Practical application of the new MACRS depreciation regs.

• Author: Afeman, Lynn
• Position: Modified accelerated cost recovery system

In March 2004, the IRS published temporary and proposed regulations (TD 9115; REG-106590-00) addressing depreciation of modified accelerated cost recovery system (MACRS) property acquired in a like-kind exchange under Sec. 1031 or as a result of a Sec. 1033 involuntary conversion, when both the relinquished and the replacement property are subject to MACRS in the acquiring taxpayer's hands. The temporary regulations are effective for like-kind exchanges and involuntary conversions of MACRS property for which the times of disposition and replacement both occur after Feb. 27, 2004. This item provides a general overview of the temporary regulations and highlights differences between the new rules and earlier guidance.

Background

Sec. 167 permits as a depreciation deduction a reasonable allowance for exhaustion or wear and tear of property held for use in a trade or business or for the production of income. Sec. 168 generally governs the depreciation of tangible property placed in service after 1986 (MACRS property). Sec. 1031 (a)(1) provides that, generally, no gain or loss is recognized on an exchange of like-kind property. Under Sec. 1033(a)(1), generally, no gain or loss is recognized if property is compulsorily or involuntarily converted into similar or related use property. Property acquired in a transaction to which Sec. 1031 or 1033 applies generally takes the same basis as the property surrendered in the exchange, less any cash received, plus any gain recognized. However, prior to 2000, there was no guidance under Sec. 168 for determining the appropriate depreciation adjustment for MACRS property acquired in these transactions.

In January 2000, the IRS issued Notice 2000-4, to provide guidance for depreciating MACRS property acquired in a Sec. 1031 like-kind exchange or as a result of a Sec. 1033 involuntary conversion. According to the notice, the IRS intended to issue regulations under Sec. 168 to address these transactions, and taxpayers were instructed to follow the principles of Notice 2000-4 until the IRS issued the regulations.

Under the notice, the carryover basis of acquired MACRS property is depreciated over the remaining recovery period of the exchanged or involuntarily converted MACRS property, using the same depreciation method, recovery period and convention. Thus, "step into the shoes" principles were required for the carryover basis. Any excess basis acquired in the exchange or involuntary conversion is treated as newly...