Depreciating MACRS Property in Tax-Free Exchanges

By Lesli S. Laffie, J.D., LL.M.

Final regulations (TD 9314, 2/26/07) explain how to depreciate certain property acquired in a like-kind exchange under Sec. 1031. The rules address how to determine annual depreciation allowances using the modified accelerated cost recovery system (MACRS) under Sec. 168 for replacement property acquired in a like-kind exchange.

The guidance also applies to involuntary conversions under Sec. 1033, when both the acquired and relinquished property are subject to MACRS by the acquiring taxpayer.

The rules finalize proposed regulations (REG-106590-00) and remove temporary regulations (TD 9115) issued Feb. 27, 2004; the final rules said that while no public hearing on the 2004 regulations was requested, the Service received several recommendations in submitted comments and incorporated some of them into the final rules. These rules were effective Feb. 26, 2007 and apply to like-kind exchanges or involuntary conversions of MACRS property for which the time of disposition and the time of replacement both occur after Feb. 27, 2004. For exchanges or involuntary conversions occurring before that date, taxpayers may apply the final rules or rely on prior guidance.

Permitted methods: The final rules provide guidance on how taxpayers may determine the annual depreciation allowance under Sec. 168 while electing to use optional tables to determine depreciation allowances for replacement property instead of using Sec. 168 formulas. One commenter stated that presenting a choice of depreciation methods may confuse taxpayers, but the regulations said the Service retained the optional tables to provide taxpayers with an alternative method of calculating depreciation. The guidance contained rules on choosing the optional table that would correctly calculate the depreciation.

Multiple properties and depreciation conventions: Commenters requested examples of how to determine basis in Sec. 1031 exchanges when multiple properties are involved and when Sec. 1033 applies to a compulsory exchange. The IRS declined to address these issues in the final rules, stating that any basis adjustments are subject to Sec. 168 and, thus, could not be addressed in final rules under Secs. 1031 and 1033.

The final rules, at the request of a commenter, did include an example to show how depreciation is calculated on replacement property received in exchange for property used only partially for business purposes.

The Service heeded other suggestions as well. For example, it added Regs. Sec. 1.168(i)-6(c)(5)(ii)(A) and a new rule to provide explanations for electing applicable depreciation conventions separate from explanations for the rules determining recovery periods of MACRS property.

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