Section 167 allows as a depreciation deduction a reasonable allowance for the exhaustion, wear, and tear of property used in a trade or business or held for the production of income. The depreciation allowable for depreciable tangible property placed in service after 1986 generally is determined under section 168 (MACRS property). Under section 1031(a)(1), no gain or loss is recognized on an exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of like kind that is to be held either for productive use in a trade or business or for investment. Section 1031(b) provides that if an exchange would be within the provision of section 1031(a) were it not for the fact that the property received in the exchange consists not only of property permitted to be received in such an exchange, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property. Under section 1031(c), no loss from such a transaction is recognized. Under section 1031(d), the basis of property acquired in an exchange described in section 1031 is the same as that of the property exchanged, decreased by the amount of any money received by the taxpayer and increased by the amount of gain (or decreased by the amount of loss) that was recognized on such exchange.

Section 1033(a)(1) provides that if property (as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof) is compulsorily or involuntarily converted into property similar or related in service or use to the property so converted, no gain is recognized. Under section 1033(b)(1), the basis of property acquired by the taxpayer in such a transaction is the basis of the converted property. Under section 1033(a)(2)(A), if property is compulsorily or involuntarily converted into money or into property not similar or related in service or use to the converted property, and, within the time frame described in section 1033(a)(2)(B), the taxpayer purchases property that is related in service or use to the converted property or purchases stock in the acquisition of control of a corporation owning such property, then the taxpayer may elect to recognize gain only to the extent that the amount realized upon such conversion exceeds the cost of such other property. Under section 1033(b)(2), if such an election is made, the basis of the replacement property acquired by the taxpayer generally is the cost of that property decreased by any gain not recognized by reason of section 1033(a)(2).

The IRS became aware of inconsistent depreciation treatment by taxpayers of property that has a basis determined under section 1031(d) or section 1033(b) (replacement property). Certain taxpayers were depreciating the replacement property using the same depreciation method, recovery period, and convention as the exchanged or involuntarily converted property (relinquished property) while other taxpayers were depreciating the replacement property as if it were newly placed in service.

In response, the IRS and Treasury issued Notice 2000-4, 2000-1 C.B. 313, published January 18, 2000. Notice 2000-4 instructed taxpayers how to depreciate MACRS property that has a basis determined under section 1031(d) or section 1033(b) (replacement MACRS property), provided that the exchanged or involuntarily converted property was also MACRS property (relinquished MACRS property). The notice stated that replacement MACRS property placed in service after January 3, 2000, is depreciated over the remaining recovery period of, and using the same depreciation method and convention as, the relinquished MACRS property and that any excess of the basis in the replacement MACRS property over the adjusted basis in the relinquished MACRS property is treated as newly purchased MACRS property. Notice 2000-4 also stated that the IRS and Treasury intended to issue regulations to address these transactions. Public comments on the nature and scope of these temporary regulations were requested.

The temporary regulations instruct taxpayers how to determine the annual depreciation allowance under section 168 for replacement MACRS property. Generally, MACRS property, which is defined in §1.168(b)-1T(a)(2), is tangible property of a character subject to the allowance for depreciation provided in section 167(a) that is placed in service after December 31, 1986, and subject to section 168. The temporary regulations also apply to a transaction to which section 1031(a), (b), or (c) applies (like-kind exchange) or a transaction in which gain or loss is not recognized pursuant to section 1033 (involuntary conversion) involving MACRS property that is replaced with other MACRS property in a transaction between members of the same affiliated group.

Property acquired in a like-kind exchange or involuntary conversion to replace property whose depreciation allowance is computed under a depreciation system other than MACRS, or to replace property for which a taxpayer made a valid election under section 168(f)(1) to exclude it from the application of section 168 (MACRS), is not within the scope of the temporary regulations. Additionally, this regulation does not provide guidance for a taxpayer acquiring property in an exchange for property that the taxpayer depreciated under the Accelerated Cost Recovery System (ACRS) or for a taxpayer acquiring an automobile for another automobile for which the taxpayer used the Standard Mileage Rate method of deducting expenses. Comments are requested on the depreciation treatment of like-kind exchange or involuntary conversion transactions described above and whether the depreciation treatment of these transactions should fall within the scope of this regulation.

The depreciation treatment used by previous owners in determining depreciation allowances for the replacement MACRS property is not relevant. For example, a taxpayer exchanging MACRS property for property that was depreciated under ACRS by the person relinquishing the property may use this regulation (because the acquired property will become MACRS property in the hands of the acquiring taxpayer). In addition, elections made by previous owners in determining depreciation allowances of the replacement MACRS property have no effect on the acquiring taxpayer. For example, a taxpayer exchanging MACRS property that the taxpayer depreciates under the general depreciation system for other MACRS property that the previous owner elected to depreciate under the alternative depreciation system pursuant to section 168(g)(7) does not have to continue using the alternative depreciation system for the replacement MACRS property.

Finally, the IRS has learned that some taxpayers question whether Notice 2000-4 allows depreciation of land, if the land is acquired in a like-kind exchange or involuntary conversion for MACRS property. As explained in further detail below, neither the temporary regulations nor Notice 2000-4 allow taxpayers to depreciate land or other nondepreciable property.

The temporary regulations provide rules for determining the applicable recovery period, depreciation method, and convention used to determine the depreciation allowances for the replacement MACRS property with respect to so much of the taxpayer’s basis (as determined under section 1031(d) and the regulations under section 1031(d) or section 1033(b) and the regulations under section 1033(b)) in the replacement MACRS property as does not exceed the taxpayer’s adjusted depreciable basis in the relinquished MACRS property (exchanged basis). In general, the exchanged basis is depreciated over the remaining recovery period of, and using the depreciation method and convention of, the relinquished MACRS property (general rule).

This general rule applies if the replacement MACRS property has the same or a shorter recovery period or the same or a more accelerated depreciation method than the relinquished MACRS property. Under certain circumstances, this rule could adversely affect taxpayers engaging in like-kind exchanges or involuntary conversions. For example, under the general rule, a taxpayer must depreciate replacement MACRS property with a shorter recovery period over the longer recovery period of the relinquished MACRS property even if the taxpayer could depreciate the replacement MACRS property over a shorter recovery period by treating such property as newly acquired MACRS property. Accordingly, the temporary regulations provide an election not to apply the temporary regulations and to treat the replacement MACRS property as MACRS property placed in service by the acquiring taxpayer at the time of replacement. Taxpayers may use this election to ameliorate the possible adverse effects of applying the general rule to this type of transaction.

