[Federal Register Volume 72, Number 40 (Thursday, March 1, 2007)]
[Rules and Regulations]
[Pages 9245-9262]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 07-922]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9314]
RIN 1545-BF37


Depreciation of MACRS Property That Is Acquired in a Like-Kind 
Exchange or as a Result of an Involuntary Conversion

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations relating to the 
depreciation of property subject to the accelerated cost recovery 
system under section 168 of the Internal Revenue Code (MACRS property). 
Specifically, these final regulations provide guidance on how to 
depreciate MACRS property acquired in a like-kind exchange under 
section 1031 or as a result of an involuntary conversion under section 
1033 when both the acquired and relinquished property are subject to 
MACRS in the hands of the acquiring taxpayer. These final regulations 
will affect taxpayers involved in a like-kind exchange under section 
1031 or an involuntary conversion under section 1033. The corresponding 
temporary regulations are removed.

DATES: Effective Dates: These regulations are effective on February 26, 
2007.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.168(a)-1(b), 1.168(b)-1(b), 1.168(d)-1(d)(3), 1.168(i)-1(l), 
1.168(i)-6(k), and 1.168(k)-1(g)(3)(ii).

FOR FURTHER INFORMATION CONTACT: Patrick S. Kirwan, (202) 622-3110 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR part 1 under section 
168 of the Internal Revenue Code (Code). Section 168 provides the 
depreciation deduction for tangible property generally placed in 
service after December 31, 1986.
    On March 1, 2004, the IRS and the Treasury Department published in 
the Federal Register (69 FR 9529) temporary regulations (TD 9115) 
relating to the depreciation allowable for tangible property of a 
character subject to the allowance for depreciation provided in section 
167(a) that is generally placed in service after

[[Page 9246]]

December 31, 1986, and is subject to section 168 (MACRS property) that 
is acquired in a like-kind exchange or as a result of involuntary 
conversion. On the same date the IRS published a notice of proposed 
rulemaking related to this topic in the Federal Register (69 FR 9560). 
No public hearing on the regulations was requested or held. Several 
written comments to the notice of proposed rulemaking were received. 
After consideration of all the comments received, the proposed 
regulations are adopted as amended by this Treasury decision, and the 
corresponding temporary regulations are removed. The revisions to the 
proposed regulations are discussed in this preamble. Unless otherwise 
specifically stated, references to the temporary regulations are to TD 
9115.

General Overview

    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. Section 
1001 generally provides for the recognition of gain or loss on the sale 
or exchange of 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 a transaction that also involves 
other property or money 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 other 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 
or stock. 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).

Summary of Comments and Explanation of Provisions

Scope

    In general, the final regulations adopt the rules outlined in the 
proposed and temporary regulations with the addition of some clarifying 
language and examples provided in response to comments. The temporary 
regulations provided guidance as to how to determine the annual 
depreciation allowance under section 168 for replacement property 
acquired in a like-kind exchange or involuntary conversion. However, 
the temporary regulations did not apply to a like-kind exchange or 
involuntary conversion if the allowance for depreciation of either the 
relinquished or replacement property is computed under a depreciation 
system other than section 168 (MACRS), or for which a taxpayer made a 
valid election under section 168(f)(1) to exclude it from the 
application of MACRS. A commentator requested that the final 
regulations apply to all property acquired in a like-kind exchange or 
involuntary conversion. However, it is anticipated that the vast 
majority of like-kind exchanges and involuntary conversions occurring 
after the effective date of the final regulations will involve the 
exchange of MACRS property. In addition, there are differences between 
MACRS and other depreciation systems which would require the creation 
of additional rules which would only apply in a limited number of 
circumstances. Furthermore, certain types of property are statutorily 
excluded from being treated as MACRS property. Therefore, the final 
regulations do not adopt the commentator's suggestion. However, the 
final regulations allow a taxpayer to elect to treat the sum of the 
exchanged basis and excess basis of the replacement property as MACRS 
property that is placed in service at the time of replacement if the 
tangible depreciable property acquired by a taxpayer in a like-kind 
exchange or involuntary conversion replaces tangible depreciable 
property for which the taxpayer made a valid election under section 
168(f)(1) to exclude it from the application of MACRS. For example, a 
taxpayer that exchanges a machine depreciated under the unit of 
production method for a used machine may depreciate under MACRS the sum 
of the exchanged basis and excess basis of the used machine 
(replacement property) as a machine placed in service at the time of 
replacement.

Optional Depreciation Tables

    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 CB 687, 692)), the final 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. A commentator noted that under the 
temporary regulations depreciation computed using the optional tables 
could be different than the depreciation computed using the formulas 
and suggested adopting a different transaction coefficient. The IRS and 
Treasury recognize that use of the optional depreciation tables may 
result in a different computation of depreciation. Nonetheless, the 
optional depreciation tables are intended to provide an alternative 
method of calculating depreciation for taxpayers. Furthermore, the 
transaction coefficient formula provided in the temporary regulations 
is consistent with transaction coefficient formulas provided in other 
depreciation guidance. Therefore, the final regulations retain the 
rules provided in the temporary regulations.

Depreciation Convention Provisions

    Several comments were received about the application of the

[[Page 9247]]

depreciation convention provisions under the temporary regulations. In 
response to these comments, several changes were made in the final 
regulations. Section 1.168(i)-6(c)(5)(ii)(A) was added in order to 
provide an explanation of the applicable convention separate from the 
explanation of the rule for determining the remaining recovery period 
for the replacement MACRS property. Section 1.168(i)-6(c)(4)(v) 
specifically addresses the convention that applies to the exchanged 
basis when the year of replacement is after the year of disposition and 
the relinquished MACRS property was placed in service in the year of 
disposition. Section 1.168(i)-6(c)(5)(i)(B) of the final regulations 
contains a new rule that provides that if, using the convention that 
applies to the relinquished MACRS property, the remaining recovery 
period of the relinquished MACRS property at the beginning of the year 
of disposition is less than the number of months between the first of 
that year and the time of disposition, the entire basis in the 
relinquished MACRS property is deductible in the year of disposition 
and the exchanged basis is zero. In light of this new rule, Example 4 
of Sec.  1.168(i)-6T(c)(6) of the temporary regulations has been 
replaced by Example 5 of Sec.  1.168(i)-6(c)(6).

Deferred Exchanges

    The temporary regulations did not permit a taxpayer to take 
depreciation on relinquished MACRS property during the period between 
the disposition of the relinquished MACRS property and the acquisition 
of the replacement MACRS property. A comment was received which noted 
that under the half-year convention if relinquished MACRS property is 
disposed of in year 1 and the replacement MACRS property is not 
acquired until year 2, the taxpayer would only be entitled to deduct a 
half-year of depreciation in each year. The IRS and Treasury Department 
recognize that this result could occur under the convention rules. 
However, similar results occur when property is disposed of and 
replaced in a transaction to which section 1031 or section 1033 do not 
apply. In addition, the IRS and Treasury Department believe that a 
taxpayer cannot depreciate property the taxpayer does not own. 
Therefore, the final regulations retain the rule provided in the 
temporary regulations with respect to this issue. The final regulations 
reserve on providing specific guidance as to whether an intermediary 
(such as an exchange accommodation titleholder) is entitled to 
depreciation.

Acquisition Prior to Disposition for an Involuntary Conversion

    The temporary regulations allowed taxpayers to begin depreciating 
replacement property upon acquisition even if the acquisition occurs 
prior the disposition of the relinquished property if the replacement 
property is acquired to meet the requirements of section 1033(a)(2)(B) 
(acquisition under threat of condemnation). However, the temporary 
regulations also required taxpayers to include in taxable income any 
excess depreciation allowable on the unadjusted depreciable basis of 
the replacement MACRS property over the depreciation 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. A comment was 
received suggesting that taxpayers be permitted to reduce the exchanged 
basis of the replacement property by the excess depreciation rather 
than requiring a taxpayer to recognize the excess depreciation as 
taxable income. This suggestion was not adopted in the final 
regulations because it would have the effect of inappropriately 
accelerating depreciation deductions for the replacement property.

Exchanges of Multiple Properties

    The determination of the basis of property acquired in a like-kind 
exchange involving multiple properties is described in Sec.  1.1031(j)-
1 and the determination of the basis of multiple properties acquired as 
a result of an involuntary conversion is described in Sec.  1.1033(b)-
1. Commentators requested examples to show how the temporary 
regulations apply to the depreciation treatment of a like-kind exchange 
or an involuntary conversion involving multiple properties. Other 
commentators suggested that taxpayers be permitted to use any 
reasonable, consistent method of allocating basis among the properties. 
The IRS and Treasury Department believe that these comments concern the 
allocation of basis principles under sections 1031 and 1033, rather 
than the depreciation rules under section 168. Once basis in property 
is determined or allocated under section 1031 or section 1033, these 
final regulations would then apply for determining the depreciation 
allowable with respect to such basis. The IRS and Treasury Department 
believe that issues related to allocation of basis among multiple 
properties involved in like-kind exchanges or involuntary conversions 
for purposes of depreciation are beyond the scope of the final 
regulations. Therefore the final regulations do not address these 
issues. However, the IRS and Treasury Department intend to invite 
interested parties to submit written comments regarding whether 
additional published guidance is needed in this area, and to invite 
written comments that specifically propose or address possible 
resolutions to these issues.

Transactions Involving Nondepreciable Property

    A commentator requested guidance as to how depreciation is 
calculated if the relinquished property was only partially used for 
business purposes. In response to this comment, the final regulations 
provide an example to show how depreciation is calculated on 
replacement property received in exchange for property that was used 
only partially for business purposes (see Example 2 in Sec.  1.168(i)-
6(d)(3)(iii)).

General Asset Accounts

    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 
Department requested 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. No comments were received on this 
rule and no alternatives were suggested. Therefore, the regulations are 
adopted as proposed.

