I have been holding out hope that eventually, after so many years, I would accumulate a critical mass of knowledge after which all the tax attributes and consequences of the items and transactions within the scope of my practice would suddenly present themselves, perhaps in the form of the flowing columns of green letters that appeared to Neo at the end of The Matrix.
I'm no longer sure this is the endgame. What's actually happened is that the more I learn, the less I perceive any kind of underlying structure and logic in the Code. I'm hoping there's a Morpheus out there who can open my eyes.
Here's one of my conundrums. Any and all responses are appreciated.
Point 1: Under the new tangible property regulations, improvements to a building structure are not treated as separate units of property. However, for depreciation purposes, Publication 527 indicates that they "can generally be depreciated as if [they] were separate property". The source of this statement appears to be §168(i)(6), but the statute only directly addresses the placed-in-service date and says nothing about whether the improvements count as separate for the purposes of allocation or proration.
Point 2: Publication 527 directs taxpayers who rent out a part of a property to "divide certain expenses between the part of the property used for rental purposes and the part of the property used for personal purposes, as though [they] actually had two separate pieces of property".
Point 3: Regulation 1.168(i)-6(b)(7) defines the "exchanged basis" of property acquired in a like kind exchange as "The adjusted depreciable basis (as defined in § 1.168(b)-1(a)(4)) of the relinquished MACRS property", taking into account depreciation for the year and limited by the overall basis of the new property. The exchanged basis is depreciated over a number of years equal to the new asset's standard recovery period minus the period that has already elapsed since the original asset was first placed in service.
Question 1: My tax software calculates depreciation by first reducing the overall basis of an asset by the percentage of business use that has been entered, then by multiplying that reduced basis by the applicable percentage for the year. Does anyone know why this would be the appropriate treatment as opposed to first getting the depreciation deduction, then prorating it for business use? Can anyone point to where this is in the Code or the Regs?
Question 2: Should the method for prorated depreciation described above always be used, or would it differ depending on why the prorating is happening? For example, point 2 involves prorating based on space, whereas the more common type of proration involves time - that is, a taxpayer uses an entire unit of property for business part of the time and for personal purposes part of the time.
Question 3: If prorating the overall basis of a unit of property (point 1) based on space as suggested in questions 1 and 2 in order to accomplish the rental calculation required by point 2 is indeed the correct method, how would improvements to a building structure (point 1) be handled in that calculation? The common sense treatment would be to look at the purpose of the improvements and apply a separate depreciation allocation based on that - for example, if the improvements were directly to the personal portion of the unit, they wouldn't be depreciable. However, the regs specify that improvements are not a separate unit of property, and the only direct authority I can find, §168(i)(6), says nothing that would contradict the logical conclusion, which is that the improvements would be subject to the same space allocation percentage.
Question 4: In the case where a taxpayer initially rented out only a third of his house, then rented out the entire thing beginning several years later, should the "lesser of basis or FMV" for assets converted from personal use have any impact on the new, increased basis for depreciation, or was the depreciable basis of the entire house set the moment he started to rent out a portion of it?
Question 5: How should the computation of the recovery period of the "exchanged basis" in point 3 be handled in the scenario proposed in question 4, with the added complexity that the taxpayer has also made improvements over the years? Should the exchanged basis simply use the initial start date of the first rental activity as a reference point, or should the depreciation continue to act more like it would have if the initial property had stayed in service with the multiple start dates for improvements and lower accumulated depreciation for prior personal use?