The general rule does not apply if the replacement MACRS property has a longer recovery period or less accelerated depreciation method than the relinquished property. If the recovery period of the replacement MACRS property is longer than that of the relinquished MACRS property, the taxpayer’s exchanged basis in the relinquished MACRS property is depreciated beginning in the year of replacement over the remainder of the recovery period that would have applied to the replacement MACRS property if the replacement MACRS property had originally been placed in service when the relinquished MACRS property was placed in service by the acquiring taxpayer. Similarly, if the depreciation method of the replacement MACRS property is less accelerated than that of the relinquished MACRS property, then the taxpayer’s exchanged basis in the relinquished MACRS property is depreciated beginning in the year of replacement using the less accelerated depreciation method of the replacement MACRS property that would have applied to the replacement MACRS property if the replacement MACRS property had originally been placed in service when the relinquished MACRS property was placed in service by the acquiring taxpayer.

For taxpayers who wish to use the optional depreciation tables to determine the depreciation allowances for the replacement MACRS property instead of the formulas (for example, see section 6 of Rev. Proc. 87-57, 1987-2 C.B. 687, 692), the temporary regulations provide guidance on choosing the applicable optional table as well as how to modify the calculation for computing the depreciation allowances for the replacement MACRS property.

Any excess of the taxpayer’s basis in the replacement MACRS property over the taxpayer’s exchanged basis in the relinquished MACRS property is referred to as the excess basis. Generally, the excess basis in the replacement MACRS property is treated as property that is placed in service by the acquiring taxpayer in the taxable year in which the replacement MACRS property is placed in service by the acquiring taxpayer or, if later, the taxable year of the disposition of the relinquished MACRS property (time of replacement). The depreciation allowances for the excess basis are determined by using the applicable recovery period, depreciation method, and convention prescribed under section 168 for the replacement MACRS property at the time of replacement. In addition, the excess basis may be taken into account for purposes of computing the deduction allowed under section 179.

Because of the complex nature of certain like-kind exchange and involuntary conversion transactions, the temporary regulations provide special rules for certain circumstances. If a taxpayer disposes of the relinquished MACRS property prior to the acquisition of the replacement MACRS property, the temporary regulations do not allow the taxpayer to take depreciation on the relinquished MACRS property during the period between the disposition of the relinquished MACRS property and the acquisition of the replacement MACRS property. This results because, in a deferred exchange under §1.1031(k)-1, or if a taxpayer does not replace converted property until after the taxpayer no longer owns the converted property, the taxpayer has no property to depreciate during that intervening period. Accordingly, the recovery period for the replacement MACRS property is suspended during this period. The temporary regulations do not address the issue of whether an intermediary (such as an exchange accommodation titleholder) is entitled to depreciation.

When replacement MACRS property is acquired and placed in service by a taxpayer before the relinquished MACRS property is disposed of by the taxpayer (for example, under threat of condemnation), the regulations allow the taxpayer to depreciate the unadjusted depreciable basis of the replacement MACRS property until the time of disposition of the relinquished MACRS property by the taxpayer. The taxpayer must include in taxable income in the year of disposition of the relinquished MACRS property the excess of the depreciation allowable on the unadjusted depreciable basis of the replacement MACRS property over the depreciation that would be allowable on the excess basis of the replacement MACRS property from the date the replacement MACRS property was placed in service by the taxpayer to the time of disposition of the relinquished MACRS property. The depreciation of the depreciable excess basis of the replacement MACRS property continues to be depreciated by the taxpayer. The IRS and Treasury may consider providing additional future guidance with respect to this issue and request comments relating thereto. The IRS and Treasury also invite taxpayers to comment on whether the allowance of depreciation for the replacement MACRS property should be followed by basis reduction at the time of disposition of the relinquished MACRS property, or whether some other approach should be taken.

Because land or other nondepreciable property acquired in a like-kind exchange or involuntary conversion for MACRS property is not depreciable, such property is not within the scope of the temporary regulations. Further, if MACRS property or both MACRS property and land or other nondepreciable property are acquired in a like-kind exchange or involuntary conversion for land or other nondepreciable property, the basis of the replacement MACRS property is treated as property placed in service by the acquiring taxpayer in the year of replacement.

The IRS received many comments concerning the like-kind exchange of automobiles. In response, the temporary regulations contain detailed rules regarding the annual allowable depreciation for automobiles acquired in a like-kind exchange or involuntary conversion. The temporary regulations provide that if the replacement MACRS property consists of a passenger automobile that is subject to the depreciation limitations of section 280F(a), then the depreciation limitation that applies for the taxable year is based on the date the replacement MACRS automobile is placed in service by the acquiring taxpayer. In allocating the depreciation limitation, the depreciation allowance for the exchanged basis in the replacement MACRS automobile generally is limited to the amount that would have been allowable under section 280F(a) for the relinquished MACRS automobile had the transaction not occurred. The depreciation allowance for the excess basis is generally limited to the section 280F(a) limitation that applies for that taxable year less the amount of the depreciation allowance for the exchanged basis.

Commentators suggested that implementing the general rule for all depreciable property was burdensome because taxpayers would have onerous computational and administrative difficulties due to the possibility of having to track different depreciation components of one asset. Responding to these comments, the temporary regulations include a provision by which taxpayers may elect not to apply these temporary regulations. If a taxpayer elects not to apply the temporary regulations, the taxpayer must treat the entire basis (i.e., both the exchanged and excess basis) of the replacement MACRS property as being placed in service by the acquiring taxpayer at the time of replacement. Consistent with this treatment, the taxpayer treats the relinquished MACRS property as disposed of at the time of the disposition of the relinquished MACRS property. The election must be made by typing or legibly printing at the top of Form 4562, Depreciation and Amortization, “ELECTION MADE UNDER SECTION 1.168(i)-6T(i),” or in the manner provided for on Form 4562 and its instructions.

Temporary regulations issued under §§1.168(k)-1T and 1.1400L(b)-1T (T.D. 9091, 2003-44 I.R.B. 939 [68 FR 52986] (September 8, 2003)) provide that the exchanged basis (referred to as the “carryover basis” in such regulations) and the excess basis, if any, of the replacement MACRS property (referred to as the “acquired MACRS property” in such regulations) is eligible for the additional first year depreciation deduction provided under section 168(k) or 1400L(b) if the replacement MACRS property is qualified property under section 168(k)(2), 50-percent bonus depreciation property under section 168(k)(4), or qualified New York Liberty Zone property under section 1400L(b)(2). However, if qualified property, 50-percent bonus depreciation property, or qualified New York Liberty Zone property is placed in service by the taxpayer and then disposed of by that taxpayer in a like-kind exchange or involuntary conversion in the same taxable year, the relinquished MACRS property (referred to as the “exchanged or involuntarily converted MACRS property” in such regulations) is not eligible for the additional first year depreciation deduction under section 168(k) or 1400L(b), as applicable. However, the exchanged basis (and excess basis, if any) of the replacement MACRS property may be eligible for the additional first year depreciation deduction under section 168(k) or 1400L(b), as applicable, subject to the requirements of section 168(k) or 1400L(b), as applicable. The rules provided under §§1.168(k)-1T and 1.1400L(b)-1T apply even if the taxpayer elects not to apply these temporary regulations.

