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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!
On top of that depreciation recapture is taxed as ordinary income. This means that any gain from the sale of the property, including the recaptured depreciation, is subject to capital gains tax. How long is investment real estate typically depreciated?
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.
It’s important to note that a 1031 exchange can be complex, and it’s important to consult with a tax professional and qualified intermediary to ensure that the exchange is conducted properly and in compliance with IRS guidelines.
It's important to note that a 1031 exchange can be complex, and it's important to consult with a tax professional and qualified intermediary to ensure that the exchange is conducted properly and in compliance with IRS guidelines.