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I've recently come across Internal Revenue Code section 1031, which as I understand it allows me to postpone paying taxes on income from the sale of an investment property, so long as I purchase a similar investment property of equal or greater value within 180 days.

From wikipedia, this specific section stuck out to me (emphasis mine):

This would result in a gain of $50,000, on which the investor would typically have to pay three types of taxes: a federal capital gains tax, a state capital gains tax and a depreciation recapture tax based on the depreciation he or she has taken on the property since the investor purchased the property. If the investor invests the proceeds from the $250,000 sale into another property or properties (without touching the proceeds and using a Qualified Intermediary), then he would not have to pay any taxes on the gain at that time.

But when I purchase a new investment property with the money from the sale of the old investment property, wouldn't that new property begin its depreciation schedule anew, allowing me to once-again depreciate that property against my income for the next 27.5 years?

If so, that means that I'm getting the benefit of depreciation again. Would that mean I could then sell (exchange) the second property for a third, once-again resetting the depreciation schedule on a new property?

If not, can someone explain the reason why not?

I'm expecting that this isn't possible as it seems too good to be true, but I can't find any details explaining why it's not possible.

  • Is this for your primary residence? – RonJohn Jun 20 at 18:45
  • Nope, for rental properties, I will edit the question to clarify. – Victor Chelaru Jun 20 at 18:45
  • I figured that, but just wanted to verify. – RonJohn Jun 20 at 18:46
  • I am not a real estate investor, but from what I was able to google e.g. efirstbank1031.com/2accountantsInfo/…, you do get to defer the depreciation capture. I think it's saying that the new property gets its own depreciation schedule. Nothing is "reset"; the two depreciation amounts are tracked separately. The rolled depreciation amount stays as-is with no further changes. If and when you cash out, or 1031 the property for one that can't be depreciated (e.g. land), at that time you have to pay for all the unrecaptured depreciation. – stannius Jun 20 at 20:33
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As you say, you do get to "restart" your depreciation schedule on the new property, however, your depreciable basis from the first property follows you to the next. I'm not an accountant, so caveat emptor, but my understanding is as follows:

If you buy property 1 for $50,000, own it for a few years, and during that time you deducted $10,000 of depreciation, your new taxable basis on the property is $40,000 (50k-10k).

If you sell it for $75k without doing a 1031 exchange, you owe taxes on your gain - the difference between your sale price, and the adjusted tax basis. So your taxable gain would be $75k-$40k -> $35k. Assuming a 15% capital gains rate, you'd owe $5,250 in gains taxes.

If instead you do a 1031 exchange and buy a new property, you pay no taxes immediately, but your tax basis on the new property starts at your previous property's tax basis of $40k.

So when you eventually sell outside of a 1031 exchange, your tax bill will account for all of the gains from the entire chain of properties. You don't avoid the taxes, but can defer them, possibly for a very long time.

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