Many Taxpayers are familiar with §1031 exchanges of real estate.  What many people do not know is that section 1031 applies equally to the exchange of personal property.  Taxpayers that sell personal property used in a trade or business or held for investment may miss a valuable opportunity to defer the tax gain on the sale if they do not consider like kind exchange treatment for their transaction.

 Typically, gain on the sale of personal property, such as machinery and equipment, comes only from depreciation recapture.  Even though the used asset is worth considerably less than the original purchase price, the tax on the amount subject to recapture can be substantial.  Recapture on personal property is taxed at ordinary income tax rates which are considerably higher than capital gains rates.  Thus, if the fair market value of the relinquished personal property asset is greater than its adjusted basis (cost of the asset minus depreciation allowed), a gain will be realized, and it makes good sense to consider a tax deferred exchange.

 The rules for exchanges of personal property are the same as those for real property.  The “like-kind” requirement, however, is a bit more challenging for personal property.  To qualify for exchange treatment, the relinquished and replacement assets must be either “like-kind” or “like-class.”  “Like-kind” refers to assets that are the same, such as an airplane for an airplane, or a backhoe for a backhoe.  “Like-class” refers to tangible, depreciable personal property that falls within the same General Asset Class or within the same Product Class.  Your tax advisor can assist you with determining what exactly qualifies as “like kind” or “like class” under §1031.

Ron Ricard – Investment Property Exchange Service

 Let’s assume you have lived in your home as a primary residence more than two years, but decide to move out and turn the property into rental housing.  If you sell the property less than three years after you move out, you still qualify for that primary residence exemption of $250,000 or $500,000.  So if your gain (profit) is less than those thresholds, you will have no tax to pay on your gain, though you will have to pay depreciation recapture tax on the amount that you depreciated the property while it was a rental.  

But what if your gain is in excess of the exemption?  In 2005 the IRS issued Revenue Procedure 2005-14, which showed how you can combine the primary residence exemption with a 1031 exchange.  For example, you bought your house for $200,000 and it is now worth $900,000.  After living in it for many years, you convert your house into a rental property.  After renting the property for a couple years you have established the house as investment real estate, BUT you still meet the criteria of having lived in the property for two of the last five years.  When you sell it, it qualifies under both parts of the tax code.  That allows you to keep your exemption amount (either $250,000 or $500,000) in cash and do a 1031 exchange with the remainder. If you are married, you pocket $500,000 and exchange the remaining $400,000 towards another piece of investment real estate.  Note that the original basis goes into the exchange property, as you only get to keep the exemption tax-free.

 Lastly, if you do not sell the property in that three year window after you move out, your property no longer qualifies for the primary residence exemption and is now fully investment real estate.

  DISCLAIMER:  The information above is based on current tax code, which is subject to change. The above information should not be considered to be tax advice. You should discuss your personal situation with your qualified tax advisor.

 Ron Ricard

Investment Property Exchange Services, Inc

(877) 747-7875

ron.ricard@ipx1031.com