accelerated Cost Recovery System (MACRS). ) property, resulting in increased depreciation even though a taxpayer recognizes no gain. Until the Service issues regulations, taxpayers must follow, for property acquired after Jan. 2, 2000, the guidance provided in Notice 2000-4. Based on the guidance in Regs. Secs. 1.1250-3(d)(6)(ii) and 1.1031(j)-1(d), the Halls realized and recognized gain Recognized Gain The amount of gain reported for income tax purposes. Notes: You can defer recognizing some gains until the following year(s). See also: Capital Gain, Capital Loss, Deferred Income Tax, Drought Sale, Exempt Income, Exemption, Gain, Recognized Loss . The bases of the properties they receive are as follows: Prior to Notice 2000-4, the Halls might have treated the $501,896 as new real property and depreciated Depreciated may refer to:
The total amount of depreciation that has been recorded for an asset since its date of acquisition. For example, a computer with a 5-year estimated life that was purchased for $2,000 would have accumulated depreciation of $800 [( of $138,104) and a new portion (equal to the $240,000 allocable portion of the cash paid). The old portion would continue to be depreciated as it was prior to the like-kind exchange, and the new portion would be treated as new 39-year property placed in service in February 2001 (Method B). Although the two methods will eventually result in the same total depreciation claimed, due to the time value of money (i.e., a deduction today is worth more than a deduction tomorrow, assuming a constant tax rate), Method B is superior. Of course, in the Halls' situation, that is fortuitous; because the like-kind exchange occurred after Jan. 2, 2000, they must use Method B. To illustrate the advantage of Method B over Method A, Exhibit 1 presents the Halls' depreciation deductions over the next five years under the two methods. Planning tip. Although the regulations that the Service plans to issue may say otherwise, currently there is nothing that prevents a taxpayer from acquiring an asset with a short depreciable depreciable Of, relating to, or being a long-term tangible asset that is subject to depreciation. life and later (before the original asset is fully depreciated Fully depreciated An asset that has already been charged with the maximum amount of depreciation allowed by the IRS for accounting purposes. fully depreciated Of or relating to a fixed asset that has been depreciated to a book value of zero. ) swapping it for a longer depreciable-life asset, as long as both properties are like-kind and held either for investment purposes or for use in a trade or business. The effect of such a transaction would be to speed up the depreciation of the asset acquired in the exchange. Variation. The facts are the same, except that the Halls' old property is an apartment building (rather than a manufacturing facility). In this situation, the carryover portion of the basis in the new building would be depreciated over what was left of the apartment building's original 27.5-year depreciable life. Thus, the advantage of Method B over Method A in the exhibit would be even greater. Case Study Update In the August 2001 Case Study, "Computing Stock and Debt Basis when Stock Is Sold during he Year," p. 560, it was indicated that William had a long-term capital gain Long-term capital gain A profit on the sale of a security or mutual fund share that has been held for more than one year. of $22,000 from a note repayment. Rather, the gain was short-term capital gain Short-term capital gain A profit on the sale of a security or mutual fund share that has been held for one year or less. A short-term capital gain is taxed as ordinary income. (as the note had a short-term holding period).
Land Building
Value of property
received $200,000 $800,000
Less: Adjusted basis
of properly given (100,000) (261,896)
Cash boot given
(allocated based on
relative fair market value
(FMV) of properly received) (60,000) (240,000)
Gain realized $ 40,000 $298,104
Gain recognized (lesser of gain
realized or boot received) $ 0 $ 0
Adjusted basis of
properly given up $100,000 $261,896
Plus: FMV of boot given
(allocated based on
relative FMV of properly
received) 60,000 240,000
Gain recognized
in the transaction 0 0
Less: FMV of boot
received (0) (0)
Basis of property
received $160,000 $501,896
Exhibit 1: Methods A and B Comparison
2001 2002 2003 2004 2005
Method A $11,278 $12,869 $12,869 $12,869 $12,869
Method B $18,089 $18,854 $18,850 $18,854 $18,850
Advantage of
B over A $ 6,811 $ 5,985 $ 5,981 $ 5,985 $ 5,981
Editor: Albert B. Ellentuck, Esq. Of Counsel King and Nordlinger, L.L.P. Arlington, VA |
|
||||||||||||||||||
Printer friendly
Cite/link
Email
Feedback
Reader Opinion