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Answer by Kristy M. W.

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Hi Henry,

This sounds messy.

I’ve seen this happen when a client has bounced from one tax professional to another through the years. Without continuity, or the benefit of prior year’s returns, an inexperienced professional could make this mistake easily.

On the face of it, it does appear that a recapture is in order as ordinary income, but when you dig a little deeper, you find otherwise.

With that being said, I would have to commend you on recognizing that this in fact is/was a like-kind exchange, and that this changes the rules as to how the recapture is taken into account. In this case, it affects the adjusted basis of the replacement property because there was no boot (sales proceeds or other property that was not “like-kind”).

A vehicle can be like-kind property. The IRS specifically states that: “Properties are of like kind if they are of the same nature or character, even if they differ in grade or quality. Personal properties of a like class are like-kind properties.”

Further, that: “Section 1031(a) provides that no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment (relinquished property) if the property is exchanged solely for property of like kind (replacement property) that is to be held either for productive use in a trade or business or for investment. Under § 1031(b), if a taxpayer also receives cash or property that is not like-kind property (boot) in an exchange that otherwise qualifies under § 1031(a), the taxpayer must recognize gain to the extent of the boot.”

Please also see IRC § 1245. Gain from dispositions of certain depreciable property. You will find like-kind exchanges under exceptions and limitations.

To keep things clean moving forward, I would compute the basis of the replacement vehicle for the purpose of depreciation as follows:

  1. Cost of Old Vehicle – (minus) Depreciation Claimed = Adjusted Basis

  2. Adjusted Basis of Old Vehicle + (plus) Additional Cash Paid for Replacement Vehicle

  3. Sum of No.2 – (minus) the difference between... Depreciation Claimed and the Depreciation Allowable

This will have the effect of reducing the basis of the replacement vehicle by the amount of excess depreciation.

I hope this helps!


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