Depreciation under Section 1031 Exchange

[7012simon]

Under Section 1031 Exchange, a residential rental property was sold at net amount of $900,000 (after deducting commission and fees) with cost basis of $500,000 and 5 years accumulated depreciation of $90,909.  A replacement residential property has been purchased at $900,000 including land value of $300,000.

Please advise how do I claim annual depreciation in coming years. Can I continue to use the cost basis of $500,000 of the relinquished property claiming annual depreciation for the remaining 22.5 years OR I have to use the replacement property cost of $600,000 ($900,000- $300.000 cost of land) claiming annual depreciation for 27.5 years.

Thank you.

[MaryK4]

The new cost basis that is used to determine the amount you can depreciate after you complete a 1031 exchange is generally composed of 1) the remaining depreciation on the property you sold, and 2) new basis in the property that you acquire.  You use the 27.5 years.

[7012simon]

Thank you for the information.  After completing 1031 Exchange transaction, in my example, in coming years, can I claim annual depreciation of $18,181 (cost basis of $500,000 of the relinquished property) for the remaining 22.5 years OR I can only claim annual depreciation of $21,818 (cost basis of $600,000 of the replacement property) for 27.5 years?

Thank you.

[RobertB4444]

Weirdly, neither of those.  Hold on to your hat.

First, the basis of the property you exchanged transfers over.  So that remaining basis of $409,091 transfers to the new property.  

Second, you take the purchase price of the new property and subtract the original purchase price of the property you exchanged (in this case that is $600,000 minus the $500,000 you paid for the original building) and add that to the basis that transferred for a total of $509,091 to be depreciated over 27.5 years.

@7012simon 

[7012simon]

Thank you for the answer.  Do I need to file IRS Form 4562 along with my tax return?

[RobertB4444]

If it is necessary, then the system will add it to your return.

@7012simon