Depreciation after a 1031 Exchange; trading up, DST?
- Todd Phillips
- Aug 25
- 3 min read
Comprehensive Guide: Depreciating a DST in 1031 Exchanges
When replacing property through a 1031 exchange and choosing a Delaware Statutory Trust (DST) as the replacement property, depreciation plays a vital role in maximizing tax benefits. This guide delves into the two primary methods of depreciating a DST, particularly when the replacement property is worth more than the relinquished property (commonly referred to as a "trade-up").
1. Continuation of the Original Depreciation Schedule
How It Works
This method allows you to continue using the depreciation schedule of your relinquished property while applying a separate depreciation schedule to the "trade-up" portion.
Carryover Basis: The adjusted basis of the relinquished property continues to depreciate over its original remaining schedule.
Trade-Up Basis: Any additional value from the replacement property (the "trade-up" portion) starts on a new depreciation schedule.
Example
Relinquished Property: Original value of $1,000,000, with $500,000 of depreciation already taken (15 years into a 27.5-year schedule).
Replacement Property: Value of $1,500,000.
Depreciation Breakdown:
Carryover Basis:
$500,000 remaining basis continues to depreciate over the remaining 12.5 years.
Annual depreciation = $500,000 ÷ 12.5 years = $40,000 per year.
Trade-Up Basis:
$500,000 trade-up value (replacement property value minus relinquished property value) is depreciated over 27.5 years.
Annual depreciation = $500,000 ÷ 27.5 years = $18,182 per year.
Total Annual Depreciation: $40,000 + $18,182 = $58,182 per year.
Advantages
Maintains continuity with the relinquished property’s depreciation schedule.
Higher initial deductions due to the shorter schedule for the carryover basis.
Disadvantages
Flexibility is limited if the remaining depreciation schedule is short, as it may provide fewer total deductions.
Requires careful recordkeeping to track multiple schedules.
2. Starting Depreciation Anew
How It Works
This method treats the entire replacement property value as a new asset, allowing a fresh depreciation schedule to be applied.
Residential Property: Depreciated over 27.5 years.
Commercial Property: Depreciated over 39 years.
Example
Replacement Property: Value of $1,500,000.
Annual Depreciation: $1,500,000 ÷ 27.5 years = $54,545 per year.
Advantages
Simplifies recordkeeping by using a single, uniform depreciation schedule.
Spreads deductions evenly over a longer period, which may be beneficial for long-term holds.
Disadvantages
Offers lower initial depreciation deductions compared to continuing the original schedule, especially if the relinquished property was midway or late in its depreciation cycle.
3. Deciding Between the Two Methods
Selecting the best depreciation method depends on your specific tax and investment strategy.
Key Considerations
Tax Impact:
If higher immediate deductions are a priority, continuing the original schedule is typically advantageous.
If steady, predictable deductions over the long term are preferred, starting a new schedule may be better.
Holding Period:
For short- to mid-term holds, continuation offers faster depreciation.
For long-term holds, a new schedule provides smoother depreciation benefits over time.
Recordkeeping:
Continuing the original schedule requires tracking multiple schedules (carryover and trade-up basis).
Starting anew simplifies bookkeeping by consolidating depreciation into a single schedule.
Regulatory Compliance:
Ensure your chosen method complies with IRS rules. A tax professional can help determine the optimal strategy.
Trade-Up Allocation Rule
When the replacement property exceeds the relinquished property value, the IRS requires a precise allocation of basis:
Carryover Basis: Depreciation continues based on the adjusted value of the relinquished property.
Trade-Up Basis: Depreciation begins anew for the excess value (trade-up).