TYPES OF PROPERTY QUALIFYING FOR IRC §1031 TREATMENT

If a taxpayer holds relinquished property "for investment" or "for productive use in a trade or business," then except for certain exceptions listed below it may be exchanged for property of a like-kind. The taxpayer must purchase property with the intent of holding it for a similar use in order to take advantage of a tax-deferred exchange. The purpose for which the property is held is determined at the time of the transaction. Finally, a taxpayer may exchange investment property for business use property and business use property for investment property within one exchange.

Application of §1031 to Real Property

The most common type of property exchanged today is real estate.  Because the term like-kind refers to the character of the property and not to its grade or quality, all real property held for the proper purpose is potentially of a like-kind to all other real property. Some good examples of real properties which qualify for exchange treatment are:

                        Raw land                                                                     Vacant lot

                        Commercial property                                                  Retail property

                        Farm land                                                                    Industrial property

                        Residential rental                                                        Commercial/office rental

                        Leasehold interest of 30 years or more                       Delaware Statutory Trust

Application of IRC §1031 to Personal Property

Although it is the most common property exchanged, real estate is not the only property subject to §1031.  Tax-deferred treatment is available for all trade, business or investment property, both real and personal.  For example, a dentist could exchange his equipment and his real estate in one location for similar equipment and real estate in another location, thus upgrading both his facility and the tools of his trade.  Alternatively, an airline could exchange 5 passenger planes for three newer planes.  However, as stated previously, the definition of like-kind for personal property is much stricter.

In order to qualify as like-kind, the relinquished and replacement personal property must be either like-kind or like-class.  The like-kind test is a generalized fact specific determination while the like-class test is a bright line test of whether the assets fall within either the same General Asset Class or Product Class.  This means that business fleet trucks must be exchanged for business fleet trucks, airplanes for airplanes, computer equipment for computer equipment, and so on, while a tractor used to pull a trailer may not be exchanged for the trailer it pulls.  If the personal property to be exchanged does not fall under a specific General Asset Class or Product Class, an exchange may still take place, as long as the properties being exchanged are still considered “like-kind”.  Therefore, the copyright to a novel may even be exchanged, but the replacement property must be the copyright to another novel, not the copyright to a screenplay, as this would not be like-kind.  Livestock may also be exchanged; however, livestock of different sexes does not qualify as like-kind.

In applying the like-class test a few rules must be remembered.  First, only certain of the General Asset Classes are used for purposes of Section 1031. A taxpayer must apply the General Asset Class test.  If a property is found in a General Asset Class then it must be exchanged for property within the same General Asset Class.  A taxpayer may only look to Product Classes if no General Asset Class covers the relinquished property.  Moreover, a taxpayer may not choose between Product Class and General Asset Class if the property is found in a General Asset Class.

Certain intangible and non-depreciable personal property do not qualify for §1031 treatment, such as an exchange of goodwill or going concern for a business.  The IRS states that this is because “the nature of goodwill or going concern value is so inherently unique and inseparable from the business” that it could never be like-kind to another business’ goodwill or going concern value. Additionally, prorations of interest, property taxes, insurance, and other operating expense items on both the relinquished and replacement property closing statements could possibly result in taxable income to the taxpayer, notwithstanding the fact that the transaction may otherwise qualify for an exchange.

Properties That Do Not Qualify for §1031 Treatment

Certain properties will never qualify for Section 1031 exchanges.  The Code and Regulations do not allow the following properties to be exchanged:
Primary residences                                          Second homes

                        Stock in trade or inventory                             Property held for resale

                        Vacation homes (most)                                   Stocks, bonds or notes

                        Partnership interests                                        Choses in action

Certificates of trust or beneficial interests (most)

Securities or other evidences of indebtedness

Exchange Proceeds Used to Improve Currently Owned Property

Exchange proceeds from the sale of a relinquished property cannot be used to improve upon or relieve debt on a currently owned property.  The Regulations state that an actual exchange of property must occur, and that investment property must be sold and new property purchased.  A taxpayer cannot sell an investment property, use the proceeds to improve or build upon another currently owned investment property, pay down any debt on the property, or pay off any debt they hold otherwise to complete a valid §1031 exchange.