Our previous blogs on 1031 Exchanges focus mostly on real property, or real estate. However, the Internal Revenue Code (IRC) 1031 also covers what is dubbed “personal property.” In other words, property held for investment and/or business purposes, but that isn’t real estate, is also eligible for 1031 exchanges - at least for the current time.
If you’ve been following the Realized Blog Series “2017 Tax Reform Impact on Real Estate”, you may know that big changes are potentially on the way for exchanges of personal property. While the 1031 exchange is looking to prevail for real estate, the existing proposed Tax Cuts and Jobs Act, if enacted as proposed, would eliminate the 1031 exchange for personal property.
Let’s review your options as they stand today. If you’ve read our previous writings on 1031 Exchanges, you know that, to qualify for tax deferrals, property exchanges need to meet stringent timelines, and also need to be true exchanges, with a Qualified Intermediary (QI) involved. The rules governing exchanges on personal property are different than those dealing with real estate exchanges.
First, let’s examine the difference between “personal property” and “personal use property.” That one small word – “use” – has large ramifications. As mentioned above, personal property is defined as tangible or intangible property that isn’t real property. Personal USE property, on the other hand, is an asset acquired by a taxpayer for his or her own personal enjoyment.
The Ferrari you acquire only for business purposes (maybe you own a dealership, or it’s part of a fleet) or investment purposes (perhaps that Ferrari is a race car) could be considered personal property, and is possibly eligible for a 1031 Exchange. However, if you are buying that Ferrari because you always wanted to own and drive one, that car would be considered personal use property. Likely as not, it would be ineligible for an exchange.
The chart below lists examples of tangible and intangible personal property that could qualify for exchange treatment, as well as that excluded from exchange treatment.
| Tangible Personal Property | Intangible Personal Property | Property Excluded from Exchange | |
| Agricultural Equipment | Contruction Equipment | Broadcast Spectrums | CertificatesofTrust |
| Airplanes & Helicopters | Precious Metals | Copyrights | Debt |
| Artwork | Precious Musical Instruments | Distribution Routes | Inventory or Stock in Trade |
| Auto/Truck Fleets | Race Horses | Franchise Licenses | Stocks, Bonds, or Notes |
| Coin Collections | Rail Cars & Locomotives | Patents | Partnership Interests |
Another aspect of 1031 Exchanges is the concept of “like-kind.” In real estate exchanges, “like-kind” translates into any other piece of real estate, that would be used for investment or business. So, you could exchange your rental-income duplex for raw land. Or a triple-net retail property for an industrial warehouse. A vacation rental (with certain caveats) on the East Coast could be exchanged for a small office building on the West Coast, and if all goes according to plan, taxes on gains could be deferred.
But, things are a little different when it comes to exchange treatment for personal property. The “like-kind” definition is more restrictive. Tangible, personal property into the same General Asset Class, or must share the same six-digit code found in the North American Industry Classification System, or NAICS.
You can’t exchange your fleet of autos for a fleet of light, general-purpose trucks. Though both asset classes have wheels, and are methods of transportation, they are assigned different NAICS codes. Plus, like-kind doesn’t mean you can take your collection of cattle, and exchange it for an apartment building. Cows and real estate are not “like-kind.”
Speaking of cattle, exchange rules on the four-legged investments can be even more restrictive. Your dairy cow herd isn’t allowed to be exchanged for a beef cow herd. Nor can you exchange your bull (male) for a heifer (female). The animals need to be the same sex to be eligible for tax-deferred treatment.
Finally, like-kind also exerts an influence on intangible assets. In such a situation, the IRS defines like-kind as the “nature or character of the underlying property to which the intangible of personal property relates.” Breaking this down into English, it means that intangible property has to be like to like – such as copyright to copyright, not copyright to patent. Identical purpose is also essential. You can’t exchange a copyright on your novel for a song copyright, for instance. You can, however, exchange that novel copyright for another novel copyright.
Even with differences, there are some similarities between real and personal property when it comes to exchange rules. You still can’t take control of cash or other proceeds until the exchange is complete. And, much as is the case for real property exchanges, you must outsource the QI job to someone who isn’t your agent, investment broker, accountant or attorney. Also, you’re still responsible for finding that replacement property within 45 days, and need to settle on your replacement properties by day 180.
The recently released tax reform proposal (Tax Cuts and Jobs Act) calls for 1031 exchanges to only apply to investment properties. As described above, the IRS Code currently permits for 1031 exchanges on a wide variety of investment or business assets. However, assuming the proposal is passed, personal property would no longer be eligible for like-kind exchanges. So what does this mean for investors in personal property? If you were considering selling and/or exchanging personal property, now may be a good time to speak with your tax advisor. If you were seeking to make investments in tax-advantaged asset classes, your choice of options may be narrowing.
To read the full legislative text of the Tax Cuts and Jobs Act, click here; or for a summary of the respective sections, click here.
If you have any questions regarding 1031 exchanges or how upcoming tax reform could impact them, please contact Realized® at 877-797-1031 or log onto www.realized1031.com.