These temporary regulations amend the definition of time of replacement in §1.168(k)-1T(f)(5)(ii)(F) to be consistent with the definition of that term under these temporary regulations. In addition, these temporary regulations modify the like-kind exchange or involuntary conversion examples contained in §1.168(k)-1T(f)(5)(v) to reflect the placed in service date (taking into account the convention as determined under these temporary regulations) for the relinquished MACRS property and the replacement MACRS property in the year of disposition and year of replacement.

Since the publication of §§1.168(k)-1T and 1.1400L(b)-1T, we have received comments regarding the application of the additional first year depreciation deduction rules in §§1.168(k)-1T(f)(5) and 1.1400L(b)-1T(f)(5) to qualified property, 50-percent bonus depreciation property, or qualified New York Liberty Zone property acquired in a like-kind exchange or an involuntary conversion. We will consider these comments when §§1.168(k)-1T and 1.1400L(b)-1T are finalized.

Some commentators questioned how the general rule set forth in Notice 2000-4 affects the tax treatment of like-kind exchanges or involuntary conversions involving MACRS assets contained in general asset accounts as described in §1.168(i)-1.

Section 1.168(i)-1(e)(2)  treats like- kind exchanges or involuntary conversions as dispositions of the relinquished MACRS property and acquisitions of the replacement MACRS property. As a result, any amount realized on a like-kind exchange or involuntary conversion is recognized as ordinary income and the basis of the relinquished MACRS property in the general asset account continues to be depreciated. However, §1.168(i)-1(e)(3)(iii) allows a taxpayer to elect to terminate general asset account treatment for the relinquished MACRS property, and, as a result, the tax treatment of the like-kind exchange or involuntary conversion is determined under section 1031 or section 1033, as applicable.

These temporary regulations amend the final regulations under section 168(i)(4) (T.D. 8566, 1994-2 C.B. 20 [59 FR 51369] (1994)) to address the like-kind exchange or involuntary conversion of MACRS property contained in a general asset account. Under the temporary regulations, general asset account treatment terminates for the relinquished MACRS property as of the first day of the year of disposition. Because this rule would require taxpayers to track each property in a general asset account, the IRS and Treasury request comments on alternative methods to account for a like-kind exchange or involuntary conversion involving MACRS property contained in a general asset account when the replacement MACRS property has a longer recovery period or less accelerated depreciation method than the relinquished MACRS property or when the basis of the general asset account would change as a result of the like-kind exchange or involuntary conversion.

The determination of the basis of property acquired in a like-kind exchange involving multiple properties is described in §1.1031(j)-1 and the determination of the basis of multiple properties acquired as a result of an involuntary conversion is described in §1.1033(b)-1. Commentators question how the rules set forth in Notice 2000-4 affects the depreciation treatment of a like-kind exchange or an involuntary conversion involving multiple properties. At this time, taxpayers may apply the principles of this temporary regulation to determine the depreciation treatment of MACRS property acquired in these transactions. The IRS and Treasury may consider providing future guidance with respect to this issue and request comments relating thereto. Specifically, comments are requested on the depreciation treatment of these transactions when the depreciation methods or recovery periods of the replacement MACRS properties differ from those of the relinquished MACRS properties.

(a) Section 168 determines the depreciation allowance for tangible property that is of a character subject to the allowance for depreciation provided in section 167(a) and that is placed in service after December 31, 1986 (or after July 31, 1986, if the taxpayer made an election under section 203(a)(1)(B) of the Tax Reform Act of 1986; 100 Stat. 2143). Except for property excluded from the application of section 168 as a result of section 168(f) or as a result of a transitional rule, the provisions of section 168 are mandatory for all eligible property. The allowance for depreciation under section 168 constitutes the amount of depreciation allowable under section 167(a). The determination of whether tangible property is property of a character subject to the allowance for depreciation is made under section 167 and the regulations under section 167.

(b) This section is applicable on and after February 27, 2004.

(c) The applicability of this section expires on or before February 26, 2007.

(a) Definitions. For purposes of section 168 and the regulations under section 168, the following definitions apply:

(1) Depreciable property is property that is of a character subject to the allowance for depreciation as determined under section 167 and the regulations under section 167.

(2) MACRS property is tangible, depreciable property that is placed in service after December 31, 1986 (or after July 31, 1986, if the taxpayer made an election under section 203(a)(1)(B) of the Tax Reform Act of 1986; 100 Stat. 2143) and subject to section 168, except for property excluded from the application of section 168 as a result of section 168(f) or as a result of a transitional rule.

(3) Unadjusted depreciable basis is the basis of property for purposes of section 1011 without regard to any adjustments described in section 1016(a)(2) and (3). This basis reflects the reduction in basis for the percentage of the taxpayer’s use of property for the taxable year other than in the taxpayer’s trade or business (or for the production of income), for any portion of the basis the taxpayer properly elects to treat as an expense under section 179, and for any adjustments to basis provided by other provisions of the Internal Revenue Code and the regulations under the Code (other than section 1016(a)(2) and (3)) (for example, a reduction in basis by the amount of the disabled access credit pursuant to section 44(d)(7)). For property subject to a lease, see section 167(c)(2).

(4) Adjusted depreciable basis is the unadjusted depreciable basis of the property, as defined in §1.168(b)-1T(a)(3), less the adjustments described in section 1016(a)(2) and (3).

(b) Effective date. (1) This section is applicable on February 27, 2004.

(2) The applicability of this section expires on or befre February 26, 2007.

Par. 3. Section 1.168(d)-1 is amended by:

1. Revising paragraph (b)(3).

2. Adding paragraph (d)(3).

The addition and revision read as follows:

* * * * *

(b) * * *

(3) * * * (i) and (ii) [Reserved]. For further guidance, see §1.168(d)-1T(b)(3)(i) and (ii).

* * * * *

(d) * * *

(3) Like-kind exchanges and involuntary conversions. [Reserved]. For further guidance, see §1.168(d)-1T(d)(3)(i).

Par. 4. Section 1.168(d)-1T is amended by:

1. Revising paragraphs (a) through (b)(3)(ii).

2. Adding paragraph (d)(3).

The addition and revisions read as follows:

(a) through (b)(2) [Reserved]. For further guidance, see §1.168(d)-1(a) through (b)(2).

(b)(3) Property placed in service and disposed of in the same taxable year—(i) Under section 168(d)(3)(B)(ii), the depreciable basis of property placed in service and disposed of in the same taxable year is not taken into account in determining whether the 40-percent test is satisfied. However, the depreciable basis of property placed in service, disposed of, subsequently reacquired, and again placed in service, by the taxpayer in the same taxable year must be taken into account in applying the 40-percent test, but the basis of the property is only taken into account on the later of the dates that the property is placed in service by the taxpayer during the taxable year. Further, see §1.168(i)-6T(c)(4)(v)(B) and §1.168(i)-6T(f) for rules relating to property placed in service and exchanged or involuntarily converted during the same taxable year.

