Increase Depreciation Deductions
Both 1031 exchanges and depreciation reduce taxable income. This reduction is like an interest free loan of sorts from the government to the taxpayer.
However, what one hand gives the other takes away. Depreciation deductions are subject to complex rules that limit their usefulness. However, when used in conjunction with 1031 exchanges, depreciation can avoid the complex rules that limit their use.
Example: The sale of business assets results in taxable gain to a business.
- When the sale of business assets takes place in connection with the acquisition of assets, current depreciation rules permit a portion of the taxable gain to be offset by the depreciation deduction.
- More Taxable Income in Year of Sale. The amount of the depreciation deduction varies from a low of 2.5% to 33% of the taxable gain, leaving 97.5% to 65% in taxable gains. The company must borrow funds to offset the payment of taxes in order to purchase property.
- The value of depreciation deductions are less since depreciation deductions are taken over time. The net present value of depreciation deduction for a 5 year asset is 87.4%.
- Depreciation deductions taken are added back to income on later sale. For Section 1031, the gains can be deferred indefinitely. As the value of exchanged assets decrease, depreciation recapture is eliminated permanently.
- Higher taxable income and higher tax liabilities in 38 states because they do not accept bonus depreciation, resulting in at the state level. These taxes are avoided completely with a 1031 exchange.
- Tax benefits of depreciation are limited by excess tax losses or net operating losses.
- Valuable net operating losses and tax loss carry forwards are needlessly reduced by gains from asset sales. These reductions are avoided completely with a 1031 exchange.
- Alternative Minimum Taxes increase taxable income on owner’s tax returns by reducing equipment deductions; reduce net operating losses by 10% even in a loss year; and results in higher gain on the sale of assets with excess equipment depreciation.
- Continuous Multi Asset Exchanges (CMAES) can avoid these negative tax consequences, reduce taxes, interest, debt and taxes on operating income used to pay these items and productively reinvest all proceeds for the highest rate of return.