recapture in a like-kind exchange
When I sell one of my rental condos, how will recapture
of the depreciated value be addressed if I use a 1031 like-kind tax
exchange to buy a replacement property? Thanks for your help. -- Deborah
Just as you will defer the tax on the sale of
the property, you'll also defer the recapture of the accumulated
depreciation in most cases. A section 1031 exchange allows the seller
to defer tax on the gain from the sale of the property if he or
she purchases replacement property of a like kind. The sale has
to occur in escrow and the identification and closing of the replacement
property have to meet strict time limits.
The gain is deferred by reducing the cost basis of
the replacement property. The reduction is equal to the amount of
the gain that was realized on the sale. For example, if condo No.
1 had a cost of $100,000 and accumulated depreciation of $10,000
and it sold for $120,000 in the exchange, $30,000 in gain was realized.
This $30,000 gain is not recognized but instead reduces the cost
basis of the replacement property. Upon a later sale, tax would
be paid on this deferred gain.
Since depreciation recapture increases the amount
of gain realized on the sale, this additional gain gets rolled into
the cost of the replacement property but maintains its character
upon a later sale. The reason that it maintains its character is
that recapture is taxed at a higher rate: 28 percent versus 15 percent.
For example, if you claimed $10,000 in depreciation on condo No.
1 and $5,000 on the replacement condo, the first $15,000 in gain
on the eventual sale of the replacement condo would be taxed at
One type of depreciation recapture that is not
eligible for rollover in a like-kind exchange is the amount that
would be treated as ordinary income if the relinquished property
were sold. In the context of real estate, this exception would apply
mainly to commercial real estate depreciated using an accelerated
depreciation method that applied to property prior to 1987. As a
condominium is generally residential real estate, your depreciation
would roll over into the replacement property.