(ii) The applicable convention, as determined under this section, applies to all depreciable property (except nonresidential real property, residential rental property, and any railroad grading or tunnel bore) placed in service by the taxpayer during the taxable year, excluding property placed in service and disposed of in the same taxable year. However, see §1.168(i)-6T(c)(4)(v)(A) and §1.168(i)-6T(f) for rules relating to MACRS property that has a basis determined under section 1031(d) or section 1033(b). No depreciation deduction is allowed for property placed in service and disposed of during the same taxable year. However, see §1.168(k)-1T(f)(1) for rules relating to qualified property or 50-percent bonus depreciation property, and §1.1400L(b)-1T(f)(1) for rules relating to qualified New York Liberty Zone property, that is placed in service by the taxpayer in the same taxable year in which either a partnership is terminated as a result of a technical termination under section 708(b)(1)(B) or the property is transferred in a transaction described in section 168(i)(7).

* * * * *

(d)(2) * * *

(3) Like-kind exchanges and involuntary conversions. (i) The last sentence in paragraph (b)(3)(i) and the second sentence in paragraph (b)(3)(ii) of this section apply to exchanges to which section 1031 applies, and involuntary conversions to which section 1033 applies, of MACRS property for which the time of disposition and the time of replacement both occur after February 27, 2004.

(ii) The applicability of this section expires on or before February 26, 2007.

Par. 5. In §1.168(i)-0, the entries for §1.168(i)-1(d)(2), (e)(3)(i), (f), (f)(1), (f)(2), (f)(2)(i), (i), (j) and (l) are revised, the entry for (e)(3)(v) is removed and a new entry for (e)(3)(v) and (vi) is added.

* * * * *

* * * * *

(d) * * *

(2) [Reserved]. For further guidance, see the entry for §1.168(i)-1T(d)(2).

* * * * *

(e) * * *

(3) * * *

(i) [Reserved]. For further guidance, see the entry for §1.168(i)-1T(e)(3)(i).

* * * * *

(v) and (vi) [Reserved]. For further guidance, see the entries for §1.168(i)-1T(e)(3)(v) and (vi).

* * * * *

(f) through (f)(2)(i) [Reserved]. For further guidance, see the entries for §1.168(i)-1T(f) through (f)(2)(i).

* * * * *

(i) and (j). [Reserved]. For further guidance, see the entries for §1.168(i)-1T(i) and (j).

* * * * *

(l) [Reserved]. For further guidance, see the entry for §1.168(i)-1T(l).

Par. 6. Section 1.168(i)-0T is added to read as follows:

This section lists the major paragraphs contained in §1.168(i)-1T.

(a) through (d)(1) [Reserved]. For further guidance, see the entries for §1.168(i)-1(a) through (d)(1).

(2) Special rule for passenger automobiles.

(e) through (e)(3) [Reserved]. For further guidance, see the entries for §1.168(i)-1(e) through (e)(3).

(i) In general.

(e)(3)(ii) through (e)(3)(iv) [Reserved]. For further guidance, see the entries for §1.168(i)-1(e)(3)(ii) through (iv).

(v) Transactions subject to section 1031 or 1033.

(vi) Anti-abuse rule.

(f) Assets generating foreign source income.

(1) In general.

(2) Source of ordinary income, gain, or loss.

(i) Source determined by allocation and apportionment of depreciation allowed.

(f)(2)(ii) through (h)(2) [Reserved]. For further guidance, see the entries for §1.168(i)-1(f)(2)(ii) through (h)(2).

(i) Identification of disposed or converted asset.

(j) Effect of adjustments on prior dispositions.

(k)(1) through (k)(3) [Reserved]. For further guidance, see the entries for §1.168(i)-1(k)(1) through (k)(3).

(l) Effective date.

(l)(1) through (l)(3) [Reserved]. For further guidance, see the entries for §1.168(i)-1(l)(1) through (l)(3).

Par. 7. Section 1.168(i)-1 is amended by:

1. Redesignating paragraph (e)(3)(v) as paragraph (e)(3)(vi).

2. Adding paragraphs (c)(2)(ii)(E) and (e)(3)(v).

3. Revising paragraphs (d)(2), (e)(3)(i), (e)(3)(iii)(B)(4), (e)(3)(vi), (f)(1), (f)(2)(i), (i), (j), and (l).

The additions and revisions read as follows:

* * * * *

(c) * * *

(2) * * * (ii) * * *

(E) [Reserved]. For further guidance, see §1.168(i)-1T(c)(2)(ii)(E).

(d) * * *

(2) [Reserved]. For further guidance, see §1.168(i)-1T(d)(2).

(e) * * *

(3) * * *

(i) [Reserved]. For further guidance, see §1.168(i)-1T(e)(3)(i).

* * * * *

(iii) * * *

(B) * * *

(4) [Reserved]. For further guidance, see §1.168(i)-1T(e)(3)(iii)(B)(4).

* * * * *

(e)(3)(v) [Reserved]. For further guidance, see §1.168(i)-1T(e)(3)(v).

(vi) Anti-abuse rule—[Reserved]. For further guidance,  see §1.168(i)- 1T(e)(3)(vi).

(f) Assets generating foreign source income—(1) In general. [Reserved]. For further guidance, see §1.168(i)-1T(f)(1).

(2) Source of ordinary income, gain or loss—(i) [Reserved]. For further guidance, see §1.168(i)-1T(f)(2)(i).

(i) Identification of disposed or converted asset. [Reserved]. For further guidance, see §1.168(i)-1T(i).

(j) Effect of adjustments on prior dispositions. [Reserved]. For further guidance, see §1.168(i)-1T(j).

* * * * *

(l) Effective date—[Reserved]. For further guidance, see §1.168(i)-1T(l).

Par. 8. Section 1.168(i)-1T is added to read as follows:

(a) through (c)(2)(ii)(D) [Reserved]. For further guidance, see §1.168(i)-1(a) through (c)(2)(ii)(D).

(c)(2)(ii)(E) [Reserved].

(d)(1) [Reserved]. For further guidance, see §1.168(i)-1(d)(1).

(d)(2) Special rule for passenger automobiles. For purposes of applying section 280F(a), the depreciation allowance for a general asset account established for passenger automobiles is limited for each taxable year to the amount prescribed in section 280F(a) multiplied by the excess of the number of automobiles originally included in the account over the number of automobiles disposed of during the taxable year or in any prior taxable year in a transaction described in paragraph (e)(3)(iii) (disposition of an asset in a qualifying disposition), (e)(3)(iv) (transactions subject to section 168(i)(7)), (e)(3)(v) (transactions subject to section 1031 or 1033), (e)(3)(vi) (anti-abuse rule), (g) (assets subject to recapture), or (h)(1) (conversion to personal use) of this section.

(e)(1) through (e)(2) [Reserved]. For further guidance, see §1.168(i)-1(e)(1) through (e)(2).

