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DEPRECIATION AND 1031 EXCHANGES: WHAT YOU NEED TO KNOW?

During a 1031 exchange, the accumulated depreciation recapture tax is deferred. In other words, if you were to sell your investment property without doing a 1031 exchange you would have to pay 25% of the depreciation you have taken over the lifetime of depreciating the asset! This means that any gain from the sale of the property is subject to capital gains but if that wasn’t already enough add in 25% of the total depreciation as tip for the IRS.

Completing a 1031 exchange allows you to defer paying capital gains tax on the sale of the relinquished property and continue to defer the recapture of depreciation as well. The basis of the replacement property is adjusted by the amount of deferred gain and recaptured depreciation from the relinquished property. The depreciation schedule for the replacement property will start anew based on its adjusted basis, which includes the deferred gain and recaptured depreciation from the relinquished property.

This means that you can continue to take depreciation on the replacement property, but it will be based on its new adjusted basis. If you are out of depreciation, you can gain new depreciation through buying a property of greater value. It’s important to note that if you eventually sell the replacement property without completing another 1031 exchange, you will need to recapture the deferred gain and recaptured depreciation from the relinquished property.

The information contained herein is given as general information and informal strategy and should not to be construed as a legal opinion or tax advice. Each exchangor has the responsibility to seek legal and/or tax advice from their tax and legal advisors to ensure the tax benefits anticipated in the exchange.