Rules for Real Estate and Personal Property Exchanges are not always of Like-Kind

Martin Edwards's picture

Differences between Real & Personal Property Exchanges

The 1991 Treasury Department regulations set forth detailed guidelines for tax deferred exchanges of real property and personal property. Prior to that time, exchanges could be done but very little guidance was available to make sure they were done correctly. This set of rules and regulations covered like-kind exchanges of both real and personal property. However, these two types of exchange property are not covered the same way. Below, I’ll summarize some of the differences between real property and personal property exchanges.

What Constitutes Like-Kind in a 1031 Exchange?

Perhaps the largest point of divergence between real property and personal property is in the like-kind requirement. In the case of real estate, the determination is quite straightforward. Any kind of real estate is considered like-kind to any other type of real estate. For example, a three-unit rental property could be exchanged for a strip center. A vacant lot being held for appreciation could be exchanged for a factory building. Even seemingly disparate assets like mineral rights or water rights are like-kind to more conventional types of real estate.

Determining like-kind in connection with personal property is quite a bit more difficult. For starters, assets that are “like class” can be said to meet the like-kind requirement. But to be considered like class, reference needs to be made to certain published General Asset Classes. If sold assets and purchased assets share a common General Asset Class they are deemed to be like kind.

What are the General Asset Classes for Like-Kind Exchanges?

The thirteen General Asset Classes are as follows:

  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)

For example, under General Asset Class 4, an airplane is considered like class to a helicopter even though they are very different. However, light purpose trucks and heavy purpose trucks are in separate General Asset Classes and therefore not like-kind.

What if the Assets Being Exchanged Don't Fall into the General Asset Classes?

Most assets don’t fall into any of the General Asset Classes. In that case, reference has to be made to the product code for the asset. These product codes can be found in the North American Industry Classification System Manual (NAICS), and were created by Federal statistical agencies for analyzing data related to business The regulations make separate use of these codes to help determine like class.

Describing Replacement Property within the 45-Day Identification Period

The 45-day property identification can also be more difficult in the personal property arena than it is in the case of real estate. Regulations provide that the possible replacement property must be “unambiguously described.” Regulations go on to state that, for real estate, the taxpayer simply needs to provide the legal description, the address or a distinguishable name. Presumably, providing the real estate tax permanent index number would suffice. An example of a distinguishable name might be “the Smith Farm in Kane County, Illinois” or the “Empire State Building.”

Personal property, however, “is identified if it is described by a specific description of the particular type of property.” The example contained in the Regulations regarding the “specific description” is that a truck being purchased should reference the specific make, model and year. For the many taxpayers that are in the car rental business or in the equipment leasing business, it is very difficult to be that specific when they don’t know their specific needs so early in the exchange period. For example, a railcar leasing company is able to say that they are identifying 100 railcars. But providing greater detail within the 45-day identification period when they don’t know future lessee needs can be a hardship.

Receipt of Property to be Constructed

Another area where the rules diverge for real and personal property is in connection with property that is being produced. For real estate, that might entail buying a new factory to be built within the 180-day exchange period. A personal property taxpayer may wish to acquire an airplane that will be put together within that same period. If, by the end of the time limit, the real estate taxpayer takes the property unfinished, there are no adverse consequences to the exchange. The taxpayer simply gets credit only for the value of the property as of that time and can finish construction after the exchange period. Not so with personal property which is required to be completed on or before the 180-day exchange period.

Summary

While the Tax Deferred Exchange Regulations apply both to real property and personal property exchanges, there are some important differences. Perhaps the most significant difference is the determination of what constitutes like-kind, in which personal property definitions are more stringent. In addition, the very detailed identification required in the case of personal property and the restrictions regarding unfinished personal property can be troublesome.

For more information on this or other 1031 topics, contact me today.

(312) 207-1031
martine@accruit.com

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