Depreciation of property received in a like-kind exchange.

• Author: Blumenreich, Richard G.

Sec. 1031(a) provides that a taxpayer that transfers depreciable property held for use in its business and receives back solely property of like kind to be held for productive use in its business (i.e., a like-kind exchange) does not recognize gain or loss on the exchange. Instead, under Sec. 1031(d), the taxpayer takes a basis in the depreciable property received in the exchange equal to the basis it had in the depreciable property transferred. In a like-kind exchange of depreciable tangible property after 1986, must a taxpayer depreciate the entire basis of the property received in the exchange over a new depreciation period, as if the taxpayer had purchased the property? This has proven to be a "trap for the unwary" in many cases, because the conclusion is that the taxpayer will be required to do so.

The analysis that supports this conclusion begins with Sec. 168 as in effect prior to the fax Reform Act of 1986 (TRA) (former Sec. 168). Generally, under former Sec. 168, the basis of depreciable tangible property placed in service by a taxpayer after 1980 (referred to as "recovery property") was treated as new property and was depreciated over the applicable recovery period incorporated in tables provided in former Sec. 168. Unless an exception applied, this general rule applied whether the taxpayer purchased the property, constructed it or acquired it in a transaction in which no gain or loss was required to be recognized (e.g., a Sec. 731 or 1031 transaction).

Former Sec. 168 contained two exceptions to the general rule that applied to nonrecognition transactions. The first exception, in former Sec. 168(f)(10), provided that, in the case of recovery property transferred in a transaction described in Sec. 332, 351, 361, 371(a), 374(a), 721 or 731, the transferee was treated as the transferor for purposes of computing the depreciation deductions allowable with respect to so much of the basis in the hands of the transferee as did not exceed the adjusted basis in the hands of the transferor (the "step-into-the-shoes" rule). Thus, for example, if a taxpayer received property in a distribution from a partnership under Sec. 731, the taxpayer "stepped into the shoes" of the partnership, to the extent of the partnership's basis in the property at the time of the distribution, and continued depreciating the property as if the property had not been distributed.

The second exception, in former Sec. 168(f)(7),provided that,notwithstanding any other...