Effective Date

    These final regulations generally apply to a like-kind exchange or 
an involuntary conversion of MACRS property for which the time of 
disposition and the time of replacement both occur after February 27, 
2004. For a like-kind exchange or an involuntary conversion of MACRS 
property for which the time of disposition, the time of replacement, or 
both occur on or before February 27, 2004, a taxpayer may apply these 
final regulations or rely on prior guidance issued by the IRS.

[[Page 9248]]

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations and, because 
these regulations do not impose a collection of information requirement 
on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
does not apply. Therefore, a Regulatory Flexibility Analysis is not 
required. Pursuant to section 7805(f) of the Code, the notice of 
proposed rulemaking preceding these final regulations was submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Patrick S. Kirwan, 
Office of the Associate Chief Counsel (Passthroughs and Special 
Industries). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Sections 1.168(a)-1 and 1.168(b)-1 are added to read as 
follows:


Sec.  1.168(a)-1  Modified accelerated cost recovery system.

    (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.


Sec.  1.168(b)-1  Definitions.

    (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, section 179C, 
or any similar provision, 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 Sec.  1.168(b)-1(a)(3), less the 
adjustments described in section 1016(a)(2) and (3).
    (b) Effective date. This section is applicable on or after February 
27, 2004.


Sec. Sec.  1.168(a)-1T and 1.168(b)-1T  [Removed]

0
Par. 3. Sections 1.168(a)-1T and 1.168(b)-1T are removed.
0
Par. 4. Section 1.168(d)-1 is amended by revising the section heading 
and paragraphs (b)(3) and (d)(3) to read as follows:


Sec.  1.168(d)-1  Applicable conventions--half-year and mid-quarter 
conventions.

* * * * *
    (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 Sec. Sec.  1.168(i)-6(c)(4)(v)(B) and 1.168(i)-6(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 Sec. Sec.  1.168(i)-6(c)(4)(v)(A) and 
1.168(i)-6(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 Sec.  1.168(k)-1(f)(1) for 
rules relating to qualified property or 50-percent bonus depreciation 
property, and Sec.  1.1400L(b)-1(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) * * *
    (3) Like-kind exchanges and involuntary conversions. 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.

[[Page 9249]]

Sec.  1.168(d)-1T  [Removed]

0
Par. 5. Section 1.168(d)-1T is removed.

0
Par. 6. Section 1.168(i)-0 is amended as follows:
0
1. The entries for Sec.  1.168(i)-1(d)(2), (e)(3)(i), (e)(3)(v), 
(e)(3)(vi), (f), (f)(1), (f)(2), (f)(2)(i), (i), (j), and (l) are 
revised.
0
2. The entries for Sec.  1.168(i)-1(l)(1), (l)(2), and (l)(3) are 
added.
    The revisions and additions read as follows:


Sec.  1.168(i)-0  Table of contents for the general asset account 
rules.

* * * * *


Sec.  1.168(i)-1  General asset accounts.

* * * * *
    (d) * * *
    (2) Special rule for passenger automobiles.
* * * * *
    (e) * * *
    (3) * * *
    (i) In general.
* * * * *
    (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.
* * * * *
    (i) Identification of disposed or converted asset.
    (j) Effect of adjustments on prior dispositions.
* * * * *
    (l) Effective date.
    (1) In general.
    (2) Exceptions.
    (3) Like-kind exchanges and involuntary conversions.

Sec.  1.168(i)-0T  [Removed]

0
Par. 7. Section 1.168(i)-0T is removed.

0
Par. 8. Section 1.168(i)-1 is amended as follows:
0
1. Paragraphs (d)(2), (e)(3)(i), (e)(3)(iii)(B)(4), (e)(3)(v), 
(e)(3)(vi), (f)(1), (f)(2)(i), (i), (j), (l)(1), and (l)(3) are 
revised.
0
2. The first sentence in paragraph (l)(2)(ii)(B) is amended by removing 
the language ``as modified by Rev. Proc. 2004-11 (2004-3 I.R.B. 311)''.
    The revisions read as follows:


Sec.  1.168(i)-1  General asset accounts.

* * * * *
    (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) * * *
    (3) * * *
    (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.
* * * * *
    (iii) * * *
    (B) * * *
    (4) A transaction, other than a transaction described in paragraphs 
(e)(3)(iv) (pertaining to transactions subject to section 168(i)(7)) 
and (e)(3)(v) (pertaining to transactions subject to section 1031 or 
1033) of this section, to which a nonrecognition section of the Code 
applies (determined without regard to this section).
* * * * *
    (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 Sec.  1.168-6(b)(11)) or in an involuntary 
conversion (as defined under Sec.  1.168-6(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 Sec.  1.168(i)-
6(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 Sec.  1.168(i)-6(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 Sec.  1.168(i)-6(b)(2)) in 
the year of disposition is determined under Sec.  1.168(i)-6. 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 Sec.  
1.168(i)-6(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 Sec.  1.168(i)-6(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 Sec.  1.168(i)-6(b)(2)) in the year of disposition is 
determined under Sec.  1.168(i)-6. 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

[[Page 9250]]

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


Sec.  1.168(i)-1T  [Removed]

0
Par. 9. Section 1.168(i)-1T is removed.

0
Par. 10. Section 1.168(i)-5 is added to read as follows:


Sec.  1.168(i)-5  Table of contents.

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


Sec.  1.168(i)-6  Like-kind exchanges and involuntary conversions.

    (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.

[[Page 9251]]

    (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) Either the relinquished MACRS property or the replacement 
MACRS property is mid-month property.
    (B) Neither the relinquished MACRS property nor the replacement 
MACRS property is mid-month property.
    (5) Year of disposition and year of replacement.
    (i) Relinquished MACRS property.
    (A) General rule.
    (B) Special rule.
    (ii) Replacement MACRS property.
    (A) Remaining recovery period of the replacement MACRS property.
    (B) Year of replacement is 12 months.
    (iii) Year of disposition or year of replacement is less than 12 
months.
    (iv) Deferred transactions.
    (A) In general.
    (B) Allowable depreciation for a qualified intermediary.
    (v) 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) Examples.
    (4) Involuntary conversion for which the replacement MACRS 
property is 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) Elections.
    (1) Election not to apply this section.
    (2) Election to treat certain replacement property as MACRS 
property.
    (j) Time and manner of making election under paragraph (i)(1) of 
this section.
    (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.
    (3) Like-kind exchanges and involuntary conversions where the 
taxpayer made the election under section 168(f)(1) for the 
relinquished property.


Sec.  1.168(i)-5T  [Removed]

0
Par. 11. Section 1.168(i)-5T is removed.
0
Par. 12. Section 1.168(i)-6 is added to read as follows:


Sec.  1.168(i)-6  Like-kind exchanges and involuntary conversions.

    (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 Sec.  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 under paragraph (i) of this section has not been made.
    (b) Definitions. For purposes of this section, the following 
definitions apply:
    (1) Replacement MACRS property is MACRS property (as defined in 
Sec.  1.168(b)-1(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 
Sec.  1.168(d)-1, 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 Sec.  1.168(b)-
1(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 (Code) and the regulations under the Code 
(including section 1016(a)(2) and (3), for example, depreciation 
deductions in the year of

[[Page 9252]]

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 
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 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 section 168 of the Internal Revenue Code of 1954 (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 of section 168(a) 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.
    (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 
under section 168, 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 CB 
687, 692) and Sec.  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

[[Page 9253]]

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. The applicable convention for the exchanged basis 
is determined under this paragraph (c)(4)(v).
    (A) Either the relinquished MACRS property or the replacement MACRS 
property is mid-month property. If either the relinquished MACRS 
property or the replacement MACRS property is property for which the 
applicable convention (as determined under section 168(d)) is the mid-
month convention, the exchanged basis must be depreciated using the 
mid-month convention.
    (B) Neither the relinquished MACRS property nor the replacement 
MACRS property is mid-month property. If neither the relinquished MACRS 
property nor the replacement MACRS property is property for which the 
applicable convention (as determined under section 168(d)) is the mid-
month convention, the applicable convention for the exchanged basis is 
the same convention that applied to the relinquished MACRS property. If 
the relinquished MACRS property is placed in service in the year of 
disposition, and the time of replacement is also in the year of 
disposition, the convention that applies to the relinquished MACRS 
property is determined under paragraph (f)(1)(i) of this section. If, 
however, relinquished MACRS property was placed in service in the year 
of disposition and the time of replacement is in a taxable year 
subsequent to the year of disposition, the convention that applies to 
the exchanged basis is the convention that applies in that

[[Page 9254]]

