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1031 Exchanges
on Personal Property
Section 1031 of
the Internal Revenue Code is actually divided into
two sections, one dealing with 1031 exchanges on real
estate; and the other dealing with 1031 exchanges
on personal property. I’ve written
an extensive number of articles about the requirements
of real estate exchanges because that’s what
most people want to know about. But you should also
have a basic awareness of the rules governing personal
property.
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by
Author Gary Gorman
Founding Partner,
1031 Exchange Experts, LLC |
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When the IRS talks about “personal
property”, they’re talking about stuff
that moves (planes, boats, trains, cars, etc.). If
you can move it, the personal property rules apply.
In the real estate industry we see a lot of mixed-use
properties – properties that have both real estate
and personal property components. For example, hotels,
motels, restaurants, bars and Bed-and-Breakfasts are
all mixed use properties since they consist of both
real estate and personal property. In other words,
you have two exchanges when you sell these types of
properties.
The big difference between real estate
exchanges and personal property exchanges involve the
concept of “like-kind.” In a real estate
exchange, you can sell a purple duplex and buy an office
building, or an apartment building, or a warehouse,
or even bare land. Both your Old Property and your
New Property, in a real estate exchange, are like-kind
if they are both held for investment, so the rules
are very flexible.
The rules are much more complicated
for personal property. In an exchange of personal property,
to be like-kind, both the Old and New Properties have
to be used within the same business. Every business
within the United States is assigned an industry classification
number by the government from the North American Industry
Classification System, or “NAICS.” (The
NAICS manual that lists all the different classification
codes is the size of a large, city phone book) To meet
the IRS definitions of like-kind for Section 1031,
both the Old and New Properties have to fall within
the same classification code.
Assume, for example, that Fred and
Sue own a Bed-and-Breakfast that they wish to sell
and replace with a motel. Can they do a 1031 exchange?
The Old and New Properties both have real estate and
personal property components; both properties have
land and a building, and both properties have furnishings
in the guest rooms that are essentially similar (bed,
night stands, dresser, television, etc.). So at first
blush you would think they could do this exchange,
(you would be correct about the real estate), but what
about the personal property?
The NAICS classification code assigned
to a Bed-and-Breakfast is 721191, but the code assigned
to a motel is 721110. Since the two classification
codes pertaining to the personal property are different,
Fred and Sue would not be able to do a 1031 exchange
for the personal property part of the sale. But they
could do an exchange for the portion attributed to
the land and buildings. The personal property portion
of the exchange will be disallowed, even though the
guest room furnishings in both properties were exactly
identical, because Fred and Sue did not replace their
sale within the same NAICS code. In other words, if
Fred and Sue wanted to have a successful exchange of
their personal property they would have to buy another
Bed-and-Breakfast.
One thing should be obvious by now
but needs to be emphasized if you are a real estate
agent or broker, and your client is selling a mixed-use
property, you are in way over your head on a very complicated
transaction. As soon as you have a signed listing agreement,
I strongly recommend that you contact a good, national,
1031 intermediary (preferably one with a strong CPA
staff) and set up a conference call between the intermediary
and your clients CPA and attorney. You need to have
your strategy well planned before you get an offer
on the property. Otherwise your client could unnecessarily
end up paying a lot of tax.
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