Multiple Properties

If you dispose of both depreciable property and other property in one transaction and realize a gain, you must allocate the amount realized between the two types of property in proportion to their respective fair market values to figure the part of your gain to be reported as ordinary income from depreciation. Different rules may apply to the allocation of the amount realized on the sale of a business that includes a group of assets. See chapter 2.

In general, if a buyer and seller have adverse interests as to the allocation of the amount realized between the depreciable property and other property, any arm's-length agreement between them will establish the allocation.

In the absence of an agreement, the allocation should be made by taking into account the appropriate facts and circumstances. These include, but are not limited to, a comparison between the depreciable property and all the other property being disposed of in the transaction. The comparison should take into account all the following facts and circumstances.

• The original cost and reproduction cost of construction, erection, or production.
• The remaining economic useful life.
• The state of obsolescence.
• The anticipated expenditures required to maintain, renovate, or modernize the properties.

Like-kind exchanges and involuntary conversions.   If you dispose of and acquire both depreciable personal property and other property (other than depreciable real property) in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. The amount allocated to the depreciable personal property disposed of is treated as consisting of, first, the fair market value of the depreciable personal property acquired and, second (to the extent of any remaining balance), the fair market value of the other property acquired. The amount allocated to the other property disposed of is treated as consisting of the fair market value of all property acquired that has not already been taken into account.

If you dispose of and acquire depreciable real property and other property in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. The amount allocated to each of the three types of property (depreciable real property, depreciable personal property, or other property) disposed of is treated as consisting of, first, the fair market value of that type of property acquired and, second (to the extent of any remaining balance), any excess fair market value of the other types of property acquired. (If the excess fair market value is more than the remaining balance of the amount realized and is from both of the other two types of property, you can apply the unallocated amount in any manner you choose.)

Example.   A fire destroyed your property with a total fair market value of $50,000. It consisted of machinery worth $30,000 and nondepreciable property worth $20,000. You received an insurance payment of $40,000 and immediately used it with $10,000 of your own funds (for a total of $50,000) to buy machinery with a fair market value of $15,000 and nondepreciable property with a fair market value of $35,000. The adjusted basis of the destroyed machinery was $5,000 and your depreciation on it was $35,000. You choose to postpone reporting your gain from the involuntary conversion. You must report $9,000 as ordinary income from depreciation arising from this transaction, figured as follows.

1. The $40,000 insurance payment must be allocated between the machinery and the other property destroyed in proportion to the fair market value of each. The amount allocated to the machinery is 30,000/50,000 x $40,000, or $24,000. The amount allocated to the other property is 20,000/50,000 x $40,000, or $16,000. Your gain on the involuntary conversion of the machinery is $24,000 minus $5,000 adjusted basis, or $19,000.
2. The $24,000 allocated to the machinery disposed of is treated as consisting of the $15,000 fair market value of the replacement machinery bought and $9,000 of the fair market value of other property bought in the transaction. All $16,000 allocated to the other property disposed of is treated as consisting of the fair market value of the other property that was bought.
3. Your potential ordinary income from depreciation is $19,000, the gain on the machinery, because it is less than the $35,000 depreciation. However, the amount you must report as ordinary income is limited to the $9,000 included in the amount realized for the machinery that represents the fair market value of property other than the depreciable property you bought.

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