When selling a business, consideration of the tax consequences, including a 1031 exchange is often not at the top of the list. Following a meeting with your CFO or CPA, the federal, state and recaptured depreciation tax obligation is determined and now included in the dizzying array of outcomes as is the decision of whether or not to replace the assets. By replacing all or some of the assets, the federal, state and recaptured depreciation taxes can be deferred in a 1031 exchange. Rather than paying the tax, those dollars can be used towards as an interest free loan towards acquiring replacement property. The tax obligation does not go away, but is postponed; delayed until time the newly acquired property is sold. Another 1031 exchange is possible, or should the assets be inherited, the basis is stepped up to the heirs.
How a 1031 Exchange Works When Selling a Business
Internal Revenue Code Section 1031 allows the taxpayer, whether foreign or domestic, to not recognize or defer the gain or loss from real property held in the productive use of a business or investment, if such property is exchanged solely for property of like-kind which is to be held for productive use in business or for investment. For purposes of a 1031 exchange, Businesses real property is all that is considered for 1031 exchange treatment. If the real property is replaced with like-kind property, then the federal, state and recaptured depreciation is deferred. Good will and effective January 1, 2018 per the Tax Cut and Jobs Act of 2017, tangible and intangible personal property are no eligible for 1031 consideration.
Like-Kind Property
Real property can be any type of real estate, whether that is land, leasehold improvements or a thirty-year lease and can be exchanged for any real property, including a vacation property, triple net lease or tenants-in-common commercial properties. Personal property was eligible for 1031 tax deferral treatment prior to January 1, 2018 however is no longer eligible. Real property located in the US can only be exchanged for real property in the US, while real property held internationally is eligible for real property held outside the US.