subsequent taxable year (see paragraph (f)(1)(ii) of this section).
    (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 property is disposed of by a taxpayer during the same 
taxable year that the relinquished MACRS property is placed in service 
by the taxpayer, no depreciation deduction is allowable for either 
MACRS property. Otherwise, the depreciation allowances for the year of 
disposition and for the year of replacement are determined as follows:
    (i) Relinquished MACRS property--(A) General rule. Except as 
provided in paragraphs (c)(5)(i)(B), (c)(5)(iii), (e), and (i) of this 
section, the depreciation allowance in the year of disposition for the 
relinquished MACRS property is computed by multiplying the allowable 
depreciation deduction for the property for that year by a fraction, 
the numerator of which is the number of months (including fractions of 
months) the property is deemed to be placed in service during the year 
of disposition (taking into account the applicable convention of the 
relinquished MACRS property), and the denominator of which is 12. In 
the case of termination under Sec.  1.168(i)-1(e)(3)(v) of general 
asset account treatment of an asset, or of all the assets remaining, in 
a general asset account, the allowable depreciation deduction in the 
year of disposition for the asset or assets for which general asset 
account treatment is terminated is determined using the depreciation 
method, recovery period, and convention of the general asset account. 
This allowable depreciation deduction is adjusted to account for the 
period the asset or assets is deemed to be in service in accordance 
with this paragraph (c)(5)(i).
    (B) Special rule. If, at the beginning of the year of disposition, 
the remaining recovery period of the relinquished MACRS property, 
taking into account the applicable convention of such property, is less 
than the period between the beginning of the year of disposition and 
the time of disposition, the depreciation deduction for the 
relinquished MACRS property for the year of disposition is equal to the 
adjusted depreciable basis of the relinquished MACRS property at the 
beginning of the year of disposition. If this paragraph applies, the 
exchanged basis is zero and no depreciation is allowable for the 
exchanged basis in the replacement MACRS property.
    (ii) Replacement MACRS property--(A) Remaining recovery period of 
the replacement MACRS property. The replacement MACRS property is 
treated as placed in service at the time of replacement under the 
convention that applies to the replacement MACRS property as determined 
under this paragraph (c)(5)(ii). The remaining recovery period of the 
replacement MACRS property at the time of replacement is the excess of 
the recovery period for the replacement MACRS property, as determined 
under paragraph (c) of this section, over the period of time that the 
replacement MACRS property would have been in service if it had been 
placed in service when the relinquished MACRS property was placed in 
service and removed from service at the time of disposition of the 
relinquished MACRS property. This period is determined by using the 
convention that applied to the relinquished MACRS property to determine 
the date that the relinquished MACRS property is deemed to have been 
placed in service and the date that it is deemed to have been disposed 
of. The length of time the replacement MACRS property would have been 
in service is determined by using these dates and the convention that 
applies to the replacement MACRS property.
    (B) Year of replacement is 12 months. Except as provided in 
paragraphs (c)(5)(iii), (e), and (i) of this section, the depreciation 
allowance in the year of replacement for the depreciable exchanged 
basis is determined by--
    (1) Calculating the applicable depreciation rate for the 
replacement MACRS property as of the beginning of the year of 
replacement taking into account the depreciation method prescribed for 
the replacement MACRS property under paragraph (c)(3) of this section 
and the remaining recovery period of the replacement MACRS property as 
of the beginning of the year of disposition as determined under this 
paragraph (c)(5)(ii);
    (2) Calculating the depreciable exchanged basis of the replacement 
MACRS property, and adding to that amount the amount determined under 
paragraph (c)(5)(i) of this section for the year of disposition; and
    (3) Multiplying the product of the amounts determined under 
paragraphs (c)(5)(ii)(B)(1) and (B)(2) of this section by a fraction, 
the numerator of which is the number of months (including fractions of 
months) the property is deemed to be in service during the year of 
replacement (in the year of replacement the replacement MACRS property 
is deemed to be placed in service by the acquiring taxpayer at the time 
of replacement under the convention determined under paragraph 
(c)(4)(v) of this section), and the denominator of which is 12.
    (iii) Year of disposition or year of replacement is less than 12 
months. If the year of disposition or the year of replacement is less 
than 12 months, the depreciation allowance determined under paragraph 
(c)(5)(ii)(A) of this section must be adjusted for a short taxable year 
(for further guidance, for example, see Rev. Proc. 89-15 (1989-1 CB 
816) and Sec.  601.601(d)(2)(ii)(b) of this chapter).
    (iv) Deferred transactions--(A) In general. If the replacement 
MACRS property is not acquired until after the disposition of the 
relinquished MACRS property, taking into account the applicable 
convention of the relinquished MACRS property and replacement MACRS 
property, depreciation is not allowable during the period between the 
disposition of the relinquished MACRS property and the acquisition of 
the replacement MACRS property. The recovery period for the replacement 
MACRS property is suspended during this period. For purposes of 
paragraph (c)(5)(ii) of this section, only the depreciable exchanged 
basis of the replacement MACRS property is taken into account for 
calculating the amount in paragraph (c)(5)(ii)(B)(2) of this section if 
the year of replacement is a taxable year subsequent to the year of 
disposition.
    (B) Allowable depreciation for a qualified intermediary. 
[Reserved].
    (v) Remaining recovery period. The remaining recovery period of the 
replacement MACRS property is determined as of the beginning of the 
year of disposition of the relinquished MACRS property. For purposes of 
determining the remaining recovery period of the replacement MACRS 
property, the replacement MACRS property is deemed to have been 
originally placed in service under the convention determined under 
paragraph (c)(4)(v) of this section, but at the time the relinquished 
MACRS property was deemed to be placed in service under the convention 
that applied to it when it was placed in service.
    (6) Examples. The application of this paragraph (c) is illustrated 
by the following examples:

    Example 1. A1, a calendar-year taxpayer, exchanges Building M, 
an office building, for Building N, a warehouse in a like-kind 
exchange. Building M is relinquished in July 2004 and Building N is 
acquired and placed in service in October 2004. A1 did not make any 
elections under section 168 for either Building M or Building N. The 
unadjusted depreciable basis of Building M was

[[Page 9255]]

$4,680,000 when placed in service in July 1997. Since the recovery 
period and depreciation method prescribed under section 168 for 
Building N (39 years, straight line method) are the same as the 
recovery period and depreciation method prescribed under section 168 
for Building M (39 years, straight line method), Building N is 
depreciated over the remaining recovery period of, and using the 
same depreciation method and convention as that of, Building M. 
Applying the applicable convention, Building M is deemed disposed of 
on July 15, 2004, and Building N is placed in service on October 15, 
2004. Thus, Building N will be depreciated using the straight line 
method over a remaining recovery period of 32 years beginning in 
October 2004 (the remaining recovery period of 32 years and 6.5 
months at the beginning of 2004, less the 6.5 months of depreciation 
taken prior to the disposition of the exchanged MACRS property 
(Building M) in 2004). For 2004, the year in which the transaction 
takes place, the depreciation allowance for Building M is 
($120,000)(6.5/12) which equals $65,000. The depreciation allowance 
for Building N for 2004 is ($120,000)(2.5/12) which equals $25,000. 
For 2005 and subsequent years, Building N is depreciated over the 
remaining recovery period of, and using the same depreciation method 
and convention as that of, Building M. Thus, the depreciation 
allowance for Building N is the same as Building M, namely $10,000 
per month.
    Example 2. B, a calendar-year taxpayer, placed in service Bridge 
P in January 1998. Bridge P is depreciated using the half-year 
convention. In January 2004, B exchanges Bridge P for Building Q, an 
apartment building, in a like-kind exchange. Pursuant to paragraph 
(k)(2)(i) of this section, B decided to apply Sec.  1.168(i)-6 to 
the exchange of Bridge P for Building Q, the replacement MACRS 
property. B did not make any elections under section 168 for either 
Bridge P or Building Q. Since the recovery period prescribed under 
section 168 for Building Q (27.5 years) is longer than that of 
Bridge P (15 years), Building Q is depreciated as if it had 
originally been placed in service in July 1998 and disposed of in 
July 2004 using a 27.5 year recovery period. Additionally, since the 
depreciation method prescribed under section 168 for Building Q 
(straight line method) is less accelerated than that of Bridge P 
(150-percent declining balance method), then the depreciation 
allowance for Building Q is computed using the straight line method. 
Thus, when Building Q is acquired and placed in service in 2004, its 
basis is depreciated over the remaining 21.5 year recovery period 
using the straight line method of depreciation and the mid-month 
convention beginning in July 2004.
    Example 3. C, a calendar-year taxpayer, placed in service 
Building R, a restaurant, in January 1996. In January 2004, C 
exchanges Building R for Tower S, a radio transmitting tower, in a 
like-kind exchange. Pursuant to paragraph (k)(2)(i) of this section, 
C decided to apply Sec.  1.168(i)-6 to the exchange of Building R 
for Tower S, the replacement MACRS property. C did not make any 
elections under section 168 for either Building R or Tower S. Since 
the recovery period prescribed under section 168 for Tower S (15 
years) is shorter than that of Building R (39 years), Tower S is 
depreciated over the remaining recovery period of Building R. 
Additionally, since the depreciation method prescribed under section 
168 for Tower S (150% declining balance method) is more accelerated 
than that of Building R (straight line method), then the 
depreciation allowance for Tower S is also computed using the same 
depreciation method as Building R. Thus, Tower S is depreciated over 
the remaining 31 year recovery period of Building R using the 
straight line method of depreciation and the mid-month convention. 
Alternatively, C may elect under paragraph (i) of this section to 
treat Tower S as though it is placed in service in January 2004. In 
such case, C uses the applicable recovery period, depreciation 
method, and convention prescribed under section 168 for Tower S.
    Example 4. (i) In February 2002, D, a calendar-year taxpayer and 
manufacturer of rubber products, acquired for $60,000 and placed in 
service Asset T (a special tool) and depreciated Asset T using the 
straight line method election under section 168(b)(5) and the mid-
quarter convention over its 3-year recovery period. D elected not to 
deduct the additional first year depreciation for 3-year property 
placed in service in 2002. In June 2004, D exchanges Asset T for 
Asset U (not a special tool) in a like-kind exchange. D elected not 
to deduct the additional first year depreciation for 7-year property 
placed in service in 2004. Since the recovery period prescribed 
under section 168 for Asset U (7 years) is longer than that of Asset 
T (3 years), Asset U is depreciated as if it had originally been 
placed in service in February 2002 using a 7-year recovery period. 
Additionally, since the depreciation method prescribed under section 
168 for Asset U (200-percent declining balance method) is more 
accelerated than that of Asset T (straight line method) at the time 
of disposition, the depreciation allowance for Asset U is computed 
using the straight line method. Asset U is depreciated over its 
remaining recovery period of 4.75 years using the straight line 
method of depreciation and the mid-quarter convention.
    (ii) The 2004 depreciation allowance for Asset T is $7,500 
($20,000 allowable depreciation deduction for 2004) x 4.5 months / 
12).
    (iii) The depreciation rate in 2004 for Asset U is 0.1951 (1 / 
5.125 years (the length of the applicable recovery period remaining 
as of the beginning of 2004)). Therefore, the depreciation allowance 
for Asset U in 2004 is $2,744 (0.1951 x $22,500 (the sum of the 
$15,000 depreciable exchanged basis of Asset U ($22,500 adjusted 
depreciable basis at the beginning of 2004 for Asset T, less the 
$7,500 depreciation allowable for Asset T for 2004) and the $7,500 
depreciation allowable for Asset T for 2004) x 7.5 months / 12).
    Example 5. The facts are the same as in Example 4 except that D 
exchanges Asset T for Asset U in June 2005, in a like-kind exchange. 
Under these facts, the remaining recovery period of Asset T at the 
beginning of 2005 is 1.5 months and, as a result, is less than the 
5-month period between the beginning of 2005 (year of disposition) 
and June 2005 (time of disposition). Accordingly, pursuant to 
paragraph (c)(5)(i)(B) of this section, the 2005 depreciation 
allowance for Asset T is $2,500 ($2,500 adjusted depreciable basis 
at the beginning of 2005 ($60,000 original basis minus $17,500 
depreciation deduction for 2002 minus $20,000 depreciation deduction 
for 2003 minus $20,000 depreciation deduction for 2004)). Because 
the exchanged basis of asset U is $0.00, no depreciation is 
allowable for asset U.
    Example 6. On January 1, 2004, E, a calendar-year taxpayer, 
acquired and placed in service Canopy V, a gas station canopy. The 
purchase price of Canopy V was $60,000. On August 1, 2004, Canopy V 
was destroyed in a hurricane and was therefore no longer usable in 
E's business. On October 1, 2004, as part of the involuntary 
conversion, E acquired and placed in service new Canopy W with the 
insurance proceeds E received due to the loss of Canopy V. E elected 
not to deduct the additional first year depreciation for 5-year 
property placed in service in 2004. E depreciates both canopies 
under the general depreciation system of section 168(a) by using the 
200-percent declining balance method of depreciation, a 5-year 
recovery period, and the half-year convention. No depreciation 
deduction is allowable for Canopy V. The depreciation deduction 
allowable for Canopy W for 2004 is $12,000 ($60,000 x the annual 
depreciation rate of .40 x \1/2\ year). For 2005, the depreciation 
deduction for Canopy W is $19,200 ($48,000 adjusted basis x the 
annual depreciation rate of .40).
    Example 7. The facts are the same as in Example 6, except that E 
did not make the election out of the additional first year 
depreciation for 5-year property placed in service in 2004. E 
depreciates both canopies under the general depreciation system of 
section 168(a) by using the 200-percent declining balance method of 
depreciation, a 5-year recovery period, and the half-year 
convention. No depreciation deduction is allowable for Canopy V. For 
2004, E is allowed a 50-percent additional first year depreciation 
deduction of $30,000 for Canopy W (the unadjusted depreciable basis 
of $60,000 multiplied by .50), and a regular MACRS depreciation 
deduction of $6,000 for Canopy W (the depreciable exchanged basis of 
$30,000 multiplied by the annual depreciation rate of .40 x \1/2\ 
year). For 2005, E is allowed a regular MACRS depreciation deduction 
of $9,600 for Canopy W (the depreciable exchanged basis of $24,000 
($30,000 minus regular 2003 depreciation of $6,000) multiplied by 
the annual depreciation rate of .40).
    Example 8. In January 2001, F, a calendar-year taxpayer, places 
in service a paved parking lot, Lot W, and begins depreciating Lot W 
over its 15-year recovery period. F's unadjusted depreciable basis 
in Lot W is $1,000x. On April 1, 2004, F disposes of Lot W in a 
like-kind exchange for Building X, which is nonresidential real 
property. Lot W is depreciated using the 150 percent declining 
balance method and the half-year convention. Building X is 
depreciated using the straight-line method with a 39-year

