Depreciating property following a like-kind exchange. (Case Study).
According to Notice 2000-4, the IRS 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 (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. 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 this entire amount over 39 years, beginning in February 2001 (Method A), or they might have treated the property's basis as having two parts--an old portion (equal to a cost of $400,000 and accumulated depreciation 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 life and later (before the original asset is fully depreciated) 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 of $22,000 from a note repayment. Rather, the gain was short-term capital gain (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
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|Author:||Ellentuck, Albert B.|
|Publication:||The Tax Adviser|
|Date:||Nov 1, 2001|
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