s.1250 recapture - 1031 exchange

[Snaggletooth]

If a building is exchanged under 1031, does the accompanying s. 1250 recapture go away?

Example; TP owns building $500,000 original value with $230,000 depreciation taken - adjusted basis thus is $270,000. Exchanges it tax free for another building with no cash. Is the new basis $500,000 with $230,000 latent recapture, or is the new basis simply $270,000 with no latent depreciation recapture?

[Lion]

TTB has a Section 1031 Basis Worksheet and a filled-in example (using TTB WebLibrary, it's page 9-5, but that might be in the Depreciation book.

Here's what TaxBert says:

Yes, there is a worksheet for calculating the basis of new property in a like-kind exchange.

Basis Calculation Formula:
The basis of property received in a like-kind exchange is calculated as [1]:

The basis of the property transferred, plus
Any additional costs incurred, plus
Any gain recognized on the exchange, minus
Any money received, minus
Any loss recognized on the exchange

This basis should be allocated first to any unlike property (other than money) up to its fair market value on the date of the exchange. The remainder becomes the basis of the like-kind property [1].

Simplified Worksheet:
There is also a simplified worksheet in the Depreciation book that shows the basis consists of two parts [2]:

Carryover basis: The remaining adjusted basis of the original property
Depreciable excess basis: The amount by which your basis in the replacement property exceeds the basis in the relinquished property (which may include cash and boot)

You can find these worksheets in TheTaxBook Federal 2025 at page 6-19 and in the Depreciation book at page 9-1.

WebLibrary Citations
[1] - Deluxe Plus & Supplement - Investment Income, B, D, 4797 - (Page 6-19)
[2] - Depreciation - Like-Kind Exchanges and Involuntary Conversions - (Page 9-1)

Related Topics
- Deluxe Plus & Supplement - Real Estate and Rental Activities - (Page 40-14)
- Deluxe Plus & Supplement - Depreciation, 4562 - (Page 9-18)

[Rapid Robert]

When you talk about "latent depreciation recapture", I think you might be confusing this with "nonrecaptured section 1231 losses [which] are your net section 1231 losses of the previous 5 years that have not been applied against a net section 1231 gain."

Maybe not; but then, why are you talking about something "going away"? Sec. 1250 gain only comes into play when there is recognized gain; and in your example there is no recognized gain.

Not to mention that unrecaptured Sec 1250 gain does not involve recapture of anything. Essentially all 1250 gain these days is unrecaptured, so I normally just drop that word since it adds nothing to the meaning.

[Snaggletooth]

I appreciate the response from two of our most learned members, but I don't think I was successful portraying the real impact of the question. Please allow me to augment my example:

TP owns building "A" $500,000 original value with $230,000 depreciation taken - adjusted basis thus is $270,000. Exchanges it tax free for another building "B" with no cash. $500,000 with $230,000 latent recapture, or is the new basis simply $270,000 with no latent depreciation recapture?

Then a couple years later, the taxpayer sells building "B" for $600,000 The gain is $330,000 but how is it reported?

1. Proceeds $600,000, LTCG of $33,000. No recapture.
2. Proceeds $600,000, s.1250 recapture of $270,000 LTCG only $100,000.

Thanks in advance for comments.

[Lion]

Did you work through the Basis Calculation Formula for your example? Or, the Simplified Worksheet?

[TaxGuyBill]

You are missing some things in your example, but the answer you are looking for is that the depreciation from the previous property WILL be classified as Unrecaptured Section 1250 Gain when the second property is sold.

[Rapid Robert]

Straight-line depreciation is not recaptured, and there is nothing "latent" about it.

It's like this: Capital Gain is generally calculated as gross proceeds net of sales expense, minus adjusted basis. Some of that gain may be treated as Sec 1250 gain (special tax rate), if it was due to a downward basis adjustment (increased gain) caused by depreciation allowed or allowable.

A 1031 exchange does not affect prior basis adjustments that were due to depreciation allowed or allowable, so it does not affect the amount of Sec. 1250 gain.

That answers your question in a general way.

[Rapid Robert]

Neither of your options is correct. See #3.

HOW IS IT REPORTED:

1. Proceeds $600,000, LTCG of $33,000. No recapture.
2. Proceeds $600,000, s.1250 recapture of $270,000 LTCG only $100,000.

3. Proceeds $600K, Long Term Capital Gain $330K (*). Of that gain, $230K gets its own Sec. 1250 tax calculation on Schedule D, the rest of the gain is taxed according to "normal" capital gain rules on Schedule D.

Correct answer is #3.


(*) does not include ongoing depreciation of Building B, as TaxGuyBill noted was missing

[Snaggletooth]

RR You did hit the nail on the head. Thanks. The specific answer is unrecaptured 1250 gains cannot be avoided by doing a 1031 exchange.