CAN I START DEPRECIATION ALL OVER AGAIN?

Depreciation of the improvements (now called Cost Recovery) is an accounting process required by the Internal Revenue Code.

Cost Recovery applies only to the improved portion of the real estate package. Upon acquisition of real estate the taxpayer is required to allocate the purchase price between the land, the improvements and the personal property (if any) acquired with the real estate. The portion of the price paid for the real estate that is allocated to the improvement is then applied to the cost recovery tables to determine the proper amount to deduct from the income of the property for that year. This is roughly the allocated value divided by 27 ½ years for residential property and 39 years for commercial property. Personal property has different useful life periods over which its cost is recovered depending on the type of personal property. In determining what is a proper, allocation of value, the courts will consider all the facts and circumstances, including the good faith of the taxpayer! The IRS rarely considers real property tax assessor’s records to be a valid allocation of value.

• Tax basis¹ is increased by acquisition costs and by capital improvements. It is decreased by cost recovery and by partial sales.
• The basis in replacement property acquired in a Section 1031 exchange is calculated on an Internal Revenue Form 8824, which must be filed for the tax year in which the relinquished property is transferred.
• To figure the approximate tax basis in the replacement property subtract any gain upon which tax would have had to be paid from the purchase price of the replacement property, add any net increase in the amount of mortgage on the replacement property, add any cash paid, whether to balance equities or to pay transaction costs.
• The substitute basis (new basis in the replacement property) is what must be allocated between land, improvement and personal property. The amount allocated to the improvements will be used to calculate the new amount of cost recovery to be taken annually.

¹ A number given an asset for tax purposes