A 1031 exchange is used to defer federal and state capital gain and recaptured depreciation taxes when selling real and personal property given like-kind property is replaced within 180 calendar days of the initial closing. The sale is grouped into asset or product classes including real property, tangible and intangible personal property. Good will is not eligible for a 1031 exchange. Should the business owner be the lessor of a thirty year or more lease, the lease is considered real property and can be replaced with a real property fee interest.
Like-Kind Property
The Internal Revenue Code Section 1031 defines property held in the productive use of a trade, business or investment as eligible for the tax deferral. Real property may be exchanged for any real property located in the United States, while real property held in overseas is eligible for the tax deferral for any real property held internationally. Personal property must be exchanged for like-kind or like-class personal property. Gold bullion must be exchange for gold bullion, furniture for furniture, fixtures for fixtures, equipment for equipment, cars for cars, collectibles for collectibles, etc. The General Asset Class or North American Industry Classification System (NAICS) is used to determine whether the property is like-kind or like-class.
Franchise rights are considered intangible personal property and eligible for the 1031 tax deferral. Leasehold improvements may be sold as real property and exchanged for improvements to be constructed using the 1031 exchange proceeds.
1031 Exchange Rules
There are many exchange rules that must be followed.
Equal or Greater Value – The replacement property must be equal or greater value than the property sold. Otherwise, a tax is triggered on the difference. The net equity and the debt retired must be equal to or greater in the replacement property.
Same Taxpayer – The taxpayer on title to the relinquished or old property is the taxpayer who must be on title to the replacement property. The taxpayer can take title as tenants in common with another taxpayer.
Timelines – In a forward exchange, the replacement property must be identified by the 45th calendar day to the Qualified Intermediary and the replacement property acquired within 135 calendars for a total of 180 calendar days to complete the 1031 exchange.
Personal Use – Property ineligible for a 1031 exchange includes primary residence, partnership interests, indebtedness, inventory and securities. Personal use in a vacation property must be less than 14 overnights a year including time given to family members.
Related Party – The taxpayer can sell to a related party but should the related party sell the property within two years of the closing, the tax deferred is triggered. In addition, the replacement property cannot be acquired from a related party unless the related party is also initiating a 1031 exchange and not cashing out.
Disqualified Person – Anyone can be a Qualified Intermediary; however, there are persons and entities that cannot provide the accommodation services.
1031 Business Example
Taxpayer owns a Subway franchise and wants to relocate. The taxpayer is the sub lessor of a lease with a major retailer. The lessor allows the taxpayer to sell their interest in the thirty year or more lease to acquire real property. The equipment is categorized and it is determined that the value does not exceed fifteen percent of the sale; consequently, replacement equipment can be acquired given it is considered like-kind without separating the personal property as a line item on the settlement statement. If the personal property is greater than fifteen percent, then a line item on the closing statement should reflect the sales price. If the personal property is not replaced, then the recaptured depreciation tax of twenty –five percent is paid.
The Subway franchise owner sells the real and personal property to exchange for either another Subway franchise or for real and personal property if desired in a new business.
When considering the sale of your business, determine the tax consequences with your CPA or tax attorney. If the intent is to replace with real or personal property, contact a Qualified Intermediary to discuss a 1031 exchange. It is far better to have considered a 1031 exchange before the sale rather than after, when it is too late.
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
