Like-Kind Exchanges and Unadjusted Basis

Published on: 15:28PM Feb 21, 2018

The new Section 199A 20% of net farm income deduction is limited if your taxable income exceeds a threshold amount ($415,000 MFJ and $207,500 for all others).  The limit is the greater of 50% of wages paid by the farm or 25% of wages plus 2.5% of unadjusted basis of qualified assets.  Wages are essentially box 5 Medicare wages on form W-3 (commodity wages do not qualify) and qualified assets are any assets acquired in the last 10 years plus any assets older than 10 years still being depreciated (land improvements and buildings).

Here is a quick example:

Farmer Wallace has net farm income of $500,000.  Wages paid are $100,000 and qualified property is $2 million.  His limit is the greater of:

  • $50,000 ($100,000 times 50%), or
  • $75,000 ($100,000 times 25% plus $2 million times 2.5)

Therefore, his maximum Section 199A deduction is $75,000 (it may be then limited to 20% of taxable income minus capital gains).

What if the qualified property was acquired in a Section 1031 exchange.  In that case, what is the unadjusted basis of that property.  Right now, we don't know.  It can either be the cost of the new replacement property, it could be the cost of the replacement property minus the rollover gain or even some other number.

In our example, let's assume the qualified property is a building that was fully depreciated and then rolled over into a new building costing $2 million.  If unadjusted basis is equal to replacement value minus gain, our new unadjusted basis become zero ($2 million cost of new building minus the $2 million gain rolled over).  This drops our maximum Section 199A deduction to $50,000 instead of $75,000.

The IRS knows they need to give guidance on this (the Code even instructed the IRS to provide guidance).  Once we have that, we will provide an update.  Until then, We Don't Know.