[[Page 9256]]

recovery period and using the mid-month convention. Both Lot W and 
Building X were in service at the time of the exchange. Because Lot 
W was depreciated using the half-year convention, it is deemed to 
have been placed in service on July 1, 2001, the first day of the 
second half of 2001, and to have been disposed of on July 1, 2004, 
the first day of the second half of 2004. To determine the remaining 
recovery period of Building X at the time of replacement, Building X 
is deemed to have been placed in service on July 1, 2001, and 
removed from service on July 1, 2004. Thus, Building X is deemed to 
have been in service, at the time of replacement, for 3 years (36 
months = 5.5 months in 2001 + 12 months in 2002 + 12 months in 2003 
+ 6.5 months in 2004) and its remaining recovery period is 36 years 
(39 - 3). Because Building X is deemed to be placed in service at 
the time of replacement, July 1, 2004, the first day of the second 
half of 2004, Building X is depreciated for 5.5 months in 2004. 
However, at the beginning of the year of replacement the remaining 
recovery period for Building X is 36 years and 6.5 months (39 years 
- 2 years and 5.5 months (5.5 months in 2001 + 12 months in 2002 + 
12 months in 2003)). The depreciation rate for building X for 2004 
is 0.02737 (= 1/(39-2-5.5/12)). For 2005, the depreciation rate for 
Building X is 0.02814 (= 1/(39-3-5.5/12)).
    Example 9. The facts are the same as in Example 8. F did not 
make the election under paragraph (i) of this section for Building Y 
in the initial exchange. In January 2006, F exchanges Building Y for 
Building Z, an office building, in a like-kind exchange. F did not 
make any elections under section 168 for either Building Y or 
Building Z. Since the recovery period prescribed for Building Y as a 
result of the initial exchange (39 years) is longer than that of 
Building Z (27.5 years), Building Z is depreciated over the 
remaining 33 years of the recovery period of Building Y. The 
depreciation methods are the same for both Building Y and Building Z 
so F's exchanged basis in Building Z is depreciated over 33 years, 
using the straight-line method and the mid-month convention, 
beginning in January 2006. Alternatively, F could have made the 
election under paragraph (i) of this section. If F makes such 
election, Building Z is treated as placed in service by F when 
acquired in January 2006 and F would recover its exchanged basis in 
Building Z over 27.5 years, using the straight line method and the 
mid-month convention, beginning in January 2006.

    (d) Special rules for determining depreciation allowances--(1) 
Excess basis--(i) In general. Any excess basis in the replacement MACRS 
property is treated as property that is placed in service by the 
acquiring taxpayer in the year of replacement. Thus, the depreciation 
allowances for the depreciable excess basis are determined by using the 
applicable recovery period, depreciation method, and convention 
prescribed under section 168 for the property at the time of 
replacement. However, if replacement MACRS property is disposed of 
during the same taxable year the relinquished MACRS property is placed 
in service by the acquiring taxpayer, no depreciation deduction is 
allowable for either MACRS property. See paragraph (g) of this section 
regarding the application of section 179. See paragraph (h) of this 
section regarding the application of section 168(k) or 1400L(b).
    (ii) Example. The application of this paragraph (d)(1) is 
illustrated by the following example:

    Example. In 1989, G placed in service a hospital. On January 16, 
2004, G exchanges this hospital plus $2,000,000 cash for an office 
building in a like-kind exchange. On January 16, 2004, the hospital 
has an adjusted depreciable basis of $1,500,000. After the exchange, 
the basis of the office building is $3,500,000. Pursuant to 
paragraph (k)(2)(i) of this section, G decided to apply Sec.  
1.168(i)-6 to the exchange of the hospital for the office building, 
the replacement MACRS property. The depreciable exchanged basis of 
the office building is depreciated in accordance with paragraph (c) 
of this section. The depreciable excess basis of $2,000,000 is 
treated as being placed in service by G in 2004 and, as a result, is 
depreciated using the applicable depreciation method, recovery 
period, and convention prescribed for the office building under 
section 168 at the time of replacement.

    (2) Depreciable and nondepreciable property--(i) If land or other 
nondepreciable property is acquired in a like-kind exchange for, or as 
a result of an involuntary conversion of, depreciable property, the 
land or other nondepreciable property is not depreciated. If both MACRS 
and nondepreciable property are acquired in a like-kind exchange for, 
or as part of an involuntary conversion of, MACRS property, the basis 
allocated to the nondepreciable 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)) is not depreciated and the 
basis allocated to 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)) is depreciated in 
accordance with this section.
    (ii) If MACRS property is acquired, or if both MACRS and 
nondepreciable property are acquired, in a like-kind exchange for, or 
as part of an involuntary conversion of, land or other nondepreciable 
property, the basis in the replacement MACRS property that is 
attributable to the relinquished nondepreciable property is treated as 
though the replacement MACRS property is placed in service by the 
acquiring taxpayer in the year of replacement. Thus, the depreciation 
allowances for the replacement MACRS property 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. See paragraph (g) of this section regarding the 
application of section 179. See paragraph (h) of this section regarding 
the application of section 168(k) or 1400L(b).
    (3) Depreciation limitations for automobiles--(i) In general. 
Depreciation allowances under section 179 and section 167 (including 
allowances under sections 168 and 1400L(b)) for a passenger automobile, 
as defined in section 280F(d)(5), are subject to the limitations of 
section 280F(a). The depreciation allowances for a passenger automobile 
that is replacement MACRS property (replacement MACRS passenger 
automobile) generally are limited in any taxable year to the 
replacement automobile section 280F limit for the taxable year. The 
taxpayer's basis in the replacement MACRS passenger automobile is 
treated as being comprised of two separate components. The first 
component is the exchanged basis and the second component is the excess 
basis, if any. The depreciation allowances for a passenger automobile 
that is relinquished MACRS property (relinquished MACRS passenger 
automobile) for the taxable year generally are limited to the 
relinquished automobile section 280F limit for that taxable year. In 
the year of disposition the sum of the depreciation deductions for the 
relinquished MACRS passenger automobile and the replacement MACRS 
passenger automobile may not exceed the replacement automobile section 
280F limit unless the taxpayer makes the election under Sec.  1.168(i)-
6(i). For purposes of this paragraph (d)(3), the following definitions 
apply:
    (A) Replacement automobile section 280F limit is the limit on 
depreciation deductions under section 280F(a) for the taxable year 
based on the time of replacement of the replacement MACRS passenger 
automobile (including the effect of any elections under section 168(k) 
or section 1400L(b), as applicable).
    (B) Relinquished automobile section 280F limit is the limit on 
depreciation deductions under section 280F(a) for the taxable year 
based on when the relinquished MACRS passenger automobile was placed in 
service by the taxpayer.
    (ii) Order in which limitations on depreciation under section 
280F(a) are applied. Generally, depreciation

