Depreciation can be a confusing and difficult concept to understand. Individuals and businesses need to have a working knowledge of how to use depreciation to maximize their profits. More importantly, they need to understand the tax consequences of recaptured depreciation and how to effectively defer the tax in a 1031 tax deferred exchange.
A 1031 exchange allows taxpayers who own and lease equipment to replace their equipment with new equipment and defer the resulting recaptured depreciation tax. Large rental car companies use the Section 1031 Exchange tax deferral to update their fleets. In addition, a variety of companies lease, sell and replace their equipment through 1031 exchanges including construction, agriculture, communication, oil and gas drilling. Personal property held simultaneously for both sale and lease is under review by the Internal Revenue Service (IRS) for so called "dual-use."
Tags: recaptured depreciation
In the normal course of business, when you sell a property that has appreciated in value, the gain is subject to federal capital gains taxes according to the Internal Revenue Code as well as subject to state capital gains taxes pursuant to individual state tax laws. The sale of an asset may also be subject to depreciation recapture tax. Both of these potential tax obligations can be deferred if the transaction qualifies for a 1031 exchange.
Are you aware depreciation on real and personal property held as an investment or for use in a business can be deferred when sold in what is known as a 1031 tax deferred exchange? As long as real or personal property of equal or greater value is acquired within 180 calendar days of the sale, the depreciation is effectively deferred. The tax obligation does not go away, it is delayed or postponed until the replacement property is sold. At that time, another 1031 exchange can be initiated to defer the capital gains and recaptured depreciation.
In a call this week, a prospective client is considering initiating a 1031 exchange for a rental property that represents the replacement property of a prior 1031 exchange. We discussed the length of hold given Revenue Procedure 2008-16 two year hold requirement for rental properties and the value of the exchange. What is the tax that would be paid if an exchange is not initiated? This is one data point all exchangors should know and confirm with their CPA.
If you own investment or rental property, you must understand a 1031 exchange. First, investment property is different from a second home or vacation property used greater than 14 overnights per year. Second homes are not eligible for 1031 tax deferred treatment. Investment property like a condominium must be held for two years prior to the sale according to Revenue Procedure 2008-16.