Personal property held in the productive use of a business when sold triggers a federal and state capital gain tax on the appreciation and a twenty five percent depreciation recapture tax that is deferrable in a 1031 exchange. The tax can be sizable given past years of bonus depreciation. If the owner will replace with like-kind or like-class property of equal or greater value than the net sales price, the deferral represents additional working capital or an indefinite interest free loan until the replacement property is sold or another 1031 exchange is initiated.
1031 Exchange
The Internal Revenue Code Section 1031 states “no gain or loss shall be recognized on the exchange of property held for productive use in trade or business, or for investment, if such property is exchanged solely for property of like kind which is to be held for productive use in trade or business or for investment.” Property is either real, tangible or intangible personal property. All taxpayers (individual, husband and wife, limited liability company, trust, corporation) subject to federal taxes can utilize a 1031 exchange to defer, postpone or push the recognized gain or federal and state capital gain tax until the replacement property is sold. Beneficiaries of taxpayers who die with the property receive a stepped up basis meaning the heir receives the property at the then current value based upon market comparable, not the original purchase price.
The 1031 exchange can defer upwards of forty percent of the sales price. Long term capital gain rates or when property has been held for greater than one year and a day changed effective January 1, 2013 to rates ranging from zero to 23.8 percent depending upon marital filing status and adjusted gross income. Capital gain tax rates on collectibles is 28 percent.
Property
Any real property is eligible for any real property given ownership rights are perpetual and both are located within the United States. Property located predominantly outside the US is also eligible for a 1031 exchange given the replacement property is located predominantly overseas. Real property such as land, oil and gas royalties, single family residential, vacation condominium, shopping center, hotel and motel, apartments and other commercial property can be exchanged for other like real property. An apartment can but does not need to be exchanged for another apartment to satisfy the like-kind requirement.
Personal property must be exchanged for the same class or group of assets. Thirteen general asset classes or the North American Classification System categorizes personal property into five digit codes. When a front loader is sold, the equipment can be exchanged for any equipment categorized in the same code or group of 333120 for construction machinery.
Artwork, gold and silver bullion, numismatic coins, heirloom musical instruments, aircraft, livestock, vintage sport cars, railroad locomotives, oil and gas equipment, barges and ships, furniture are examples of tangible personal property eligible for a 1031 exchange given the asset has been held in a business or for investment.
Equipment Owners
Smart equipment owners and their fixed asset managers must be familiar with the 1031 exchange strategy. Distributors who lease their equipment later to sell and replace utilize 1031 exchanges to upgrade their equipment. Oil and gas drilling companies replace worn pipe and drilling equipment in 1031 exchanges. Aircraft owners who upgrade to a fuel efficient bank owned aircraft use 1031 exchanges acquiring their replacement aircraft to later sell the relinquished or old aircraft in a reverse 1031 exchange. Vintage sport car and thoroughbred show and race horses sell and replace with one or multiple like-kind sport cars and same sex horses.
A 1031 exchange is not only for real and tangible personal property but also applies to franchise rights, intellectual property, fishing permits, sports contracts, broadcast frequencies owned by TV and radio stations. Should you want to discuss the 1031 exchange or qualified intermediary accommodation services, contact our office directly or click on the consultation request below with your question.