[[Page 9257]]

deductions allowable under section 280F(a) reduce the basis in the 
relinquished MACRS passenger automobile and the exchanged basis of the 
replacement MACRS passenger automobile, before the excess basis of the 
replacement MACRS passenger automobile is reduced. The depreciation 
deductions for the relinquished MACRS passenger automobile in the year 
of disposition and the replacement MACRS passenger automobile in the 
year of replacement and each subsequent taxable year are allowable in 
the following order:
    (A) The depreciation deduction allowable for the relinquished MACRS 
passenger automobile as determined under paragraph (c)(5)(i) of this 
section for the year of disposition to the extent of the smaller of the 
replacement automobile section 280F limit and the relinquished 
automobile section 280F limit, if the year of disposition is the year 
of replacement. If the year of replacement is a taxable year subsequent 
to the year of disposition, the depreciation deduction allowable for 
the relinquished MACRS passenger automobile for the year of disposition 
is limited to the relinquished automobile section 280F limit.
    (B) The additional first year depreciation allowable on the 
remaining exchanged basis (remaining carryover basis as determined 
under Sec.  1.168(k)-1(f)(5) or Sec.  1.1400L(b)-1(f)(5), as 
applicable) of the replacement MACRS passenger automobile, as 
determined under Sec.  1.168(k)-1(f)(5) or Sec.  1.1400L(b)-1(f)(5), as 
applicable, to the extent of the excess of the replacement automobile 
section 280F limit over the amount allowable under paragraph 
(d)(3)(ii)(A) of this section.
    (C) The depreciation deduction allowable for the taxable year on 
the depreciable exchanged basis of the replacement MACRS passenger 
automobile determined under paragraph (c) of this section to the extent 
of any excess over the sum of the amounts allowable under paragraphs 
(d)(3)(ii)(A) and (B) of this section of the smaller of the replacement 
automobile section 280F limit and the relinquished automobile section 
280F limit.
    (D) Any section 179 deduction allowable in the year of replacement 
on the excess basis of the replacement MACRS passenger automobile to 
the extent of the excess of the replacement automobile section 280F 
limit over the sum of the amounts allowable under paragraphs 
(d)(3)(ii)(A), (B), and (C) of this section.
    (E) The additional first year depreciation allowable on the 
remaining excess basis of the replacement MACRS passenger automobile, 
as determined under Sec.  1.168(k)-1(f)(5) or Sec.  1.1400L(b)-1(f)(5), 
as applicable, to the extent of the excess of the replacement 
automobile section 280F limit over the sum of the amounts allowable 
under paragraphs (d)(3)(ii)(A), (B), (C), and (D) of this section.
    (F) The depreciation deduction allowable under paragraph (d) of 
this section for the depreciable excess basis of the replacement MACRS 
passenger automobile to the extent of the excess of the replacement 
automobile section 280F limit over the sum of the amounts allowable 
under paragraphs (d)(3)(ii)(A), (B), (C), (D), and (E) of this section.
    (iii) Examples. The application of this paragraph (d)(3) is 
illustrated by the following examples:

    Example 1. H, a calendar-year taxpayer, acquired and placed in 
service Automobile X in January 2000 for $30,000 to be used solely 
for H's business. In December 2003, H exchanges, in a like-kind 
exchange, Automobile X plus $15,000 cash for new Automobile Y that 
will also be used solely in H's business. Automobile Y is 50-percent 
bonus depreciation property for purposes of section 168(k)(4). Both 
automobiles are depreciated using the double declining balance 
method, the half-year convention, and a 5-year recovery period. 
Pursuant to Sec.  1.168(k)-1(g)(3)(ii) and paragraph (k)(2)(i) of 
this section, H decided to apply Sec.  1.168(i)-6 to the exchange of 
Automobile X for Automobile Y, the replacement MACRS property. The 
relinquished automobile section 280F limit for 2003 for Automobile X 
is $1,775. The replacement automobile section 280F limit for 
Automobile Y is $10,710. The exchanged basis for Automobile Y is 
$17,315 ($30,000 less total depreciation allowable of $12,685 
(($3,060 for 2000, $4,900 for 2001, $2,950 for 2002, and $1,775 for 
2003)). Without taking section 280F into account, the additional 
first year depreciation deduction for the remaining exchanged basis 
is $8,658 ($17,315 x 0.5). Because this amount is less than $8,935 
($10,710 (the replacement automobile section 280F limit for 2003 for 
Automobile Y) - $1,775 (the depreciation allowable for Automobile X 
for 2003)), the additional first year depreciation deduction for the 
exchanged basis is $8,658. No depreciation deduction is allowable in 
2003 for the depreciable exchanged basis because the depreciation 
deductions taken for Automobile X and the remaining exchanged basis 
exceed the exchanged automobile section 280F limit. An additional 
first year depreciation deduction of $277 is allowable for the 
excess basis of $15,000 in Automobile Y. Thus, at the end of 2003 
the adjusted depreciable basis in Automobile Y is $23,379 comprised 
of adjusted depreciable exchanged basis of $8,657 ($17,315 
(exchanged basis) - $8,658 (additional first year depreciation for 
exchanged basis)) and of an adjusted depreciable excess basis of 
$14,723 ($15,000 (excess basis) - $277 (additional first year 
depreciation for 2003)).
    Example 2. The facts are the same as in Example 1, except that H 
used Automobile X only 75 percent for business use. As such, the 
total allowable depreciation for Automobile X is reduced to reflect 
that the automobile is only used 75 percent for business. The total 
allowable depreciation of Automobile X is $9,513.75 ($2,295 for 2000 
($3,060 limit x .75), $3,675 for 2001 ($4,900 limit x .75), 
$2,212.50 for 2002 ($2,950 limit x .75), and $1,331.25 for 2003 
($1,775 limit x .75). However, under Sec.  1.280F-2T(g)(2)(ii)(A), 
the exchanged basis is reduced by the excess (if any) of the 
depreciation that would have been allowable if the exchanged 
automobile had been used solely for business over the depreciation 
that was allowable in those years. Thus, the exchanged basis, for 
purposes of computing depreciation, for Automobile Y is $17,315.
    Example 3. The facts are the same as in Example 1, except that H 
placed in service Automobile X in January 2002, and H elected not to 
claim the additional first year depreciation deduction for 5-year 
property placed in service in 2002 and 2003. The relinquished 
automobile section 280F limit for Automobile X for 2003 is $4,900. 
Because the replacement automobile section 280F limit for 2003 for 
Automobile Y ($3,060) is less than the relinquished automobile 
section 280F limit for Automobile X for 2003 and is less than $5,388 
(($30,000 (cost) - $3,060 (depreciation allowable for 2002)) x 0.4 x 
6/12), the depreciation that would be allowable for Automobile X 
(determined without regard to section 280F) in the year of 
disposition, the depreciation for Automobile X in the year of 
disposition is limited to $3,060. For 2003 no depreciation is 
allowable for the excess basis and the exchanged basis in Automobile 
Y.
    Example 4. AB, a calendar-year taxpayer, purchased and placed in 
service Automobile X1 in February 2000 for $10,000. X1 is a 
passenger automobile subject to section 280F(a) and is used solely 
for AB's business. AB depreciated X1 using a 5-year recovery period, 
the double declining balance method, and the half-year convention. 
As of January 1, 2003, the adjusted depreciable basis of X1 was 
$2,880 ($10,000 original cost minus $2,000 depreciation deduction 
for 2000, minus $3,200 depreciation deduction for 2001, and $1,920 
depreciation deduction for 2002). In November 2003, AB exchanges, in 
a like-kind exchange, Automobile X1 plus $14,000 cash for new 
Automobile Y1 that will be used solely in AB's business. Automobile 
Y1 is 50-percent bonus depreciation property for purposes of section 
168(k)(4) and qualifies for the expensing election under section 
179. Pursuant to paragraph Sec.  1.168(k)-1(g)(3)(ii) and paragraph 
(k)(2)(i) of this section, AB decided to apply Sec.  1.168(i)-6 to 
the exchange of Automobile X1 for Automobile Y1, the replacement 
MACRS property. AB also makes the election under section 179 for the 
excess basis of Automobile Y1. AB depreciates Y1 using a five-year 
recovery period, the double declining balance method and the half-
year convention. For 2003, the relinquished automobile section 280F 
limit for Automobile X1 is $1,775 and the replacement automobile 
section 280F limit for 2003 for Automobile Y1 is $10,710.
    (i) The 2003 depreciation deduction for Automobile X1 is $576. 
The depreciation

[[Page 9258]]

deduction calculated for X1 is $576 (the adjusted depreciable basis 
of Automobile X1 at the beginning of 2003 of $2,880 x 40% x \1/2\ 
year), which is less than the relinquished automobile section 280F 
limit and the replacement automobile section 280F limit.
    (ii) The additional first year depreciation deduction for the 
exchanged basis is $1,152. The additional first year depreciation 
deduction of $1,152 (remaining exchanged basis of $2,304 ($2,880 
adjusted basis of Automobile X1 at the beginning of 2003 minus $576) 
- 0.5)) is less than the replacement automobile section 280F limit 
minus $576.
    (iii) AB's MACRS depreciation deduction allowable in 2003 for 
the remaining exchanged basis of $1,152 is $47 (the relinquished 
automobile section 280F limit of $1,775 less the depreciation 
deduction of $576 taken for Automobile X1 less the additional first 
year depreciation deduction of $1,152 taken for the exchanged basis) 
which is less than the depreciation deduction calculated for the 
depreciable exchanged basis.
    (iv) For 2003, AB takes a $1,400 section 179 deduction for the 
excess basis of Automobile Y1. AB must reduce the excess basis of 
$14,000 by the section 179 deduction of $1,400 to determine the 
remaining excess basis of $12,600.
    (v) For 2003, AB is allowed a 50-percent additional first year 
depreciation deduction of $6,300 (the remaining excess basis of 
$12,600 multiplied by .50).
    (vi) For 2003, AB's depreciation deduction for the depreciable 
excess basis is limited to $1,235. The depreciation deduction 
computed without regard to the replacement automobile section 280F 
limit is $1,260 ($6,300 depreciable excess basis x 0.4 x 6/12). 
However the depreciation deduction for the depreciable excess basis 
is limited to $1,235 ($10,710 (replacement automobile section 280F 
limit) - $576 (depreciation deduction for Automobile X1) - $1,152 
(additional first year depreciation deduction for the exchanged 
basis) - $47 (depreciation deduction for exchanged basis) - 1,400 
(section 179 deduction) - $6,300 (additional first year depreciation 
deduction for remaining excess basis)).

