Like-kind Exchange Depreciation

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In a like-kind exchange there is relinquished property (property given up) and replacement property (property received). The basis remaining in the relinquished property is called exchanged or carryover basis. Any amount received in the exchange that exceeds the carryover basis is called excess basis or boot. The carryover basis and the excess basis comprise the total basis of the replacement property, the amount from Form 8824, line 25.

Prior to the 2000 tax year, there was no consistent treatment of like-kind exchanges among practitioners. The IRS then issued Notice 2000-4 which stated that the carryover basis should continue to be depreciated using the same method and convention as the relinquished property. Any excess basis would be depreciated as newly acquired property. Notice 2000-4 was replaced by Temporary Regulations 1.168(i)-6T which reinforce and clarify Notice 2000-4. For like-kind exchanges occurring after February 27, 2004 the regulations must be applied, while they may be applied to exchanges occurring before February 27, 2004.

Applying the Regulations

When applying the regulations, the relinquished property is treated as being disposed of and the depreciation deduction for the year is determined using the appropriate convention. The carryover basis will typically continue to use the same depreciation method, convention, and recovery period of the relinquished property. However, if the relinquished property is exchanged for replacement property with a different recovery period or method of depreciation, the carryover basis must be depreciated over the longer recovery period or the slower depreciation method of the relinquished property or the replacement property. The taxpayer has the option of switching from the DB/SL formula to the optional IRS tables or vice-versa for the carryover basis.

Temporary Regulations 1.168(k)-1T also impact the depreciation of property received in like-kind exchanges. These regulations provide for the 50% special depreciation allowance to be claimed on carryover basis if the replacement property is qualified (new) property and is placed in service before January 1, 2005.

Electing to not Apply the Regulations

An election to not apply the regulations is available. The election is made by attaching a statement to the return. Applying the regulations is complex, burdensome and sometimes punitive to taxpayers. It usually benefits the taxpayer to elect to not apply the regulations when the relinquished property and replacement property have different methods or recovery periods. When electing to not apply the regulations, the property is depreciated over the recovery period and depreciation method of the replacement property, even if it is shorter or faster than the recovery period or depreciation method of the relinquished property.

When making the election to not apply the Temporary Regulations 1.168(i)-6T, it’s "one property out, one property in" bookkeeping. The replacement property is comprised of both the carryover and the excess basis and is depreciated as a newly purchased MACRS asset. The new asset is eligible for the special depreciation allowance and a section 179 deduction may be claimed on the portion of the replacement asset that is excess basis.

Depreciating Automobiles Received in a Like-kind Exchange

The depreciation deduction for passenger automobiles is limited by section 280(F). When a like-kind exchange involves automobiles the limits imposed by section 280(F) must be allocated among the components involved in the like-kind exchange. The limit for all of the components in the exchange is the first year auto limit. The limit for the relinquished vehicle is the limit that would have applied if the exchange had not occurred. The limit for the carryover basis and the excess basis is the first year auto limit reduced by any depreciation claimed on the relinquished property.

Electing to not apply the regulations to like-kind exchanges involving automobiles, results in separate treatment for the relinquished and replacement properties. The relinquished vehicle is subject to the section 280(F) limits as if the exchange had not occurred, but the replacement vehicle uses the full first year auto limit, without a reduction for the depreciation claimed on the relinquished vehicle.

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