(e)(3) Special rules—(i) In general. This paragraph (e)(3) provides the rules for terminating general asset account treatment upon certain dispositions. While the rules under paragraphs (e)(3)(ii) and (iii) of this section are optional rules, the rules under paragraphs (e)(3)(iv), (v), and (vi) of this section are mandatory rules. A taxpayer applies paragraph (e)(3)(ii) or (iii) of this section by reporting the gain, loss, or other deduction on the taxpayer’s timely filed Federal income tax return (including extensions) for the taxable year in which the disposition occurs. For purposes of applying paragraph (e)(3)(iii) through (vi) of this section, see paragraph (i) of this section for identifying the unadjusted depreciable basis of a disposed asset.

(e)(3)(ii) through (e)(3)(iii)(B)(3) [Reserved]. For further guidance, see §1.168(i)-1(e)(3)(ii) through (e)(3)(iii)(B)(3).

(e)(3)(iii)(B)(4) A transaction, other than a transaction described in paragraph (e)(3)(iv) of this section (pertaining to transactions subject to section 168(i)(7)) and (e)(3)(v) of this section (pertaining to transactions subject to section 1031 or 1033), to which a nonrecognition section of the Code applies (determined without regard to this section).

(e)(3)(iii)(C) through (e)(3)(iv) [Reserved]. For further guidance, see §1.168(i)-1(e)(iii)(C) through (e)(3)(iv).

(e)(3)(v) Transactions subject to section 1031 or section 1033—(A) Like-kind exchange or involuntary conversion of all assets remaining in a general asset account. If all the assets, or the last asset, in a general asset account are transferred by a taxpayer in a like-kind exchange (as defined under §1.168-6T(b)(11)) or in an involuntary conversion (as defined under §1.168-6T(b)(12)), the taxpayer must apply this paragraph (e)(3)(v)(A) (instead of applying paragraph (e)(2), (e)(3)(ii), or (e)(3)(iii) of this section). Under this paragraph (e)(3)(v)(A), the general asset account terminates as of the first day of the year of disposition (as defined in §1.168(i)-6T(b)(5)) and—

(1) The amount of gain or loss for the general asset account is determined under section 1001(a) by taking into account the adjusted depreciable basis of the general asset account at the time of disposition (as defined in §1.168(i)-6T(b)(3)). The depreciation allowance for the general asset account in the year of disposition is determined in the same manner as the depreciation allowance for the relinquished MACRS property (as defined in §1.168(i)-6T(b)(2)) in the year of disposition is determined under §1.168(i)-6T. The recognition and character of gain or loss are determined in accordance with paragraph (e)(3)(ii)(A) of this section (notwithstanding that paragraph (e)(3)(ii) of this section is an optional rule); and

(2) The adjusted depreciable basis of the general asset account at the time of disposition is treated as the adjusted depreciable basis of the relinquished MACRS property.

(B) Like-kind exchange or involuntary conversion of less than all assets remaining in a general asset account. If an asset in a general asset account is transferred by a taxpayer in a like-kind exchange or in an involuntary conversion and if paragraph (e)(3)(v)(A) of this section does not apply to this asset, the taxpayer must apply this paragraph (e)(3)(v)(B) (instead of applying paragraph (e)(2), (e)(3)(ii), or (e)(3)(iii) of this section). Under this paragraph (e)(3)(v)(B), general asset account treatment for the asset terminates as of the first day of the year of disposition (as defined in §1.168(i)-6T(b)(5)), and—

(1) The amount of gain or loss for the asset is determined by taking into account the asset’s adjusted basis at the time of disposition (as defined in §1.168(i)-6T(b)(3)). The adjusted basis of the asset at the time of disposition equals the unadjusted depreciable basis of the asset less the depreciation allowed or allowable for the asset, computed by using the depreciation method, recovery period, and convention applicable to the general asset account in which the asset was included. The depreciation allowance for the asset in the year of disposition is determined in the same manner as the depreciation allowance for the relinquished MACRS property (as defined in §1.168(i)-6T(b)(2)) in the year of disposition is determined under §1.168(i)-6T. The recognition and character of the gain or loss are determined in accordance with paragraph (e)(3)(iii)(A) of this section (notwithstanding that paragraph (e)(3)(iii) of this section is an optional rule); and

(2) As of the first day of the year of disposition, the taxpayer must remove the relinquished asset from the general asset account and make the adjustments to the general asset account described in paragraph (e)(3)(iii)(C)(2) through (4) of this section.

(e)(3)(vi) Anti-abuse rule—(A) In general. If an asset in a general asset account is disposed of by a taxpayer in a transaction described in paragraph (e)(3)(vi)(B) of this section, general asset account treatment for the asset terminates as of the first day of the taxable year in which the disposition occurs. Consequently, the taxpayer must determine the amount of gain, loss, or other deduction attributable to the disposition in the manner described in paragraph (e)(3)(iii)(A) of this section (notwithstanding that paragraph (e)(3)(iii)(A) of this section is an optional rule) and must make the adjustments to the general asset account described in paragraph (e)(3)(iii)(C)(1) through (4) of this section.

(B) Abusive transactions. A transaction is described in this paragraph (e)(3)(vi)(B) if the transaction is not described in paragraph (e)(3)(iv) or (e)(3)(v) of this section and the transaction is entered into, or made, with a principal purpose of achieving a tax benefit or result that would not be available absent an election under this section. Examples of these types of transactions include—

(1) A transaction entered into with a principal purpose of shifting income or deductions among taxpayers in a manner that would not be possible absent an election under this section in order to take advantage of differing effective tax rates among the taxpayers; or

(2) An election made under this section with a principal purpose of disposing of an asset from a general asset account in order to utilize an expiring net operating loss or credit. The fact that a taxpayer with a net operating loss carryover or a credit carryover transfers an asset to a related person or transfers an asset pursuant to an arrangement where the asset continues to be used (or is available for use) by the taxpayer pursuant to a lease (or otherwise) indicates, absent strong evidence to the contrary, that the transaction is described in this paragraph (e)(3)(vi)(B).

(f) Assets generating foreign source income—(1) In general. This paragraph (f) provides the rules for determining the source of any income, gain, or loss recognized, and the appropriate section 904(d) separate limitation category or categories for any foreign source income, gain, or loss recognized, on a disposition (within the meaning of paragraph (e)(1) of this section) of an asset in a general asset account that consists of assets generating both United States and foreign source income. These rules apply only to a disposition to which paragraph (e)(2) (general disposition rules), (e)(3)(ii) (disposition of all assets remaining in a general asset account), (e)(3)(iii) (disposition of an asset in a qualifying disposition), (e)(3)(v) (transactions subject to section 1031 or 1033), or (e)(3)(vi) (anti-abuse rule) of this section applies.