    (4) Involuntary conversion for which the replacement MACRS property 
is acquired and placed in service before disposition of relinquished 
MACRS property. If, in an involuntary conversion, a taxpayer acquires 
and places in service the replacement MACRS property before the date of 
disposition of the relinquished MACRS property, the taxpayer 
depreciates the unadjusted depreciable basis of the replacement MACRS 
property under section 168 beginning in the taxable year when the 
replacement MACRS property is placed in service by the taxpayer and by 
using the applicable depreciation method, recovery period, and 
convention prescribed under section 168 for the replacement MACRS 
property at the placed-in-service date. However, at the time of 
disposition of the relinquished MACRS property, the taxpayer determines 
the exchanged basis and the excess basis of the replacement MACRS 
property and begins to depreciate the depreciable exchanged basis of 
the replacement MACRS property in accordance with paragraph (c) of this 
section. The depreciable excess basis of the replacement MACRS property 
continues to be depreciated by the taxpayer in accordance with the 
first sentence of this paragraph (d)(4). Further, in the year of 
disposition of the relinquished MACRS property, the taxpayer must 
include in taxable income the excess of the depreciation deductions 
allowable on the unadjusted depreciable basis of the replacement MACRS 
property over the depreciation deductions that would have been 
allowable to the taxpayer on the depreciable excess basis of the 
replacement MACRS property from the date the replacement MACRS property 
was placed in service by the taxpayer (taking into account the 
applicable convention) to the time of disposition of the relinquished 
MACRS property. However, see Sec.  1.168(k)-1(f)(5)(v) for replacement 
MACRS property that is qualified property or 50-percent bonus 
depreciation property and Sec.  1.1400L(b)-1(f)(5) for replacement 
MACRS property that is qualified New York Liberty Zone property.
    (e) Use of optional depreciation tables--(1) Taxpayer not bound by 
prior use of table. If a taxpayer used an optional depreciation table 
for the relinquished MACRS property, the taxpayer is not required to 
use an optional table for the depreciable exchanged basis of the 
replacement MACRS property. Conversely, if a taxpayer did not use an 
optional depreciation table for the relinquished MACRS property, the 
taxpayer may use the appropriate table for the depreciable exchanged 
basis of the replacement MACRS property. If a taxpayer decides not to 
use the table for the depreciable exchanged basis of the replacement 
MACRS property, the depreciation allowance for this property for the 
year of replacement and subsequent taxable years is determined under 
paragraph (c) of this section. If a taxpayer decides to use the 
optional depreciation tables, no depreciation deduction is allowable 
for MACRS property placed in service by the acquiring taxpayer and 
subsequently exchanged or involuntarily converted by such taxpayer in 
the same taxable year, and, if, during the same taxable year, MACRS 
property is placed in service by the acquiring taxpayer, exchanged or 
involuntarily converted by such taxpayer, and the replacement MACRS 
property is disposed of by such taxpayer, no depreciation deduction is 
allowable for either MACRS property.
    (2) Determination of the depreciation deduction--(i) Relinquished 
MACRS property. In the year of disposition, the depreciation allowance 
for the relinquished MACRS property is computed by multiplying the 
unadjusted depreciable basis (less the amount of the additional first 
year depreciation deduction allowed or allowable, whichever is greater, 
under section 168(k) or section 1400L(b), as applicable) of the 
relinquished MACRS property by the annual depreciation rate (expressed 
as a decimal equivalent) specified in the appropriate table for the 
recovery year corresponding to the year of disposition. This product is 
then multiplied by a fraction, the numerator of which is the number of 
months (including fractions of months) the property is deemed to be 
placed in service during the year of the exchange or involuntary 
conversion (taking into account the applicable convention) and the 
denominator of which is 12. However, if the year of disposition is less 
than 12 months, the depreciation allowance determined under this 
paragraph (e)(2)(i) must be adjusted for a short taxable year (for 
further guidance, for example, see Rev. Proc. 89-15 (1989-1 CB 816) and 
Sec.  601.601(d)(2)(ii)(b) of this chapter).
    (ii) Replacement MACRS property--(A) Determination of the 
appropriate optional depreciation table. If a taxpayer chooses to use 
the appropriate optional depreciation table for the depreciable 
exchanged basis, the depreciation allowances for the depreciable 
exchanged basis beginning in the year of replacement are determined by 
choosing the optional depreciation table that corresponds to the 
recovery period, depreciation method, and convention of the replacement 
MACRS property determined under paragraph (c) of this section.
    (B) Calculating the depreciation deduction for the replacement 
MACRS property. (1) The depreciation deduction for the taxable year is 
computed by first determining the appropriate recovery year in the 
table identified under paragraph (e)(2)(ii)(A) of this section. The 
appropriate recovery year for the year of replacement is the same as 
the recovery year for the year of disposition, regardless of the 
taxable year in which the replacement property is acquired. For 
example, if the recovery year for the year of disposition would have 
been year 4 in the table that applied before the disposition of the 
relinquished MACRS property, then the recovery year for the year of

[[Page 9259]]

replacement is Year 4 in the table identified under paragraph 
(e)(2)(ii)(A) of this section.
    (2) Next, the annual depreciation rate (expressed as a decimal 
equivalent) for each recovery year is multiplied by a transaction 
coefficient. The transaction coefficient is the formula (1 / (1 - x)) 
where x equals the sum of the annual depreciation rates from the table 
identified under paragraph (e)(2)(ii)(A) of this section (expressed as 
a decimal equivalent) corresponding to the replacement MACRS property 
(as determined under paragraph (e)(2)(ii)(A) of this section) for the 
taxable years beginning with the placed-in-service year of the 
relinquished MACRS property through the taxable year immediately prior 
to the year of disposition. The product of the annual depreciation rate 
and the transaction coefficient is multiplied by the depreciable 
exchanged basis (taking into account paragraph (e)(2)(i) of this 
section). In the year of replacement, this product is then multiplied 
by a fraction, the numerator of which is the number of months 
(including fractions of months) the property is deemed to be placed in 
service by the acquiring taxpayer during the year of replacement 
(taking into account the applicable convention) and the denominator of 
which is 12. However, if the year of replacement is the year the 
relinquished MACRS property is placed in service by the acquiring 
taxpayer, the preceding sentence does not apply. In addition, if the 
year of replacement is less than 12 months, the depreciation allowance 
determined under paragraph (e)(2)(ii) of this section must be adjusted 
for a short taxable year (for further guidance, for example, see Rev. 
Proc. 89-15 (1989-1 CB 816) and Sec.  601.601(d)(2)(ii)(b) of this 
chapter).
    (iii) Unrecovered basis. If the replacement MACRS property would 
have unrecovered depreciable basis after the final recovery year (for 
example, due to a deferred exchange), the unrecovered basis is an 
allowable depreciation deduction in the taxable year that corresponds 
to the final recovery year unless the unrecovered basis is subject to a 
depreciation limitation such as section 280F.
    (3) Excess basis. As provided in paragraph (d)(1) of this section, 
any excess basis in the replacement MACRS property is treated as 
property that is placed in service by the acquiring taxpayer at the 
time of replacement. Thus, if the taxpayer chooses to use the 
appropriate optional depreciation table for the depreciable excess 
basis in the replacement MACRS property, the depreciation allowances 
for the depreciable excess basis are determined by multiplying the 
depreciable excess basis by the annual depreciation rate (expressed as 
a decimal equivalent) specified in the appropriate table for each 
taxable year. The appropriate table for the depreciable excess basis is 
based on the depreciation method, recovery period, and convention 
applicable to the depreciable excess basis under section 168 at the 
time of replacement. However, If the year of replacement is less than 
12 months, the depreciation allowance determined under this paragraph 
(e)(3) must be adjusted for a short taxable year (for further guidance, 
for example, see Rev. Proc. 89-15 (1989-1 CB 816) and Sec.  
601.601(d)(2)(ii)(b) of this chapter).
    (4) Examples. The application of this paragraph (e) is illustrated 
by the following examples:

