Can You Use Sales Proceeds to Buy Personal Property in a 1031 Exchange?

1031 property exchange

Here’s a client scenario we recently dealt with: The client was pursuing a build-to-suit 1031 exchange, and needed to purchase $2 million in personal property for the new hotel they were building. Their question was “can we use proceeds from the sale of the relinquished property to buy that personal property during the first 180 days?"

The Basics

The short answer is this can be done, but it makes the exchange more difficult.

The “goodwill or going concern value of a business” of a company may not be exchanged under Section 1031 as per Treas. Reg. § 1.1031(a)-. (2)(c)(2). Real property and personal property can both qualify as exchange properties under Section 1031; but real property can never be like-kind to personal property. Most sellers conducting 1031 exchanges prefer to bulk-up the value of the real property because it is easier to exchange. This is because the like-kind standard is very broadly construed in the realm of real property.

Personal property may be exchanged for other like-kind personal property, however these transactions are more complicated because the like-kind standard is much more narrowly construed for personal property (chattel including all property that was not real estate and not attached or affixed to the real property as a fixture).  As an example, cars are not like-kind to trucks. 

Please see this article on the topic:  http://www.cpec1031.com/blog/can-i-1031-exchange-one-business-for-another

Internal Revenue Code Regulations

Section 1.1031(a)-2(a) provides that personal properties of a like class are to be considered of like kind for purposes of section 1031. Under §1.1031(a)-2(b), depreciable tangible personal property is of a like class to other depreciable tangible personal property if the exchanged properties are either within the same general asset class or within the same product class. The general asset classes are derived from Rev. Proc. 87-56, 1987-2 C.B. 674, (dealing with depreciation of personal property). Section 1.1031(a)-2(b)(2) adopts certain of those general asset classes to determine what property is of like kind for purposes of exchanging depreciable tangible personal property under section 1031, and identifies the types of personal property included in each general asset class listed.

Section 1.1031(a)-2(b)(3) provides, in part, that property within a product class consists of depreciable tangible personal property that is listed in a 4-digit product class (or “code”) within Division D (pertaining to the manufacturing sector of the economy) of Executive Office of the President, Office of Management and Budget, Standard Industrial Classification Manual(1987) (SIC Manual). Section 1.1031(a)-2(b)(4) states that the SIC Manual generally is modified every 5 years and that the product classes for section 1031 purposes will follow the modifications of product classes in the SIC Manual.

General Asset Classes are set forth in Treasury Regulation §1.1031(a)-2. There are 13 classes in all. They are:

  1. Office furniture, fixtures, and equipment (asset class .11)
  2. Information systems (asset class .12)
  3. Data handling equipment, except computers (asset .13)
  4. Airplanes (airframes and engines) except those used in commercial or contract carrying of passengers or freight, and all helicopters (airframes and engines) (asset class .21)
  5. Automobiles, taxis (asset class.22)
  6. Buses (asset class.23)
  7. Light general-purpose trucks (asset class .241)
  8. Heavy general-purpose trucks (asset class .242)
  9. Railroad cars and locomotives, except those owned by railroad transportation companies (asset class .25)
  10. Tractor units for use over-the-road (asset class.26)
  11. Trailers and trailer-mounted containers (asset class .27)
  12. Vessels, barges, tugs, and similar water-transportation equipment (asset class .28)
  13. Industrial steam and electric generation and/or distribution systems (asset class.4)

Product Classes are limited to those found in the North American Industry Classification System (NAICS) as set forth by the United States Government. These codes classify enterprises by their business activity. Although the NAICS classes are numerous, the product classes that involve the manufacturing sector are six-digit codes beginning 31, 32 and 33.

  • 1031 Hotline: If you have questions about personal property exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

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