(2) Source of ordinary income, gain or loss—(i) Source determined by allocation and apportionment of depreciation allowed. The amount of any ordinary income, gain, or loss that is recognized on the disposition of an asset in a general asset account must be apportioned between United States and foreign sources based on the allocation and apportionment of the—

(A) Depreciation allowed for the general asset account as of the end of the taxable year in which the disposition occurs if paragraph (e)(2) of this section applies to the disposition;

(B) Depreciation allowed for the general asset account as of the time of disposition if the taxpayer applies paragraph (e)(3)(ii) of this section to the disposition of all assets, or the last asset, in the general asset account, or if all the assets, or the last asset, in the general asset account are disposed of in a transaction described in paragraph (e)(3)(v)(A) of this section; or

(C) Depreciation allowed for the disposed asset for only the taxable year in which the disposition occurs if the taxpayer applies paragraph (e)(3)(iii) of this section to the disposition of the asset in a qualifying disposition, if the asset is disposed of in a transaction described in paragraph (e)(3)(v)(B) of this section (like-kind exchange or involuntary conversion), or if the asset is disposed in a transaction described in paragraph (e)(3)(vi) of this section (anti-abuse rule).

(f)(2)(ii) through (h) [Reserved]. For further guidance, see §1.168(i)-1(f)(2)(ii) through (h).

(i) Identification of disposed or converted asset. A taxpayer may use any reasonable method that is consistently applied to the taxpayer’s general asset accounts for purposes of determining the unadjusted depreciable basis of a disposed or converted asset in a transaction described in paragraph (e)(3)(iii) (disposition of an asset in a qualifying disposition), (e)(3)(iv) (transactions subject to section 168(i)(7)), (e)(3)(v) (transactions subject to section 1031 or 1033), (e)(3)(vi) (anti-abuse rule), (g) (assets subject to recapture), or (h)(1) (conversion to personal use) of this section.

(j) Effect of adjustments on prior dispositions. The adjustments to a general asset account under paragraph (e)(3)(iii), (e)(3)(iv), (e)(3)(v), (e)(3)(vi), (g), or (h)(1) of this section have no effect on the recognition and character of prior dispositions subject to paragraph (e)(2) of this section.

(k) [Reserved]. For further guidance, see §1.168(i)-1(k).

(l) Effective date—(1) In general. Except as provided in paragraphs (l)(2) and (l)(3) of this section, this section applies to depreciable assets placed in service in taxable years ending on or after October 11, 1994. For depreciable assets placed in service after December 31, 1986, in taxable years ending before October 11, 1994, the Internal Revenue Service will allow any reasonable method that is consistently applied to the taxpayer’s general asset accounts.

(2) [Reserved].

(3) Like-kind exchanges and involuntary conversions. (i) This section applies for an asset transferred by a taxpayer in a like-kind exchange (as defined under §1.168-6T(b)(11) or in an involuntary conversion (as defined under §1.168-6T(b)(12)) for which the time of disposition (as defined in §1.168(i)-6T(b)(3)) and the time of replacement (as defined in §1,168(i)-6T(b)(4)) both occur after February 27, 2004. For an asset transferred by a taxpayer in a like-kind exchange or in an involuntary conversion for which the time of disposition, the time of replacement, or both occur on or before February 27, 2004, see §1.168(i)-1 in effect prior to February 27, 2004 (§1.168(i)-1 as contained in 26 CFR part 1 edition revised as of April 1, 2003).

(ii) The applicability of this section expires on or before February 26, 2007.

Par. 9. Section 1.168(i)-5T is added to read as follows:

This section lists the major paragraphs contained in §1.168(i)-6T.

(a) Scope.

(b) Definitions.

(1) Replacement MACRS property.

(2) Relinquished MACRS property.

(3) Time of disposition.

(4) Time of replacement.

(5) Year of disposition.

(6) Year of replacement.

(7) Exchanged basis.

(8) Excess basis.

(9) Depreciable exchanged basis.

(10) Depreciable excess basis.

(11) Like-kind exchange.

(12) Involuntary conversion.

(c) Determination of depreciation allowance.

(1) Computation of the depreciation allowance for depreciable exchanged basis beginning in the year of replacement.

(i) In general.

(ii) Applicable recovery period, depreciation method, and convention.

(2) Effect of depreciation treatment of the replacement MACRS property by previous owners of the acquired property.

(3) Recovery period and/or depreciation method of the properties are the same, or both are not the same.

(i) In general.

(ii) Both the recovery period and the depreciation method are the same.

(iii) Either the recovery period or the depreciation method is the same, or both are not the same.

(4) Recovery period or depreciation method of the properties is not the same.

(i) Longer recovery period.

(ii) Shorter recovery period.

(iii) Less accelerated depreciation method.

(iv) More accelerated depreciation method.

(v) Convention.

(A) In general.

(B) Mid-quarter convention.

(5) Year of disposition and year of replacement.

(i) Relinquished MACRS property.

(ii) Replacement MACRS property.

(A) Year of replacement is 12 months.

(B) Year of replacement is less than 12 months.

(iii) Deferred transactions.

(A) In general.

(B) Allowable depreciation for a qualified intermediary.

(iv) Remaining recovery period.

(6) Examples.

(d) Special rules for determining depreciation allowances.

(1) Excess basis.

(i) In general.

(ii) Example.

(2) Depreciable and nondepreciable property.

(3) Depreciation limitations for automobiles.

(i) In general.

(ii) Order in which limitations on depreciation under section 280F(a) are applied.

(iii) Depreciation allowance for depreciable excess basis.

(iv) Examples.

(4) Replacement MACRS property acquired and placed in service before disposition of relinquished MACRS property.

(e) Use of optional depreciation tables.

(1) Taxpayer not bound by prior use of table.

(2) Determination of the depreciation deduction.

(i) Relinquished MACRS property.

(ii) Replacement MACRS property.

(A) Determination of the appropriate optional depreciation table.

(B) Calculating the depreciation deduction for the replacement MACRS property.

(iii) Unrecovered basis.

(3) Excess basis.

(4) Examples.

(f) Mid-quarter convention.

(1) Exchanged basis.

(2) Excess basis.

(3) Depreciable property acquired for nondepreciable property.

(g) Section 179 election.

(h) Additional first year depreciation deduction.

(i) Election not to apply this section.

(j) Time and manner of making elections.

(1) In general.

(2) Time for making election.

(3) Manner of making election.

(4) Revocation.

(k) Effective date.

(1) In general.

(2) Application to pre-effective date like-kind exchanges and involuntary conversions.

Par. 10. Section 1.168(i)-6T is added to read as follows:

(a) Scope. This section provides the rules for determining the depreciation allowance for MACRS property acquired in a like-kind exchange or an involuntary conversion, including a like-kind exchange or an involuntary conversion of MACRS property that is exchanged or replaced with other MACRS property in a transaction between members of the same affiliated group. The allowance for depreciation under this section constitutes the amount of depreciation allowable under section 167(a) for the year of replacement and any subsequent taxable year for the replacement MACRS property and for the year of disposition of the relinquished MACRS property. The provisions of this section apply only to MACRS property to which §1.168(h)-1 (like-kind exchanges of tax-exempt use property) does not apply. Additionally, paragraphs (c) through (f) of this section apply only to MACRS property for which an election has not been made under paragraph (i) of this section.

