Depreciation recapture on 1031 exchange

[Garrett8]

If I exchange a property ($1,000,000 improvements/$600,000 land) with a total of 150,000 of accumulated depreciation deductions for a new property ($200,000 improvements/$3,000,000 land) will I have to pay depreciation recapture?  I can defer capital gains as I am stepping up in total ($1.6M to $3.2M) but it is difficult to understand whether the depreciation recapture can also be deferred since I am going down from $36K annual depreciation to $7.2K annually. I want to elect out of the 2 step method for simplicity. Reg 1.168(i)-6(i) 

[KrisD15]

You have the option of continuing the depreciation (deferring depreciation recapture) on 1.6 with at least 150,000 of the improvements, and placing the remaining 1.6 as "in service"  as of the exchange date, therefore starting the depreciation on that portion at that time (with no more than 50,000 improvement) 

If you are electing out of Reg. § 1.168(i)-6(i)(1), you will recognize the 150,000 accumulated depreciation as Tax Year 2023 Ordinary Income, and place the property in service with the full 3.2 basis (200,000 improvement) 

You would need to be creative to enter this scenario into the TurboTax program. 

In order to claim the depreciation in 2023, report in TurboTax that it was sold for the same price as the unadjusted basis. 

All the depreciation will be recaptured as ordinary income. 

Enter the new property at full (3.4) basis no prior depreciation. 

You would also need to attach a statement stating "Election made under Regs. Sec. 1.168(i)-6(i)," and a description of the "disposed" property. 

Reg. § 1.168(i)-6(i)(1)

[Garrett8]

Thank you for the answer!  However it flew right over my head.  The depreciation taken on the relinquished property lowers the cost basis of that property which in turn lowers the cost basis of the replacement property therefore it seems like double taxation if required to continue depreciating that property (method 1), or alternatively pay recapture tax if I elect to opt out of Reg 1.168(i)-6(i) ?   Turbotax tells me to subtract depreciation from the cost basis.  Does Turbotax not calculate all this automatically? 

[DianeW777]

It depends.  It's not double taxation when you buy up and use the 1031 exchange keeping your original asset depreciation in place as part of the new property. 

@KrisD15 was explaining the steps to use Option 2, Simplified Method. It seems to me by carrying the exchanged property over as part of the new property and then adding any buy-up as a new asset would be easiest and allow you to defer any tax on recapture because you did buy up.  I will provide a bit more detail and the steps to complete this exchange in TurboTax if you choose to stick with Option 1. This allows you to postpone any taxable depreciation recapture because you did buy-up.

The following guidance is how you enter a 1031 exchange in TurboTax and will provide guidance for the current and new assets for depreciation.

Depreciation Rules:

The basic concept of a 1031 exchange is that the basis of your Old Property rolls over to your New Property. In other words, if you sold your Old Property for $100,000, and bought your New Property for the same, your basis on the New Property would be the same. It makes sense then that your depreciation schedule would be exactly the same, and does not change! In other words, you continue your depreciation calculations as if you still own the Old Property (your acquisition date, cost, previous depreciation taken, and remaining un-depreciated basis remain the same).

If you "bought-up" in your exchange (your New Property cost more than you sold your Old Property), the answer is easy – you treat the buy up part as you would a new addition to an existing property. In other words, you treat the amount of the buy-up the same as you would the cost of construction, for example, of a garage added to an existing house – the cost is the amount of the buy-up; the date you start depreciating it is the date you purchased the new property; and the depreciation method you use is the method most appropriate for that type of property in the year you bought the New Property (regardless of the method you used for the original house). If you think of it this way, then it's easy, even if your property is a large office building or a more complex purchase.

• Where do you enter a like-kind  or Section 1031 exchange?
• IRS Fact Sheet for Section 1031 Exchange
• IRS Instructions for Form 8824

When you have your TurboTax return open you can use the following steps to update the original assets for the exchange.

1. First use the Search (upper right) > Type rentals (or schedule c)  > Press enter > Click on the Jump to... link
2. Or Wages & Income > Rental Properties and Royalties/Self employment  > Update > Continue to Rental and Royalty Summary or Self employment > Edit the property
3. Scroll to Assets/Depreciation  > Click Update > Select 'Edit' next to each asset
4. Edit beside each asset > Continue to the Tell Us About This Rental Asset
5. Select the checkbox beside 'This item was sold, retired, .... traded in ....etc. > enter the date it was traded (sold/retired)
   1. You can choose not to select this and just change the name of the assets given up in the trade to identify them with the new property. The depreciation for the year will not change on these assets.
6. Answer the question about whether it was 100% business > Leave the original date it was placed in service (may be purchase date or later depending on your circumstances)
7. Continue to the screen 'Confirm Your Prior Depreciation'  
   • The amount displayed is only for prior years and does not include the current year. 
   • Continue until you see the current year amount displayed and make a note to add the two amounts together for the Section 1031 like kind exchange.
   • This completes the asset portion of the trade.
8. Answer 'Yes' to Special Handling. 

