In your past property acquisitions, you have probably encountered situations when you’ve had opportunities to acquire additional items that related to your main purchase. A seller may have been willing to include appliances and furniture with the sale of a home. A seller of a factory or a farm may have been willing to include equipment and tools in the sale. If you were attempting to complete a 1031 exchange with these purchases, you were probably warned that these extra items would be considered boot and could trigger a taxable event.
UPDATE: The Tax Cut and Jobs Act was signed into law on December 22, 2017, and took effect on January 1, 2018. It is a complex modification to the Internal Revenue Code that will take some time to fully understand, notwithstanding that it became effective just nine days after signing. The major change to Section 1031 is the complete repeal of personal property exchanges. The Code section now refers exclusively to real estate assets, and has been retitled, “Exchange of real property held for productive use or investment.” Learn more about the Tax Cut and Jobs Act here.
While many people understand that a 1031 exchange will allow you to exchange real property on a tax-deferred basis, many do not realize that extra, personal items can also be exchanged on a tax-deferred basis under the right circumstances.
So before you miss a tax deferral opportunity, let’s take a moment to understand “property.”
Property is anything that you can legally own. For the purposes of determining owner rights in regards to their property, common law recognizes different types of property: real property and personal property. It is important to understand the difference between these types of property because laws pertaining to property are different depending on the type of property in question.
Real property is land and everything permanently affixed to the land, including buildings and the landscape.
Personal property is anything owned that is movable. Personal property can be divided further by tangibles, things that can be felt or touched, such as furniture or equipment; and intangibles, things that cannot be felt or touched, such as stocks or intellectual property.
Section 1031 of the Internal Revenue Code (IRC) stipulates that property must be held for productive use in a trade or business or for investment in order to qualify for a tax-deferred exchange. This includes both real and personal property.
Examples of tangible personal property that might be exchanged could include: aircrafts, aviation related equipment, shipping crates, ships, trains, cars, trucks, livestock, farming equipment, gold coins, art work, etc.
Examples of intangible personal property that might be exchanged could include: broadcasting licenses, copyrights, trademarks, patents, internet domain names, franchise licenses, etc.
Section 1031 does specifically exclude several property items from qualifying for a tax-deferred exchange. These items are:
- Inventory or stock in trade
- Stocks, bonds, or notes
- Other securities or debt
- Partnership interests
- Certificates of trust
Like replacement real property, replacement personal property must be considered “like-kind” to the relinquished personal property. As such, two separate 1031 exchange processes are needed in order to defer all appropriate taxes when both personal and real property are involved in a sale. In part 2 of “Exchanging Personal Property,” we’ll discuss more about how to determine like-kind personal property, the benefits of exchanging personal property and the process of exchanging personal property.