    Example 1. J, a calendar-year taxpayer, acquired 5-year property 
for $10,000 and placed it in service in January 2001. J uses the 
optional tables to depreciate the property. J uses the half-year 
convention and did not make any elections for the property. In 
December 2003, J exchanges the 5-year property for used 7-year 
property in a like-kind exchange. Pursuant to paragraph (k)(2)(i) of 
this section, J decided to apply Sec.  1.168(i)-6 to the exchange of 
the 5-year property for the 7-year property, the replacement MACRS 
property. The depreciable exchanged basis of the 7-year property 
equals the adjusted depreciable basis of the 5-year property at the 
time of disposition of the relinquished MACRS property, namely 
$3,840 ($10,000 less $2,000 depreciation in 2001, $3,200 
depreciation in 2002, and $960 depreciation in 2003). J must first 
determine the appropriate optional depreciation table pursuant to 
paragraph (c) of this section. Since the replacement MACRS property 
has a longer recovery period and the same depreciation method as the 
relinquished MACRS property, J uses the optional depreciation table 
corresponding to a 7-year recovery period, the 200% declining 
balance method, and the half-year convention (because the 5-year 
property was depreciated using a half-year convention). Had the 
replacement MACRS property been placed in service in the same 
taxable year as the placed-in-service year of the relinquished MACRS 
property, the depreciation allowance for the replacement MACRS 
property for the year of replacement would be determined using 
recovery year 3 of the optional table. The depreciation allowance 
equals the depreciable exchanged basis ($3,840) multiplied by the 
annual depreciation rate for the current taxable year (.1749 for 
recovery year 3) as modified by the transaction coefficient [1 / (1 
- (.1429 + .2449))] which equals 1.6335. Thus, J multiplies $3,840, 
its depreciable exchanged basis in the replacement MACRS property, 
by the product of .1749 and 1.6335, and then by one-half, to 
determine the depreciation allowance for 2003, $549. For 2004, J 
multiples its depreciable exchanged basis in the replacement MACRS 
property determined at the time of replacement of $3,840 by the 
product of the modified annual depreciation rate for the current 
taxable year (.1249 for recovery year 4) and the transaction 
coefficient (1.6335) to determine its depreciation allowance of 
$783.
    Example 2. K, a calendar-year taxpayer, acquired used Asset V 
for $100,000 and placed it in service in January 1999. K depreciated 
Asset V under the general depreciation system of section 168(a) by 
using a 5-year recovery period, the 200-percent declining balance 
method of depreciation, and the half-year convention. In December 
2003, as part of the involuntary conversion, Asset V is 
involuntarily converted due to an earthquake. In October 2005, K 
purchases used Asset W with the insurance proceeds from the 
destruction of Asset V and places Asset W in service to replace 
Asset V. Pursuant to paragraph (k)(2)(i) of this section, K decided 
to apply Sec.  1.168(i)-6 to the involuntary conversion of Asset V 
with the replacement of Asset W, the replacement MACRS property. If 
Asset W had been placed in service when Asset V was placed in 
service, it would have been depreciated using a 7-year recovery 
period, the 200-percent declining balance method, and the half-year 
convention. K uses the optional depreciation tables to depreciate 
Asset V and Asset W. For 2003 (recovery year 5 on the optional 
table), the depreciation deduction for Asset V is $5,760 
((0.1152)($100,000)(1/2)). Thus, the adjusted depreciable basis of 
Asset V at the time of replacement is $11,520 ($100,000 less $20,000 
depreciation in 1999, $32,000 depreciation in 2000, $19,200 
depreciation in 2001, $11,520 depreciation in 2002, and $5,760 
depreciation in 2003). Under the table that applied to Asset V, the 
year of disposition was recovery year 5 and the depreciation 
deduction was determined under the straight line method. The table 
that applies for Asset W is the table that applies the straight line 
depreciation method, the half-year convention, and a 7-year recovery 
period. The appropriate recovery year under this table is recovery 
year 5. The depreciation deduction for Asset W for 2005 is $1,646 
(($11,520)(0.1429)(1/(1-0.5))(1/2)). Thus, the depreciation 
deduction for Asset W in 2006 (recovery year 6) is $3,290 
($11,520)(0.1428)(1/(1-0.5)). The depreciation deduction for 2007 
(recovery year 7) is $3,292 (($11,520)(.1429)(1/(1-.5))). The 
depreciation deduction for 2008 (recovery year 8) is $3292 ($11,520 
less allowable depreciation for Asset W for 2005 through 2007 
($1,646 + $3,290 + $3,292)).
    Example 3. L, a calendar-year taxpayer, placed in service used 
Computer X in January 2002 for $5,000. L depreciated Computer X 
under the general depreciation system of section 168(a) by using the 
200-percent declining balance method of depreciation, a 5-year 
recovery period, and the half-year convention. Computer X is 
destroyed in a fire in March 2004. For 2004, the depreciation 
deduction allowable for Computer X equals $480 ([($5,000)(.1920)] x 
(1/2)). Thus, the adjusted depreciable basis of Computer X was 
$1,920 when it was destroyed ($5,000 unadjusted depreciable

[[Page 9260]]

basis less $1,000 depreciation for 2002, $1,600 depreciation for 
2003, and $480 depreciation for 2004). In April 2004, as part of the 
involuntary conversion, L acquired and placed in service used 
Computer Y with insurance proceeds received due to the loss of 
Computer X. Computer Y will be depreciated using the same 
depreciation method, recovery period, and convention as Computer X. 
L elected to use the optional depreciation tables to compute the 
depreciation allowance for Computer X and Computer Y. The 
depreciation deduction allowable for 2004 for Computer Y equals $384 
([$1,920 x (.1920)(1/(1-.52))] x (1/2)).

    (f) Mid-quarter convention. For purposes of applying the 40-percent 
test under section 168(d) and the regulations under section 168(d), the 
following rules apply:
    (1) Exchanged basis. If, in a taxable year, MACRS property is 
placed in service by the acquiring taxpayer (but not as a result of a 
like-kind exchange or involuntary conversion) and--
    (i) In the same taxable year, is disposed of by the acquiring 
taxpayer in a like-kind exchange or an involuntary conversion and 
replaced by the acquiring taxpayer with replacement MACRS property, the 
exchanged basis (determined without any adjustments for depreciation 
deductions during the taxable year) of the replacement MACRS property 
is taken into account in the year of replacement in the quarter the 
relinquished MACRS property was placed in service by the acquiring 
taxpayer; or
    (ii) In the same taxable year, is disposed of by the acquiring 
taxpayer in a like-kind exchange or an involuntary conversion, and in a 
subsequent taxable year is replaced by the acquiring taxpayer with 
replacement MACRS property, the exchanged basis (determined without any 
adjustments for depreciation deductions during the taxable year) of the 
replacement MACRS property is taken into account in the year of 
replacement in the quarter the replacement MACRS property was placed in 
service by the acquiring taxpayer; or
    (iii) In a subsequent taxable year, disposed of by the acquiring 
taxpayer in a like-kind exchange or involuntary conversion, the 
exchanged basis of the replacement MACRS property is not taken into 
account in the year of replacement.
    (2) Excess basis. Any excess basis is taken into account in the 
quarter the replacement MACRS property is placed in service by the 
acquiring taxpayer.
    (3) Depreciable property acquired for nondepreciable property. Both 
the exchanged basis and excess basis of the replacement MACRS property 
described in paragraph (d)(2)(ii) of this section (depreciable property 
acquired for nondepreciable property), are taken into account for 
determining whether the mid-quarter convention applies in the year of 
replacement.
    (g) Section 179 election. In applying the section 179 election, 
only the excess basis, if any, in the replacement MACRS property is 
taken into account. If the replacement MACRS property is described in 
paragraph (d)(2)(ii) of this section (depreciable property acquired for 
nondepreciable property), only the excess basis in the replacement 
MACRS property is taken into account.
    (h) Additional first year depreciation deduction. See Sec.  
1.168(k)-1(f)(5) (for qualified property or 50-percent bonus 
depreciation property) and Sec.  1.1400L(b)-1(f)(5) (for qualified New 
York Liberty Zone property).
    (i) Elections--(1) Election not to apply this section. A taxpayer 
may elect not to apply this section for any MACRS property involved in 
a like-kind exchange or involuntary conversion. An election under this 
paragraph (i)(1) applies only to the taxpayer making the election and 
the election applies to both the relinquished MACRS property and the 
replacement MACRS property. If an election is made under this paragraph 
(i)(1), the depreciation allowances for the replacement MACRS property 
beginning in the year of replacement and for the relinquished MACRS 
property in the year of disposition are not determined under this 
section (except as otherwise provided in this paragraph). Instead, for 
depreciation purposes only, the sum of the exchanged basis and excess 
basis, if any, in the replacement MACRS property is treated as property 
placed in service by the taxpayer at the time of replacement and the 
adjusted depreciable basis of the relinquished MACRS property is 
treated as being disposed of by the taxpayer at the time of 
disposition. While the relinquished MACRS property is treated as being 
disposed of at the time of disposition for depreciation purposes, the 
election not to apply this section does not affect the application of 
sections 1031 and 1033 (for example, if a taxpayer does not make the 
election under this paragraph (i)(1) and does not recognize gain or 
loss under section 1031, this result would not change if the taxpayer 
chose to make the election under this paragraph (i)(1)). In addition, 
the election not to apply this section does not affect the application 
of sections 1245 and 1250 to the relinquished MACRS property. 
Paragraphs (c)(5)(i) (determination of depreciation for relinquished 
MACRS property in the year of disposition), (c)(5)(iii) (rules for 
deferred transactions), (g) (section 179 election), and (h) (additional 
first year depreciation deduction) of this section apply to property to 
which this paragraph (i)(1) applies. See paragraph (j) of this section 
for the time and manner of making the election under this paragraph 
(i)(1).
    (2) Election to treat certain replacement property as MACRS 
property. If the tangible depreciable property acquired by a taxpayer 
in a like-kind exchange or involuntary conversion (the replacement 
property) replaces tangible depreciable property for which the taxpayer 
made a valid election under section 168(f)(1) to exclude it from the 
application of MACRS (the relinquished property), the taxpayer may 
elect to treat, for depreciation purposes only, the sum of the 
exchanged basis and excess basis, if any, of the replacement property 
as MACRS property that is placed in service by the taxpayer at the time 
of replacement. An election under this paragraph (i)(2) applies only to 
the taxpayer making the election and the election applies to both the 
relinquished property and the replacement property. If an election is 
made under this paragraph (i)(2), the adjusted depreciable basis of the 
relinquished property is treated as being disposed of by the taxpayer 
at the time of disposition. Rules similar to those provided in 
Sec. Sec.  1.168(i)-6(b)(3) and (4) apply for purposes of determining 
the time of disposition and time of replacement under this paragraph 
(i)(2). While the relinquished property is treated as being disposed of 
at the time of disposition for depreciation purposes, the election 
under this paragraph (i)(2) does not affect the application of sections 
1031 and 1033, and the application of sections 1245 and 1250 to the 
relinquished property. If an election is made under this paragraph 
(i)(2), rules similar to those provided in paragraphs (c)(5)(iii) 
(rules for deferred transactions), (g) (section 179 election), and (h) 
(additional first year depreciation deduction) of this section apply to 
property. Except as provided in paragraph (k)(3)(ii) of this section, a 
taxpayer makes the election under this paragraph (i)(2) by claiming the 
depreciation allowance as determined under MACRS for the replacement 
property on the taxpayer's timely filed (including extensions) original 
Federal tax return for the placed-in-service year of the replacement 
property as determined under this paragraph (i)(2).
    (j) Time and manner of making election under paragraph (i)(1) of 
this section--(1) In general. The election provided in paragraph (i)(1) 
of this