[DianeW777]

It depends.  It's not double taxation when you buy up and use the 1031 exchange keeping your original asset depreciation in place as part of the new property. 

@KrisD15 was explaining the steps to use Option 2, Simplified Method. It seems to me by carrying the exchanged property over as part of the new property and then adding any buy-up as a new asset would be easiest and allow you to defer any tax on recapture because you did buy up.  I will provide a bit more detail and the steps to complete this exchange in TurboTax if you choose to stick with Option 1. This allows you to postpone any taxable depreciation recapture because you did buy-up.

The following guidance is how you enter a 1031 exchange in TurboTax and will provide guidance for the current and new assets for depreciation.

Depreciation Rules:

The basic concept of a 1031 exchange is that the basis of your Old Property rolls over to your New Property. In other words, if you sold your Old Property for $100,000, and bought your New Property for the same, your basis on the New Property would be the same. It makes sense then that your depreciation schedule would be exactly the same, and does not change! In other words, you continue your depreciation calculations as if you still own the Old Property (your acquisition date, cost, previous depreciation taken, and remaining un-depreciated basis remain the same).

If you "bought-up" in your exchange (your New Property cost more than you sold your Old Property), the answer is easy – you treat the buy up part as you would a new addition to an existing property. In other words, you treat the amount of the buy-up the same as you would the cost of construction, for example, of a garage added to an existing house – the cost is the amount of the buy-up; the date you start depreciating it is the date you purchased the new property; and the depreciation method you use is the method most appropriate for that type of property in the year you bought the New Property (regardless of the method you used for the original house). If you think of it this way, then it's easy, even if your property is a large office building or a more complex purchase.

• Where do you enter a like-kind  or Section 1031 exchange?
• IRS Fact Sheet for Section 1031 Exchange
• IRS Instructions for Form 8824

When you have your TurboTax return open you can use the following steps to update the original assets for the exchange.

1. First use the Search (upper right) > Type rentals (or schedule c)  > Press enter > Click on the Jump to... link
2. Or Wages & Income > Rental Properties and Royalties/Self employment  > Update > Continue to Rental and Royalty Summary or Self employment > Edit the property
3. Scroll to Assets/Depreciation  > Click Update > Select 'Edit' next to each asset
4. Edit beside each asset > Continue to the Tell Us About This Rental Asset
5. Select the checkbox beside 'This item was sold, retired, .... traded in ....etc. > enter the date it was traded (sold/retired)
   1. You can choose not to select this and just change the name of the assets given up in the trade to identify them with the new property. The depreciation for the year will not change on these assets.
6. Answer the question about whether it was 100% business > Leave the original date it was placed in service (may be purchase date or later depending on your circumstances)
7. Continue to the screen 'Confirm Your Prior Depreciation'  
   • The amount displayed is only for prior years and does not include the current year. 
   • Continue until you see the current year amount displayed and make a note to add the two amounts together for the Section 1031 like kind exchange.
   • This completes the asset portion of the trade.
8. Answer 'Yes' to Special Handling. 

Next you will complete the like kind exchange, Form 8824 (Section 1031 exchange):

1. Use the Search (upper right) > Type like kind > Press enter > Click on the Jump to... link
2. Select the checkbox beside 'Any additional like-kind exchanges (section 1031)' > Continue
3. Complete the information for the 'Real estate given up'  and 'Like-Kind Property Given Up' > Continue
4. Name the event > Continue > Complete the information for the 'Like-kind property received'
5. If you did not give unlike property in the exchange click 'No' and  continue past these screens, if 'Yes' answer the questions.
6. Enter any exchange expenses (sales expenses) > Continue to see your deferred gain.

If you marked the original assets as sold, traded, etc (see 6. above) then go back to your rental activity and then enter new assets with the exact same information as the property given up with a new name, but with the same date placed in service as the old property, for all assets that are part of the exchange.

Enter a new asset for any buy up/added cash in the exchange including the purchase/selling expenses you paid in the trade. The new asset will begin depreciation on the completion date of the trade/like kind exchange.

[Edited: 03/09/2024 | 11:06 PM PST\

[Panthers71]

I recently completed a 1031 exchange and deferred my rental property capital gains and depreciation recapture. However my CPA said I still needed to pay depreciation recapture taxes on the depreciated fixed assets in the the rental house that went to the buyer at no additional cost since I did a 1031 exchange.   Is that correct ?   Thank you !

[nick616]

This is such a miserable process...I decided to make a youtube video after spending ~3 hours with two separate turbotax experts on the phone.

https://youtu.be/8c1TJpmParg