IRC §168(i)(6) — Like-Kind Exchange Depreciation Rule

Where this comes from

A Section 1031 like-kind exchange lets you defer the gain on a property sale by rolling the proceeds into a replacement property. The tax code treats the replacement property as a continuation of the old one for many purposes. Depreciation is one of those purposes.

Section 168(i)(6) is the statutory hook that sends post-exchange depreciation to a specific Treasury Regulation, Treas. Reg. 1.168(i)-6. That regulation sets out the mechanics of how to compute depreciation when you acquired the property through an exchange rather than a straight purchase.

What it says

The key idea is that the replacement property's depreciable basis is split into two pieces. The exchanged basis is the amount that carries over from the relinquished property. It continues to depreciate on the old property's remaining schedule, as if the exchange never happened. The excess basis is anything you paid on top of that, such as boot or additional cash. It starts fresh on a new schedule, based on the replacement property's class and the year it was placed in service.

This two-pool approach reflects the general rule that an exchange is not a recognition event. You did not cash out the old property's accumulated depreciation, so the depreciation schedule follows the basis through the exchange.

How it shows up in a study

A cost segregation study on a property acquired through a 1031 exchange has to follow the two-pool structure. The study identifies all the personal property, land improvements, and building components in the usual way. But then it must allocate each component's cost between the exchanged basis pool and the excess basis pool.

The exchanged basis components continue on whatever depreciation schedule the old property was on, including the applicable class and method. The excess basis components get a fresh assignment based on what they are, typically the same class as the component would have if bought outright.

Skipping this step and treating the entire acquisition as a new purchase will produce incorrect depreciation deductions and creates risk on examination.

What it does not mean

Section 168(i)(6) does not change whether a component qualifies as personal property. That question is answered by the same Section 1245 analysis and case law that applies to any property. The section only addresses how depreciation is computed after the classification is done.

It also does not apply to the entire property value if you paid market price in an exchange. The exchanged basis is only the carryover amount from the relinquished property. If you paid significantly more than the old basis, the excess basis pool can be substantial, and the study's value on the new depreciation schedule is fully available for that portion.