(b) Definitions. For purposes of this section, the following definitions apply:

(1) Replacement MACRS property is MACRS property (as defined in §1.168(b)-1T(a)(2)) in the hands of the acquiring taxpayer that is acquired for other MACRS property in a like-kind exchange or an involuntary conversion.

(2) Relinquished MACRS property is MACRS property that is transferred by the taxpayer in a like-kind exchange, or in an involuntary conversion.

(3) Time of disposition is when the disposition of the relinquished MACRS property takes place under the convention, as determined under §1.168(d)-1T, that applies to the relinquished MACRS property.

(4) Time of replacement is the later of:

(i) When the replacement MACRS property is placed in service under the convention, as determined under this section, that applies to the replacement MACRS property; or

(ii) The time of disposition of the exchanged or involuntarily converted property.

(5) Year of disposition is the taxable year that includes the time of disposition.

(6) Year of replacement is the taxable year that includes the time of replacement.

(7) Exchanged basis is determined after the depreciation deductions for the year of disposition are determined under paragraph (c)(5)(i) of this section and is the lesser of—

(i) The basis in the replacement MACRS property, as determined under section 1031(d) and the regulations under section 1031(d) or section 1033(b) and the regulations under section 1033(b); or

(ii) The adjusted depreciable basis (as defined in §1.168(b)-1T(a)(4)) of the relinquished MACRS property.

(8) Excess basis is any excess of the basis in the replacement MACRS property, as determined under section 1031(d) and the regulations under section 1031(d) or section 1033(b) and the regulations under section 1033(b), over the exchanged basis as determined under paragraph (b)(7) of this section.

(9) Depreciable exchanged basis is the exchanged basis as determined under paragraph (b)(7) of this section reduced by—

(i) The percentage of such basis attributable to the taxpayer’s use of property for the taxable year other than in the taxpayer’s trade or business (or for the production of income); and

(ii) Any adjustments to basis provided by other provisions of the Internal Revenue Code and the regulations under the Code (including section 1016(a)(2) and (3), for example, depreciation deductions in the year of replacement allowable under section 168(k) or 1400L(b)).

(10) Depreciable excess basis is the excess basis as determined under paragraph (b)(8) of this section reduced by—

(i) The percentage of such basis attributable to the taxpayer’s use of property for the taxable year other than in the taxpayer’s trade or business (or for the production of income);

(ii) Any portion of the basis the taxpayer properly elects to treat as an expense under section 179; and

(iii) Any adjustments to basis provided by other provisions of the Internal Revenue Code and the regulations under the Code (including section 1016(a)(2) and (3), for example, depreciation deductions in the year of replacement allowable under section 168(k) or 1400L(b)).

(11) Like-kind exchange is an exchange of property for other property (or money) in a transaction to which section 1031(a)(1), (b), or (c) applies.

(12) Involuntary conversion is a transaction described in section 1033(a)(1) or (2) that resulted in the nonrecognition of any part of the gain realized as the result of the conversion.

(c) Determination of depreciation allowance—(1) Computation of the depreciation allowance for depreciable exchanged basis beginning in the year of replacement—(i) In general. This paragraph (c) provides rules for determining the applicable recovery period, the applicable depreciation method, and the applicable convention used to determine the depreciation allowances for the depreciable exchanged basis beginning in the year of replacement. See paragraph (c)(5) of this section for rules relating to the computation of the depreciation allowance for the year of disposition and for the year of replacement. See paragraph (d)(1) of this section for rules relating to the computation of the depreciation allowance for depreciable excess basis. See paragraph (d)(4) of this section if the replacement MACRS property is acquired before disposition of the relinquished MACRS property in a transaction to which section 1033 applies. See paragraph (e) of this section for rules relating to the computation of the depreciation allowance using the optional depreciation tables.

(ii) Applicable recovery period, depreciation method, and convention. The recovery period, depreciation method, and convention determined under this paragraph (c) are the only permissible methods of accounting for MACRS property within the scope of this section unless the taxpayer makes the election under paragraph (i) of this section not to apply this section.

(2) Effect of depreciation treatment of the replacement MACRS property by previous owners of the acquired property. If replacement MACRS property is acquired by a taxpayer in a like-kind exchange or an involuntary conversion, the depreciation treatment of the replacement MACRS property by previous owners has no effect on the determination of depreciation allowances for the replacement MACRS property in the hands of the acquiring taxpayer. For example, a taxpayer exchanging, in a like-kind exchange, MACRS property for property that was depreciated under ACRS by the previous owner must use this section because the replacement property will become MACRS property in the hands of the acquiring taxpayer. In addition, elections made by previous owners in determining depreciation allowances for the replacement MACRS property have no effect on the acquiring taxpayer. For example, a taxpayer exchanging, in a like-kind exchange, MACRS property that the taxpayer depreciates under the general depreciation system for other MACRS property that the previous owner elected to depreciate under the alternative depreciation system (ADS) pursuant to section 168(g)(7) does not have to continue using the ADS for the replacement MACRS property.

(3) Recovery period and/or depreciation method of the properties are the same, or both are not the same—(i) In general. For purposes of paragraphs (c)(3) and (c)(4) of this section in determining whether the recovery period and the depreciation method prescribed under section 168 for the replacement MACRS property are the same as the recovery period and the depreciation method prescribed under section 168 for the relinquished MACRS property, the recovery period and the depreciation method for the replacement MACRS property are considered to be the recovery period and the depreciation method that would have applied, taking into account any elections made by the acquiring taxpayer under section 168(b)(5) or 168(g)(7), had the replacement MACRS property been placed in service by the acquiring taxpayer at the same time as the relinquished MACRS property.

(ii) Both the recovery period and the depreciation method are the same. If both the recovery period and the depreciation method prescribed under section 168 for the replacement MACRS property are the same as the recovery period and the depreciation method prescribed under section 168 for the relinquished MACRS property, the depreciation allowances for the replacement MACRS property beginning in the year of replacement are determined by using the same recovery period and depreciation method that were used for the relinquished MACRS property. Thus, the replacement MACRS property is depreciated over the remaining recovery period (taking into account the applicable convention), and by using the depreciation method, of the relinquished MACRS property. Except as provided in paragraph (c)(5) of this section, the depreciation allowances for the depreciable exchanged basis for any 12-month taxable year beginning with the year of replacement are determined by multiplying the depreciable exchanged basis by the applicable depreciation rate for each taxable year (for further guidance, for example, see section 6 of Rev. Proc. 87-57, 1987-2 C.B. 687, 692, and §601.601(d)(2)(ii)(b) of this chapter).

(iii) Either the recovery period or the depreciation method is the same, or both are not the same. If either the recovery period or the depreciation method prescribed under section 168 for the replacement MACRS property is the same as the recovery period or the depreciation method prescribed under section 168 for the relinquished MACRS property, the depreciation allowances for the depreciable exchanged basis beginning in the year of replacement are determined using the recovery period or the depreciation method that is the same as the relinquished MACRS property. See paragraph (c)(4) of this section to determine the depreciation allowances when the recovery period or the depreciation method of the replacement MACRS property is not the same as that of the relinquished MACRS property.

