To qualify for a 1031 Exchange, you must trade personal property that you hold for business or investment purposes for like-kind property that you also intend to hold for business or investment purposes.
Generally when you sell personal property, you have to pay tax on the gain from the sale. The gain is caused either by depreciation/amortization or appreciation of the property over time.
A Section 1031 Exchange, named for the Internal Revenue Service Code Section, offers you the major exception to the imposition of the income tax on depreciation/amortization recapture (ordinary rates) and/or appreciation (capital gains rates). With a 1031 Exchange, if you sell equipment, vehicles, trucks, franchises, patents or other types of personal property, you can defer the payment of income tax that is normally due on the sale.
If your objective is to use the proceeds from the sale of your personal property to buy more personal property, a 1031 Exchange will provide you with more funds for investment than can be achieved through the investment of after-tax proceeds from the sale of the property.
How could a 1031 Exchange benefit you?
The savings will vary with each transaction. The following example shows how you could avoid $147,000 of income tax on the sale of equipment by structuring a 1031 Exchange:
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EXAMPLE:
Let's say you sell something you own for $350,000. You originally paid $600,000.
However, over the time that you've owned the item, you have depreciated it's value on your tax return and taken the tax write off. At the time you sell it, you have claimed it's total value (600,000) in depreciation.
Because you depreciated the value of your asset on your past tax returns, your basis value for the asset is currently at zero. So any money you make on the sale will be considered taxable gain. Your tax consideration could be as follows:
Federal tax (assume 35% rate) = 122,500
State tax (assume 7% rate) = 24,500
Total tax with no exchange = 147,000
Total tax with exchange = 0
With an exchange you have $147,000 available to you for reinvestment in replacement property.
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What kind of personal property qualifies for a 1031 Exchange?
To qualify for a 1031 Exchange, you must trade personal property that you hold for business or investment purposes for like-kind property that you hold for business or investment purposes.
Qualifying personal property includes a wide range of items used for business or investment, such as:
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Airplanes (Corporate Jets, Commercial Use, Charter)
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Boats (Yachts, Ferries, Charters, Fishing Trawlers, Freighters)
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Buses, Trolleys and other mass transit vehicles
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Recreation Vehicles - if used for business
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Tractor/trailers
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Automobiles (Business Vehicle, limousines, Taxis, Pace Car)
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Trucks (Freighters)
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Construction equipment (Graders, Backhoe, Cats, Compressor, etc)
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Manufacturing equipment
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Farm machinery (Tractors, Combines, etc)
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Personal property from business sales (inventory included in a sale)
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Office equipment (computers, copiers, printers)
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Livestock (horses, cattle, exotic animals)
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Franchises, patents, copyrights
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Anything else that is considered personal property
What personal property does not qualify for 1031 Exchange treatment?
In general, personal property held for your own personal use does not qualify. Inventory, even though it is held for business purposes, also does not qualify. Other items that do not qualify include stocks, bonds, notes or other securities, as well as partnership interests. Some mixed-use assets will qualify for a partial 1031 Exchange. For example, a plane that is used 60% for business and 40% for personal use will be eligible for an exchange on the 60% business portion.
How do you know what kind of property is like-kind?
Personal property exchanges have very tight like-kind restrictions in comparison to real estate exchanges. Both the relinquished property and replacement property must be of like class. The first test is to determine if both are included in the same "General Asset Class" as described in a 1987 IRS Revenue Procedure Ruling. If neither is classified in a "General Asset Class", then the second test must determine if both are included in the same "Product Class" per the 4-digit numbers within Division D of the Standard Industrial Classification Codes in the SIC Manual. If neither is classified under the first two tests, it must be determined if the properties are still of like kind based on judgment and existing IRS rulings.
The like-kind test is easy to determine for some items. For example, a plane will be like-kind with a plane because both are included in the same "General Asset Class". Like-kind matches that don't belong to a General Asset Class aren't so obvious. For example, a road grader could be like-kind with a mobile office unit so long as both are used in the same "Product Class" (i.e. product class 2411 "Logging"). Another example would be business swaps such as assets of a television station swapped for the assets of a different television station.
In any event, you need to have someone, who fully understands the like-kind rules regarding personal property, analyze the like-kind matching.
How much time do you have to reinvest funds from a 1031 Exchange?
The sale of your personal property and the purchase of the replacement personal property do not have to take place on the same day to qualify as an exchange. In fact, Section 1031 allows the exchanger 180-days to purchase the replacement property. The 180-day period begins on the date you sell your property. The Code Section also requires you to identify the replacement property 45-days after you sell your property.
How can a 1031 Exchange help you avoid constructive receipt?
One of the most important aspects of structuring a 1031 Exchange is to avoid the constructive receipt of the proceeds from the sale of your personal property. This means that at no time can the proceeds of the sale (either cash or note) come under your control. You cannot hold the money in your account until the replacement property is purchased nor can you have a friend, employee, broker, or even your accountant or attorney hold the money for you.
The IRS solves the constructive receipt problem through the designation of professional independent corporate intermediaries such as Summit 1031, Inc.
For more information on these types of exchanges, click on the different types of property in the menu to the left.