Discussion:1031 LKE Question

An investor owns a real property (1250) both land and building with a fair market value of $100,000 and have taken $20,000 of Straight line depreciation and so the adjusted basis of the property is $80,000. This property is exchanged for unimproved land of the value of $100,000. What happens to depreciation? Does the investor pay tax on it and how much is the tax?

This is what I have been told: According to the new Temp Regs on this topic (Reg. 1.168(i)-6) land is never depreciable nor is it MACRS property. If depreciable property and land are exchanged for land (with no building or improvements), the entire basis of the relinquished property becomes the tax basis of the land acquired as replacement property. So in the example, the basis of the land is $80,000 which means the $20,000 depreciation recapture gain will be postponed until the land sells.

Now the big unanswered question is: is the $20,000 gain depreciation recapture gain at 15 or 25 percent or is it 1231 gain at 5 or 15 percent. No one has ruled in on that one yet but I think some will say that it will be 1250 recapture. Like kind exchanges postpone the tax bite but do not change the character of it. Of course, if they hold on to it for a long time, the chances are pretty good that everyone will forget that it was acquired in a LKE and it will become 1231 gain or even capital gain.

If anyone can point out the IRS regs and documentson this subject, I would appreciate it.

See similar discussion at Discussion:Land_for_Duplex--LIke_kind_exchange-Depreciation_Question

So far I think I am siding with Kevinh5.

Scott has an interest point.. about the character of deferred gain being carried forward. I don't know of any ruling or case that addresses this. It could get very complicated with multiple exchanges and improvements so hopefully the IRS will be wise enough to let this issue lie.

Scott, My vote is that you have to set up the new asset similar to my last post on that other thread:

• Land, $80K Cost Basis
• Unrecaptured Sec 1250, $20K Cost Basis w/ Accum Sec 1250 Depr of $20K

Willy, It is my belief that maintaining the character of the deferred gain was the spirit behind those 2000 (or 2001) regulations requiring that the depreciation methods of the relinquished property be transferred to the replacement property, i.e., You can't wipe out prior Sec 1250 depreciation via a 1031 exchange.

There has been a lot of debate about what happens when you go from Land to Land+Bldg or vice versa. Can you depreciate Land? Do you end up with a non-depreciable Bldg? The IRS has provided no guidance on this. IMO, that is because they don't care. They just don't want you erasing any 25% Sec 1250 capital gain that is being deferred.

Technically, you only 'recapture' accelerated Sec 1250 depreciation. You 'recover' straight-line Sec 1250 depreciation.

Stop that! I can see you rolling your eyes.

Thus, it would appear that any taxpayer with net 1231 gains for the year would be required to somehow pay a 25% tax in the year of the exchange, if no 1250 property is acquired. All other taxpayers seem to get a break.

treated as it it is actual Section 1250 gain for purposes of Section 1031 or for purposes of 1250(d)(4)?

If taxpayer exchanges out of a property with unrecaptured Sec 1250 depreciation into another property that lacks sufficient Sec 1250 FMV to absorb this depreciation, AND if this taxpayer also has a Sec 1231 gain, even from another source, then that Sec 1231 gain will be taxed as 25% unrecaptured Sec 1250 gain.

I know all of this is true if there is recognized gain from the exchange. It is the 'even from another source' part that I have never heard of before. Riley or Jessica, can you please confirm if my understanding is correct.

WillyB, the authority for treating unrecaptured 1250 gain in the same manner as recaptured 1250 gain is the directive in Sec. 1(h)(6) to compute unrecaptured 1250 gain as if it were 1250 recapture income, and as if 100% of the depreciation were subject to recapture.

How about cleaning up Reg 1.1250-3 so it is more readable? Thanks.

Thanks.

lol

If the taxpayer has gain realized from the transaction,

and would be deferred under 1031,

but has 1245 or 1250 depreciation,

and is not acquiring enough replacement property based upon FMV and in the same nature (1245 or 1250 property) to absorb the depreciation claimed,

then he has recognized gain in the amount of the lesser of the realized gain or the depreciation.

