Depreciating property following a like-kind exchange.

• Author: Ellentuck, Albert B.
• Position: 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 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 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 (and no boot) in the transaction. Issue: How do the Halls depreciate the like-kind property received in the exchange after Notice 2000-4?

Analysis

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...