8669 / When might a taxpayer want to avoid like-kind exchange treatment?

There are many reasons why a taxpayer may wish to recognize gain in the current year rather than deferring it until some point in the future. For example, a taxpayer may wish to recognize gain in order to obtain a higher basis in the property for depreciation purposes.

Example: Asher owns a warehouse with a fair market value of $200,000 and a basis of $40,000. A like-kind exchange of the warehouse for an office building of equal value will result in Asher having a carryover basis of $40,000 in the office building. If the exchange did not qualify as a like-kind exchange, Asher would recognize a gain of $160,000 ($200,000 minus $40,000). However, due to the recognition of gain, Asher’s basis in the office building would increase to $200,000. Thus, with a higher basis, Asher would be entitled to greater depreciation deductions.

Additionally, if the taxpayer has a substantial amount of capital loss, a recognized gain would be offset by such loss (see Q 8633). Current recognition of gain can also be advantageous if the taxpayer’s current income tax rate is expected to rise in the future. See Q 8605 for a discussion of the current capital gains rates and their interaction with a taxpayer’s income tax rates.

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Planning Point: For taxpayers who anticipate that their capital gains rate will increase (perhaps from the current low of 0 percent to as much as 23.8 percent (when the investment income tax (see Q 8605 and Q 8628) is applied), deferring capital gains in a nontaxable exchange could actually cause their tax liability to increase. In 2013 and beyond, the long-term capital gains tax rate is 20 percent for high income taxpayers, or 0 percent or 15 percent for taxpayers with lower income levels.

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