The One Big Beautiful Bill Act created a favorable environment for real estate investors in 2025. Section 1031 like-kind exchanges survived intact, and 100% bonus depreciation returned permanently. The combination of these two provisions creates powerful tax planning opportunities, but also introduces complexity that finance teams must manage carefully.
Understanding how depreciation rules interact with exchange transactions is essential for accurate fixed asset records. The basis calculations, timing requirements, and recapture rules all affect how replacement properties should be tracked in depreciation schedules.
The Tax Adviser Reports on Exchange Complexities
The Tax Adviser published guidance in September 2025 addressing advanced like-kind exchange topics. The article by Jonathan S. Robirds, CPA, and Jay Blaivas, J.D., examined multiproperty exchanges, reverse exchanges, and straddle transactions that cross tax years.
The authors noted that while Section 1031 requires strict compliance, it can accommodate the complexities of real estate transactions. Proper basis allocation and depreciation treatment remain critical for successful exchanges under current law.
Section 1031 Exchanges Preserved Under OBBBA
Early discussions of tax legislation included proposals to cap like-kind exchange deferrals above $500,000. Those restrictions did not make it into the final bill. Section 1031 remains fully available for real estate held for productive use in a trade or business or for investment.
The preservation of 1031 exchanges alongside permanent bonus depreciation creates what some practitioners describe as a double tax benefit scenario. Investors can defer capital gains through the exchange while accelerating deductions on eligible components of the replacement property.
Carryover Basis and Excess Basis Explained
When a property is acquired through a Section 1031 exchange, the tax basis splits into two distinct components. Understanding this division is fundamental to applying the correct depreciation treatment.
- Carryover basis represents the adjusted basis from the relinquished property that transfers to the replacement
- Excess basis arises when the replacement property costs more than the relinquished property sold for
- The carryover basis generally continues depreciating over the remaining recovery period of the old property
- The excess basis is treated as newly placed in service and starts a fresh depreciation schedule
Consider an investor who sells a property with $400,000 adjusted basis for $1 million and purchases a replacement property for $1.5 million. The carryover basis is $400,000. The excess basis is $500,000, representing the additional investment beyond the exchange value.
How Bonus Depreciation Applies to Exchange Properties
The restoration of 100% bonus depreciation under OBBBA creates significant opportunities for replacement properties acquired after January 19, 2025. However, the rules limit which portion of the basis qualifies for immediate expensing.
Only the excess basis of property acquired through a Section 1031 exchange qualifies for bonus depreciation. The carryover basis does not qualify because it represents deferred gain from the relinquished property rather than new investment. This distinction has substantial implications for depreciation planning.
In the previous example, the $500,000 excess basis would be eligible for 100% bonus depreciation on components identified through a cost segregation study. The $400,000 carryover basis would continue depreciating under the method and convention used for the original property.
The Simplified Method Election for Cost Segregation
Regulations under Section 1.168(i)-6(i) provide an alternative that can expand the benefits of cost segregation studies on replacement properties. The simplified method election allows taxpayers to treat both the carryover basis and excess basis as if placed in service on the acquisition date of the replacement property.
Under this election, the entire net tax basis becomes available for cost segregation analysis. The taxpayer makes the election by attaching a statement to the income tax return indicating the election under Regs. Sec. 1.168(i)-6(i) and describing the property.
The tradeoff is important to understand. While the simplified method expands the basis available for cost segregation, bonus depreciation still applies only to the excess basis. The carryover basis receives accelerated depreciation through shorter recovery periods but not the immediate first-year deduction.
Critical Timing Requirements for Exchanges
Section 1031 imposes strict deadlines that affect when depreciation begins on replacement properties. Missing these deadlines can convert an intended exchange into a taxable sale with different basis and depreciation consequences.
- Replacement property must be identified within 45 days of the relinquished property sale
- The exchange must be completed within 180 days of the relinquished property sale
- The taxpayer cannot have actual or constructive receipt of exchange proceeds
- Use of a qualified intermediary is essential to avoid constructive receipt issues
When an exchange straddles two tax years, additional considerations apply. If no replacement property is acquired by year end and the taxpayer is not entitled to receive the sales proceeds from the qualified intermediary, the transaction may be treated as an installment sale with gain recognized in the following year.
Depreciation Recapture in Exchange Transactions
While Section 1031 defers capital gains and depreciation recapture, certain situations can trigger unexpected tax liability. Investors who have taken accelerated depreciation through cost segregation studies face particular exposure if the replacement property does not contain sufficient matching components.
Section 1245 property identified in a cost segregation study on the relinquished property requires matching Section 1245 property in the replacement. If the replacement property contains less personal property than the relinquished property, recapture may be triggered even in an otherwise complete exchange.
