Recapturing 1031 Depreciation....

How Do I Recapture 1031 Depreciation...?

There are two general types of 1031 exchanges: one for Real Estate (including things that the IRS says are equivalent to real estate, such as oil & gas, mineral rights, air rights, etc.), and the other for Personal Property (things like cattle, aircraft, vehicles, things that move, etc.). One of the big challenges between these is that while the definition of like-kind Real Estate is applied very broadly, the definition of like-kind Personal Property is applied very narrowly. If you sell a horse, you have to exchange into another horse. And generally speaking, of the same sex and breed. A horse is not just a horse…!

But don’t vehicles or equipment go DOWN in value? If there’s no gain (assuming we're not talking about a collector’s item), why would someone want to do a 1031 exchange on the sale? Because an exchange defers the long-term capital gain and saves you from having to pay the taxes.

The reason to do exchanges on equipment or a vehicle – even though the sales price does not produce a gain – is because there is depreciation on it. If you don’t do a 1031 exchange, you have to pay the recapture of depreciation tax at 25%. Whether depreciation was actually taken or not, the IRS is going to impute that you DID – and you’ll have to pay tax on the recapture of that depreciation – unless you do a 1031 exchange.

If you do an exchange, all the gain—including the depreciation recapture—is deferred or rolled over into the ‘new’ property.

One more point about this depreciation recapture tax: this is true for real estate as well as personal property! The formal name for depreciation on real estate is Section 1250 Gain, and for personal property it’s Section 1245 Gain.

This is a very complex subject, so always consult with your accountant or tax advisor.

--The Experts