Let’s say that you’re a farmer. You own a piece of land. On that land is a chicken coop and maybe some other agricultural buildings. What can you do with real property improvements that helps your current tax situation?
You can’t depreciate land or dirt, but real property improvements can be depreciated so you can accelerate the depreciation on components that you own. You can use those accelerated deductions to offset your gains in other areas. If you’re a real estate professional, you might have almost unfettered ability to take those paper losses and use them against your other income.
Now when you go to sell your real estate, you really have two buckets of gain. You’ve got the land, and the long-lived improvements that are either depreciable (like dirt) or 39 years straight line (e.g. for a commercial building). But those components that can be rapidly depreciated are in a different bucket of gain called the “1245 gain.”
1245 trumps 1031. If you don’t offset and match up your 1245 gains with new 1245 real property components, you’re not going to be able to fully defer your gain. So if you’re going from a small agricultural hog building operation to a large hog building, you might be OK because you can match up your 1245 components with new 1245 property. Your gains can basically be moved over. And it doesn’t have to be identical properties. You don’t have to go from a hog building to a hog building. You just need to go from 1245 component to 1245 component. What that might necessitate though is thinking ahead and conducting a cost-segregation study on your replacement property to see what components are there and to make sure you have sufficient components to offset your 1245 gains.
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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