I sold a rental unit in 2016 that I had been renting out for about twenty years. It had pretty much tripled in value during that time. Also, I had already depreciated it down to a very small basis.
I replaced it with a similar, slightly more expensive property using a 1031 Tax-Free exchange. I only had to put up a small amount of cash to make up the difference in purchase price over the sale price of the old property.
Now, I’m doing my taxes in TurboTax, and I’m getting an unexpected result. TurboTax is calculating my depreciation schedule according to the full purchase price of the new property. I had expected it to only allow me to depreciate the remaining basis of the old property, plus the increase in price of the new property as compared to the old one.
So my question is: am I doing something wrong in TurboTax to get this much higher depreciation? Or is this how it is supposed to be? It feels somehow like double-dipping to me.
Thanks to anyone who can help!
My best guess is that you input the data incorrectly. It’s also possible that Turbo Tax is wrong. Obviously you can only depreciate up to the basis of the property. However, 1031 exchanges introduce some difficulties with depreciating the new property, ones that I would probably need a half-hour of reading to be absolutely sure about. I think you’re supposed to continue the depreciation schedule of the old asset, and separately depreciate the basis you acquired by paying boot.
I would recommend that if you can’t get Turbo Tax to handle it in a way that makes sense to you, go to a professional. They may not know off the top of their head any better than you, but they should know their software well enough to input the data correctly and have access to better research resources regarding tax law than what is available publicly.
Thanks for the reply!
After some digging and a bit of hair-tearing, I found a site with a relatively understandable explanation:
Apparently the new basis is not the purchase price, but rather is the purchase price reduced by the “realized gain” from the relinquished property. Where the “realized gain” is the money you would have paid taxes on if you weren’t doing the exchange in the first place.
Depreciation must be split into two chunks: the “exchanged basis” (the basis of the relinquished property at the time of the sale) is depreciated according to the remaining schedule from the relinquished property, and the “excess basis” (the rest of the basis, due to the higher priced new property) must be depreciated according to a new schedule, 27.5 years for residential property.
Now I just have to figure out how to make TurboTax do that!