1031 exchanges are most often associated with investment real estate as a way to defer taxable investment gains. However, section 1031 of the Internal Revenue Code (“IRC”) is NOT limited to real estate transactions. A number of other assets qualify, including most tangible business assets.
1031 exchanges are most often associated with investment real estate as a way to defer taxable investment gains. However, section 1031 of the Internal Revenue Code (“IRC”) is NOT limited to real estate transactions. A number of other assets qualify, including most tangible business assets.
Section 1031 provides that “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.”
To qualify for a 1031 exchange:
- The sale of the relinquished property and the replacement property must be identified within 45 days and the acquisition completed within 180 days of the qualified sale.
- The replacement property must be of equal or greater value than the relinquished property.
- All proceeds from the relinquished property must be reinvested in the replacement property.
Nowhere does the IRC limit the use of section 1031 to investment real estate. So, let’s consider its application in the exchange of like kind business assets. The most important distinction made by the Internal Revenue Service (“IRS”) is that the sale or exchange of a business is not considered the sale or exchange of one single asset (i.e. the business). Rather, it is considered the sale or exchange of individual asset classes that comprise the business. Therefore, each class of asset must be exchanged with an asset of equal or greater value, in the same class and subject to the above requirements to qualify for section 1031 deferment. In most cases, depreciable tangible property (real estate and equipment) are the most likely to qualify for deferment under section 1031. Although, intangible property can qualify for “like kind” treatment, it is often difficult to prove that intangible assets are like kind based on the nature and character of the rights involved. For this same reason, a business’s going concern value or goodwill is never considered by the IRS to be like in kind to the going concern value or goodwill of another business. As you may imagine, 1031 business exchanges can become very complex based on the assets involved. For this reason, they are best left to the tax professional. However, it is important for you as a potential business seller to understand that 1031 exchanges are not limited to real estate transactions. They are available to business sellers with the same requirements and restrictions.