Why would an unrelated transaction impact this calculation?

I am wondering...would you be willing to tell us...how long have you been doing taxes? I have seen you post on an amazing number of general issues, then obscure specific issues (rules related to people coming in on foreign visas), you have answered CA tax law, and helped me with a Maryland question. I wonder how you acquired this vast knowledge.

I still don't understand why an unrelated transaction would impact this calculation.

I hate to speak for Riley, because I will probably be wrong, but this is what I think he said...

• IF there was Sec 1250 depr on the relinquished property, and
• IF the replacement property lacks sufficient Sec 1250 FMV to absorb the carryover depreciation, and
• IF there was no boot on the exchange, and
• IF there was a 1231 gain from an other unrelated transaction,
• THEN Sec 1250(d)(4) would require that the Sec 1231 gain from this unrelated transaction to be taxed as 25% Sec 1250 recovery up to the amount of the insufficient reinvestment of Sec 1250 property as described in the first two Ifs.

That clears it up right? :)

I'm pretty sure RILEY is an acronym for some sort of intelligence gathering software system. It uses the collective intelligence of all of our posts (excluding me) and regurgitates it into the super intelligence response system that makes us feel so inadequate.

I always wonder what happened to Riley1. I think that must have been a failed experiment. Maybe that's where Kevin came from?

There is no recapture on the disposition of MACRS real property because it is required to be depreciated under the straight-line method.

Like-kind exchanges and involuntary conversions

The exchanged basis (i.e., carryover basis) of MACRS property acquired in a like-kind exchange or involuntary conversion for other MACRS property is depreciated by applying the following rules.

If the replacement MACRS property has the same or a shorter recovery period or the same or a more accelerated depreciation method than the relinquished MACRS property, the exchanged basis is depreciated over the remaining recovery period of, and using the depreciation method and convention of, the relinquished MACRS property.

How does this fit in?

Temporary Reg 1.168(i)-6 T

JAD, I believe that the 1(h)(6) rules say to limit the unrecaptured 1250 gain to the amount of the taxpayer's 1231 gain for the taxable year.

Larry, you are correct that MACRS SL property is not subject to 1250 recapture; however, it is subject to unrecaptured 1250 gain treatment.

Dennis, I think Riley is saying that 1(h)(6) says that there is no recognition of unrecaptured 1250 depreciation is year of exchange if there is no 1231 gain that year. I think that's different from what you posted. I also thought it would be taxed, but that may be because I was confusing the treatment for depreciation recapture with the treatment for unrecaptured 1250 depreciation.

the same as Sec 1250 recapture.. as to tax free exchanges.

Unfortunately, I don't have the time now to do further research on it.

We have been talking about the taxpayer having to recognize Sec 1250 recovery in the year of the exchange if they had any other Sec 1231 gains during that year.

Does the taxpayer also have to recognize the Sec 1250 recovery next year if there is a Sec 1231 gain from another transaction in that year. Isn't the code saying, "Next Sec 1231 gain gets taxed at 25%."

Just because the there were no other Sec 1231 gains during the exchange year, doesn't mean that that the Sec 1250 recovery is now tied to only the pending future taxable sale of the replacement property.

Willy, it makes sense. If you exchange into land, there is no depreciation which the unrecaptured 1250 gain would attach to.

Paul, my read of that section is that it applies only that year, which makes sense. No carryover to future years. If there is no 1231 gain in that year, the 25% rate income has been offset by 1231 losses, right? Think of the Sch D calculation. You may have a line 19 amount, but it is irrelevant to the tax calculation unless there are net capital gains, and of course, 1231 gains flow to that schedule.

BTW, I have no cite re all that. It's just the way my mind has worked it out...rightly or wrongly.

Scott

At least some exchange facilitators seem to agree. [1]