- Perform cost segregation studies on both relinquished and replacement properties before closing
- Compare the Section 1245 property values to assess potential recapture exposure
- Consider acquiring multiple replacement properties to increase Section 1245 components
- Negotiate to include additional personal property in replacement property transactions
Basis Allocation in Multiproperty Exchanges
Investors frequently exchange one property for multiple replacement properties or consolidate multiple properties into a single larger asset. These multiproperty exchanges require careful basis allocation for proper depreciation treatment.
Under Regs. Sec. 1.1031(j)-1(c), the basis of the relinquished property is allocated to replacement properties in proportion to their relative fair market values. Each replacement property then carries its allocated portion of carryover basis along with any excess basis attributable to that property.
For example, if a taxpayer exchanges a property with $400,000 basis for two replacement properties worth $600,000 and $400,000 respectively, the basis allocation would be 60% to the first property and 40% to the second. The depreciation schedules must reflect these allocations separately.
Planning Strategies for 2025 and Beyond
The combination of preserved Section 1031 exchanges and permanent 100% bonus depreciation creates opportunities that require advance planning. Finance teams should consider these factors when structuring transactions:
- Commission cost segregation studies early to understand Section 1245 exposure before exchange
- Evaluate whether trading up in value maximizes excess basis eligible for bonus depreciation
- Consider the simplified method election when cost segregation on carryover basis is valuable
- Coordinate contract signing dates with OBBBA bonus depreciation eligibility requirements
- Document acquisition dates carefully for properties acquired through 1031 exchanges
State tax conformity also requires attention. Many states do not follow federal bonus depreciation rules, creating separate depreciation schedules for federal and state purposes on the same property.
Fixed Asset System Requirements
Properties acquired through Section 1031 exchanges present unique tracking requirements that fixed asset management systems must accommodate. Accurate records are essential for both ongoing depreciation calculations and eventual disposition reporting.
- Separate tracking of carryover basis with original placed-in-service date and recovery period
- Separate tracking of excess basis with new placed-in-service date and bonus eligibility
- Documentation of the simplified method election if made under Regs. Sec. 1.168(i)-6(i)
- Federal versus state depreciation differences when bonus conformity is limited
- Cost segregation allocations applied to the appropriate basis component
- Deferred gain tracking for future disposition calculations
The complexity increases when multiple exchanges occur over time. Each transaction creates new basis layers that must be tracked independently through the life of the property and any subsequent exchanges.
The Bottom Line for Finance Teams
Section 1031 exchanges remain one of the most powerful tax deferral tools available to real estate investors. The preservation of these rules alongside permanent 100% bonus depreciation under OBBBA creates opportunities to defer gains while accelerating deductions on new investment.
Success requires attention to detail. The distinction between carryover basis and excess basis determines bonus depreciation eligibility. The simplified method election can expand cost segregation benefits. And the matching requirements for Section 1245 property can create unexpected recapture if not planned carefully.
Finance teams managing properties acquired through exchanges must ensure their fixed asset systems capture these nuances. Proper documentation and tracking support accurate depreciation calculations and provide audit-ready records for what can be complex, multilayered transactions.
Frequently Asked Questions
Does bonus depreciation apply to 1031 exchange properties?
Bonus depreciation applies only to the excess basis of properties acquired through Section 1031 exchanges. The excess basis represents new investment beyond the exchanged value. The carryover basis from the relinquished property does not qualify for bonus depreciation because it represents deferred gain rather than new acquisition cost.
What is the simplified method election for 1031 exchanges?
The simplified method election under Regs. Sec. 1.168(i)-6(i) allows taxpayers to treat both the carryover basis and excess basis as if placed in service when the replacement property was acquired. This makes the entire basis available for cost segregation analysis, though bonus depreciation still applies only to the excess basis portion.
Can depreciation recapture be triggered in a 1031 exchange?
Yes. If the replacement property contains less Section 1245 personal property than the relinquished property, depreciation recapture may be triggered even in an otherwise complete exchange. Cost segregation studies on both properties can identify this exposure before closing.
How is basis allocated in multiproperty exchanges?
When one property is exchanged for multiple replacement properties, the basis is allocated in proportion to the relative fair market values of the replacement properties under Regs. Sec. 1.1031(j)-1(c). Each replacement property then maintains its allocated basis for depreciation purposes.
Did OBBBA change the rules for Section 1031 exchanges?
No. The One Big Beautiful Bill Act preserved Section 1031 like-kind exchanges without modification. Early proposals to cap deferrals above $500,000 were not included in the final legislation. The law did restore 100% bonus depreciation permanently, which affects how replacement property components can be depreciated.