[[Page 9261]]

section is made separately by each person acquiring replacement MACRS 
property. The election is made for each member of a consolidated group 
by the common parent of the group, by the partnership (and not by the 
partners separately) in the case of a partnership, or by the S 
corporation (and not by the shareholders separately) in the case of an 
S corporation. A separate election under paragraph (i)(1) of this 
section is required for each like-kind exchange or involuntary 
conversion. The election provided in paragraph (i)(1) of this section 
must be made within the time and manner provided in paragraph (j)(2) 
and (3) of this section and may not be made by the taxpayer in any 
other manner (for example, the election cannot be made through a 
request under section 446(e) to change the taxpayer's method of 
accounting), except as provided in paragraph (k)(2) of this section.
    (2) Time for making election. The election provided in paragraph 
(i)(1) of this section must be made by the due date (including 
extensions) of the taxpayer's Federal tax return for the year of 
replacement.
    (3) Manner of making election. The election provided in paragraph 
(i)(1) of this section is made in the manner provided for on Form 4562, 
Depreciation and Amortization, and its instructions. If Form 4562 is 
revised or renumbered, any reference in this section to that form is 
treated as a reference to the revised or renumbered form.
    (4) Revocation. The election provided in paragraph (i)(1) of this 
section, once made, may be revoked only with the consent of the 
Commissioner of Internal Revenue. Such consent will be granted only in 
extraordinary circumstances. Requests for consent are requests for a 
letter ruling and must be filed with the Commissioner of Internal 
Revenue, Washington, DC 20224. Requests for consent may not be made in 
any other manner (for example, through a request under section 446(e) 
to change the taxpayer's method of accounting).
    (k) Effective date--(1) In general. Except as provided in paragraph 
(k)(3) of this section, this section applies to a like-kind exchange or 
an involuntary conversion of MACRS property for which the time of 
disposition and the time of replacement both occur after February 27, 
2004.
    (2) Application to pre-effective date like-kind exchanges and 
involuntary conversions. For a like-kind exchange or an involuntary 
conversion of MACRS property for which the time of disposition, the 
time of replacement, or both occur on or before February 27, 2004, a 
taxpayer may--
    (i) Apply the provisions of this section. If a taxpayer's 
applicable Federal tax return has been filed on or before February 27, 
2004, and the taxpayer has treated the replacement MACRS property as 
acquired, and the relinquished MACRS property as disposed of, in a 
like-kind exchange or an involuntary conversion, the taxpayer changes 
its method of accounting for depreciation of the replacement MACRS 
property and relinquished MACRS property in accordance with this 
paragraph (k)(2)(i) by following the applicable administrative 
procedures issued under Sec.  1.446-1(e)(3)(ii) for obtaining the 
Commissioner's automatic consent to a change in method of accounting 
(for further guidance, see Rev. Proc. 2002-9 (2002-1 CB 327) and Sec.  
601.601(d)(2)(ii)(b) of this chapter); or
    (ii) Rely on prior guidance issued by the Internal Revenue Service 
for determining the depreciation deductions of replacement MACRS 
property and relinquished MACRS property (for further guidance, for 
example, see Notice 2000-4 (2001-1 CB 313) and Sec.  
601.601(d)(2)(ii)(b) of this chapter). In relying on such guidance, a 
taxpayer may use any reasonable, consistent method of determining 
depreciation in the year of disposition and the year of replacement. If 
a taxpayer's applicable Federal tax return has been filed on or before 
February 27, 2004, and the taxpayer has treated the replacement MACRS 
property as acquired, and the relinquished MACRS property as disposed 
of, in a like-kind exchange or an involuntary conversion, the taxpayer 
changes its method of accounting for depreciation of the replacement 
MACRS property and relinquished MACRS property in accordance with this 
paragraph (k)(2)(ii) by following the applicable administrative 
procedures issued under Sec.  1.446-1(e)(3)(ii) for obtaining the 
Commissioner's automatic consent to a change in method of accounting 
(for further guidance, see Rev. Proc. 2002-9 (2002-1 CB 327) and Sec.  
601.601(d)(2)(ii)(b) of this chapter).
    (3) Like-kind exchanges and involuntary conversions where the 
taxpayer made the election under section 168(f)(1) for the relinquished 
property-- (i) In general. If the tangible depreciable property 
acquired by a taxpayer in a like-kind exchange or involuntary 
conversion (the replacement property) replaces tangible depreciable 
property for which the taxpayer made a valid election under section 
168(f)(1) to exclude it from the application of MACRS (the relinquished 
property), paragraph (i)(2) of this section applies to such 
relinquished property and replacement property for which the time of 
disposition and the time of replacement (both as determined under 
paragraph (i)(2) of this section) both occur after February 26, 2007.
    (ii) Application of paragraph (i)(2) of this section to pre-
February 26, 2007 like-kind exchanges and involuntary conversions. If 
the tangible depreciable property acquired by a taxpayer in a like-kind 
exchange or involuntary conversion (the replacement property) replaces 
tangible depreciable property for which the taxpayer made a valid 
election under section 168(f)(1) to exclude it from the application of 
MACRS (the relinquished property), the taxpayer may apply paragraph 
(i)(2) of this section to the relinquished property and the replacement 
property for which the time of disposition, the time of replacement 
(both as determined under paragraph (i)(2) of this section), or both 
occur on or before February 26, 2007. If the taxpayer wants to apply 
paragraph (i)(2) of this section and the taxpayer's applicable Federal 
tax return has been filed on or before February 26, 2007, the taxpayer 
must change its method of accounting for depreciation of the 
replacement property and relinquished property in accordance with this 
paragraph (k)(3)(ii) by following the applicable administrative 
procedures issued under Sec.  1.446-1(e)(3)(ii) for obtaining the 
Commissioner's automatic consent to a change in method of accounting 
(for further guidance, see Rev. Proc. 2002-9 (2002-1 CB 327) and Sec.  
601.601(d)(2)(ii)(b) of this chapter).


Sec.  1.168(i)-6T  [Removed]

0
Par. 13. Section 1.168(i)-6T is removed.
0
Par. 14. Section 1.168(k)-1 is amended as follows:
0
1. The second and third sentences in paragraph (f)(5)(v)(B) are 
revised.
0
2. The last sentences in Example 1(i), Example 3(i), Example 4(i), and 
Example 5(i) in paragraph (f)(5)(vi) are revised.
0
3. Paragraph (g)(3)(ii) is revised.
    The revisions read as follows:


Sec.  1.168(k)-1  Additional first year depreciation.

* * * * *
    (f) * * *
    (5) * * *
    (v) * * *
    (B) * * * However, at the time of disposition of the involuntarily 
converted MACRS property, the taxpayer determines the exchanged basis 
(as defined in Sec.  1.168(i)-6(b)(7)) and the excess basis (as defined 
in

[[Page 9262]]

Sec.  1.168(i)-6(b)(8)) of the acquired MACRS property and begins to 
depreciate the depreciable exchanged basis (as defined in Sec.  
1.168(i)-6(b)(9) of the acquired MACRS property in accordance with 
Sec.  1.168(i)-6(c). The depreciable excess basis (as defined in Sec.  
1.168(i)-6(b)(10)) of the acquired MACRS property continues to be 
depreciated by the taxpayer in accordance with the first sentence of 
this paragraph (f)(5)(v)(B).
* * * * *
    (vi) * * *

    Example 1. (i) * * * Pursuant to paragraph (g)(3)(ii) of this 
section and Sec.  1.168(i)-6(k)(2)(i), EE decided to apply Sec.  
1.168(i)-6 to the involuntary conversion of Canopy V1 with the 
replacement of Canopy W1, the acquired MACRS property.
* * * * *
    Example 3. (i) * * * Pursuant to paragraph (g)(3)(ii) of this 
section and Sec.  1.168(i)-6(k)(2)(i), FF decided to apply Sec.  
1.168(i)-6 to the exchange of Computer X2 for Computer Y2, the 
acquired MACRS property.
* * * * *
    Example 4.  (i) * * * Pursuant to paragraph (g)(3)(ii) of this 
section and Sec.  1.168(i)-6(k)(2)(i), GG decided to apply Sec.  
1.168(i)-6 to the exchange of Equipment X3 for Equipment Y3, the 
acquired MACRS property.
* * * * *
    Example 5. (i) * * * Pursuant to paragraph (g)(3)(ii) of this 
section and Sec.  1.168(i)-6(k)(2)(i), GG decided to apply Sec.  
1.168(i)-6 to the exchange of Equipment Y3 for Equipment Z1, the 
acquired MACRS property.
* * * * *
    (g) * * *
    (3) * * *
    (ii) Paragraphs (f)(5)(ii)(F)(2) and (f)(5)(v) of this section 
apply to a like-kind exchange or an involuntary conversion of MACRS 
property and computer software for which the time of disposition and 
the time of replacement both occur after February 27, 2004. For a like-
kind exchange or an involuntary conversion of MACRS property for which 
the time of disposition, the time of replacement, or both occur on or 
before February 27, 2004, see Sec.  1.168(i)-6(k)(2)(ii). For a like-
kind exchange or involuntary conversion of computer software for which 
the time of disposition, the time of replacement, or both occur on or 
before February 27, 2004, a taxpayer may rely on prior guidance issued 
by the Internal Revenue Service for determining the depreciation 
deductions of the acquired computer software and the exchanged or 
involuntarily converted computer software (for further guidance, see 
Sec.  1.168(k)-1T(f)(5) published in the Federal Register on September 
8, 2003 (68 FR 53000)). In relying on such guidance, a taxpayer may use 
any reasonable, consistent method of determining depreciation in the 
year of disposition and the year of replacement.
* * * * *

Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
    Approved: February 23, 2007.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 07-922 Filed 2-26-07; 3:25 pm]
BILLING CODE 4830-01-P