(4) Recovery period or depreciation method of the properties is not the same. If the recovery period prescribed under section 168 for the replacement MACRS property (as determined under paragraph (c)(3)(i) of this section) is not the same as the recovery period prescribed under section 168 for the relinquished MACRS property, the depreciation allowances for the depreciable exchanged basis beginning in the year of replacement are determined under this paragraph (c)(4). Similarly, if the depreciation method prescribed under section 168 for the replacement MACRS property (as determined under paragraph (c)(3)(i) of this section) is not the same as the depreciation method prescribed under section 168 for the relinquished MACRS property, the depreciation method used to determine the depreciation allowances for the depreciable exchanged basis beginning in the year of replacement is determined under this paragraph (c)(4).

(i) Longer recovery period. If the recovery period prescribed under section 168 for the replacement MACRS property (as determined under paragraph (c)(3)(i) of this section) is longer than that prescribed for the relinquished MACRS property, the depreciation allowances for the depreciable exchanged basis beginning in the year of replacement are determined as though the replacement MACRS property had originally been placed in service by the acquiring taxpayer in the same taxable year the relinquished MACRS property was placed in service by the acquiring taxpayer, but using the longer recovery period of the replacement MACRS property (as determined under paragraph (c)(3)(i) of this section) and the convention determined under paragraph (c)(4)(v) of this section. Thus, the depreciable exchanged basis is depreciated over the remaining recovery period (taking into account the applicable convention) of the replacement MACRS property.

(ii) Shorter recovery period. If the recovery period prescribed under section 168 for the replacement MACRS property (as determined under paragraph (c)(3)(i) of this section) is shorter than that of the relinquished MACRS property, the depreciation allowances for the depreciable exchanged basis beginning in the year of replacement are determined using the same recovery period as that of the relinquished MACRS property. Thus, the depreciable exchanged basis is depreciated over the remaining recovery period (taking into account the applicable convention) of the relinquished MACRS property.

(iii) Less accelerated depreciation method—(A) If the depreciation method prescribed under section 168 for the replacement MACRS property (as determined under paragraph (c)(3)(i) of this section) is less accelerated than that of the relinquished MACRS property at the time of disposition, the depreciation allowances for the depreciable exchanged basis beginning in the year of replacement are determined as though the replacement MACRS property had originally been placed in service by the acquiring taxpayer at the same time the relinquished MACRS property was placed in service by the acquiring taxpayer, but using the less accelerated depreciation method. Thus, the depreciable exchanged basis is depreciated using the less accelerated depreciation method.

(B) Except as provided in paragraph (c)(5) of this section, the depreciation allowances for the depreciable exchanged basis for any 12-month taxable year beginning in the year of replacement are determined by multiplying the adjusted depreciable basis by the applicable depreciation rate for each taxable year. If, for example, the depreciation method of the replacement MACRS property in the year of replacement is the 150-percent declining balance method and the depreciation method of the relinquished MACRS property in the year of replacement is the 200-percent declining balance method, and neither method had been switched to the straight line method in the year of replacement or any prior taxable year, the applicable depreciation rate for the year of replacement and subsequent taxable years is determined by using the depreciation rate of the replacement MACRS property as if the replacement MACRS property was placed in service by the acquiring taxpayer at the same time the relinquished MACRS property was placed in service by the acquiring taxpayer, until the 150-percent declining balance method has been switched to the straight line method. If, for example, the depreciation method of the replacement MACRS property is the straight line method, the applicable depreciation rate for the year of replacement is determined by using the remaining recovery period at the beginning of the year of disposition (as determined under this paragraph (c)(4) and taking into account the applicable convention).

(iv) More accelerated depreciation method—(A) If the depreciation method prescribed under section 168 for the replacement MACRS property (as determined under paragraph (c)(3)(i) of this section) is more accelerated than that of the relinquished MACRS property at the time of disposition, the depreciation allowances for the replacement MACRS property beginning in the year of replacement are determined using the same depreciation method as the relinquished MACRS property.

(B) Except as provided in paragraph (c)(5) of this section, the depreciation allowances for the depreciable exchanged basis for any 12-month taxable year beginning in the year of replacement are determined by multiplying the adjusted depreciable basis by the applicable depreciation rate for each taxable year. If, for example, the depreciation method of the relinquished MACRS property in the year of replacement is the 150-percent declining balance method and the depreciation method of the replacement MACRS property in the year of replacement is the 200-percent declining balance method, and neither method had been switched to the straight line method in the year of replacement or any prior taxable year, the applicable depreciation rate for the year of replacement and subsequent taxable years is the same depreciation rate that applied to the relinquished MACRS property in the year of replacement, until the 150-percent declining balance method has been switched to the straight line method. If, for example, the depreciation method is the straight line method, the applicable depreciation rate for the year of replacement is determined by using the remaining recovery period at the beginning of the year of disposition (as determined under this paragraph (c)(4) and taking into account the applicable convention).

(v) Convention—(A) In general. The applicable convention for the exchanged basis is determined under this paragraph (c)(4)(v). The applicable convention for the exchanged basis is deemed to be the mid-month convention for replacement MACRS property that is nonresidential real property, residential rental property, or any railroad grading or tunnel bore. Thus, if the relinquished MACRS property was depreciated using the mid-month convention, then the replacement MACRS property is deemed to have been placed in service by the acquiring taxpayer in the same month as the relinquished MACRS property and must continue to be depreciated using the mid-month convention. If nonresidential real property, residential rental property, or any railroad grading or tunnel bore is received as a result of an exchange or an involuntary conversion of MACRS property that was depreciated using the mid-quarter convention, the replacement MACRS property is deemed to have been placed in service by the acquiring taxpayer in the month that includes the mid-point of the quarter that the relinquished MACRS property was placed in service and must be depreciated using the mid-month convention. If nonresidential real property, residential rental property, or any railroad grading or tunnel bore is received as a result of an exchange or an involuntary conversion of MACRS property that was depreciated using the half-year convention, the replacement MACRS property is deemed to have been placed in service by the acquiring taxpayer in the month that includes the mid-point of the placed-in-service year and must be depreciated using the mid-month convention (for example, for a calendar-year taxpayer with a full 12-month taxable year, the mid-point is the first day of the second half of the taxable year (the seventh month)). For all other replacement MACRS property, the applicable convention is the half-year convention, unless the applicable convention for the relinquished MACRS property is the mid-quarter convention, in which case the mid-quarter convention is applied to the replacement MACRS property.

(B) Mid-quarter convention. See paragraph (f) of this section for purposes of applying the 40-percent test of section 168(d)(3) to any replacement MACRS property.

(5) Year of disposition and year of replacement. No depreciation deduction is allowable for MACRS property disposed of by a taxpayer in a like-kind exchange or involuntary conversion in the same taxable year that such property was placed in service by the taxpayer. If replacement MACRS p