Depreciation and 1031
Someone gave me some advice that sounded too good to be true so I want to verify.
If I own a home for 27.5 years and have taken the depreciation expense every year, then I sell the house (for easy numbers let's just say at the buying price) and buy another one in a 1031, he said that I won't pay capital gains and can start depreciating the new house all over again for ANOTHER 27.5 years. Is this right or do you get 27.5 years total between the two houses when you do a 1031?
Depreciation is property specific. The depreciation on one property can't be applied to any other property.
The 1031 exchange is a tax deferment and (as far as I know) can be used to defer taxes indefinitely.
BP Article:
https://www.biggerpockets.com/blogs/5848/43140-wea...
Other links I found:
http://apiexchange.com/index_main.php?id=8&idz=26
Originally posted by @Elizabeth Woolf:
Someone gave me some advice that sounded too good to be true so I want to verify.
If I own a home for 27.5 years and have taken the depreciation expense every year, then I sell the house (for easy numbers let's just say at the buying price) and buy another one in a 1031, he said that I won't pay capital gains and can start depreciating the new house all over again for ANOTHER 27.5 years. Is this right or do you get 27.5 years total between the two houses when you do a 1031?
A couple of points. You can't fully depreciate most properties because you can't depreciate land. Secondly, for exchange purposes, when you do the exchange, your new property would be calculated using an adjusted basis for depreciation. So if you bought a 100,000 house, depreciated 80,000, and then exchanged it. You would have an adjusted basis of 20,000 when you do the exchange. If you bought another exchange property for 100,000, your adjusted basis would be 20,000.
You should post to Dave Foster or Robert Hetzler regarding 1031 exchanges as they are true experts on the topic.
Mark
Section 1031 of the Internal Revenue Code allows you to exchange real or personal property that was held for rental or investment purposes, or that was used in your trade or business (“relinquished property”), for other real or personal property that will also be held for rental or investment purposes, or that will be used in your trade or business (“replacement property”). This enables you to defer the payment of your ordinary income, capital gain, depreciation recapture and/or Medicare Surcharge (“Obamacare”) income tax liabilities.
When you completes a 1031 exchange you carry over the basic from the relinquished property to the replacement property. The new starting basis on the replacement property is affected by the gain deferred on the exchange.
This is a basic explanation you should consult with a CPA about the calculation of the basic and depreciation schedules.
William Mejia
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spot on @Mark Creason. You only get the tax break of depreciating a dollar once. However @Elizabeth Woolf the power of the 1031 is that you can move, grow, and reposition your portfolio without having to recapture (repay) the depreciation you were granted. This can be a significant savings over time and there are ways to eliminate that deferred tax permanently. It is possible though to buy yourself more depreciation buy selling a property using a 1031 exchange and purchasing a larger property or properties. The additional. Amount you purchase adds to your depreciable basis. Not quite as good as you were told but certainly a very good tool.
Your question is: If you 1031 exchange a fully depreciated rental property for what you originally paid for it and then acquire a replacement property for the same price, do you get to depreciate the new property for another 27.5 years?
The answer is NO. Just for emphasis, the answer is NO, you were misinformed. The adjusted basis for the relinquished property becomes the tax basis for the replacement property AND the relinquished property depreciation schedule continues for the replacement property until the depreciation basis is exhausted.
You cannot use a 1031 exchange to depreciate the same dollar of tax basis more than once.
Let's say you had $20K of adjusted depreciation basis and 9 years left on the relinquished property depreciation schedule. Let's call this OLD BASIS. If you trade up and acquire a more expensive property than the relinquished property, then the portion of the trade up value of the replacement property attributed to the dwelling structure is NEW BASIS and can be depreciated on a new 27.5 year depreciation schedule. In this exchange, the OLD BASIS in the replacement property is depreciated for the 9 years left on the old depreciation schedule. The NEW BASIS is depreciated on a new 27.5 year depreciation schedule.
An example. In a deferred 1031 exchange you sold the relinquished property for $100K and had $20K of depreciation basis and 9 years left on the depreciation schedule. Your replacement property cost is $150K with 20% of your purchase price attributed to the value of the land and 80% of the purchase price attributed to the dwelling structure. Even though you paid $30K more for the replacement property than you received from the sale of the relinquished property, only 80% of the $30K is attributed to the dwelling structure. This $24K is your NEW BASIS for depreciation that is depreciated for 27.5 years. The $20K of OLD BASIS is depreciated on the 9 years left on the old depreciation schedule. You have to run two separate depreciation schedules for the replacement property in this example.
Hope this answers the question.
@Dave Foster @Dave Toelkes @William Mejia
Can I ask for help? I am still confused and trying to develop an equation for my and other's benefit.
How to Calculate new Property Basis in 1031 Exchange for a SFR
(27.5 yr depreciation for SFR)
As an engineer, I like equations for a process.
Define terms:
Property sold (assume this was purchased w/o any 1031 Exchange)
P1 = Original Purchase price of property exchanged
TDP1 = Total Depreciable Improved Property = P1 – LV1
Where: LV1 = land value when purchased
DPY1 = TDP1 / 27.5 depreciation to be taken per year for SFH
TD1 = total depreciation taken = DPY1* X
Where X = years of depreciation taken
S1 = Net Sale = cash to QI
G1 = Net gain to be deferred = S1 – (B1+ LV1)
D1 = Debt paid off in sale
B1 = Basis of property sold = TDP1-TD1
=====================================
Property bought in 1031 Exchange w/o boot
Deferred Gain = G1
Deferred Depreciation Recapture = 0.25*TD1
======================================
1031 Requirements: P2 ≥ (S1) & D2 ≥ D1
======================================
P2 = Purchase price of property bought
AC2 = Additional Consideration = P2 – S1
TDP2 = P2 - LV2= Total Improved Property bought
LV2 = land value of property purchased
D2 = Debt assumed in new purchase
B2 = Calculated Basis of property purchased
So just:
B2 = B1 + AC2
And
DPY2 = DPY1 for the next Y years + DPY2+ for the next 27.5 years
Where Y = 27.5-X (for a SFH)
And DPY2+= AC2*(TDP2/P2)/27.5 for the next 27.5 years
Can we agree on this? If not please offer corrections.
Please define new variables if needed.
Help somebody!!