In order to successfully complete a Section 1031 exchange, both the relinquished property and the replacement property must be "like-kind."  Different rules apply for real estate exchanges and personal property exchanges.

A.  Real Estate Exchanges.

The like-kind requirement is, generally speaking, easily satisfied in connection with exchanges of real property.  Basically, any category of real property used in a trade or business or held for investment may be swapped for any other property so used or held that qualifies as real estate under local law (i.e., the law of the State in which the replacement property is located). This means that land can be exchanged for residential property, residential can be exchanged for commercial, or commercial property can be exchanged for industrial property.

Please note that US property is not considered like-kind with non-US property.

Property owners who own residential investment property or a commercial property that requires significant time and effort can exchange this property for a NNN property that is subject to a long term lease.  The tenant is responsible for maintenance, insurance and taxes, enabling the property owner to remain fully invested in real estate while moving out of the active property management business.

As with personal property, it is possible to exchange different quantities of properties, for example a property owner can sell two properties and take back one, or sell one and take back three to complete his or her exchange. Prudential California Realty, through its relationships with brokers, property owners and developers, provides Property Location Services services to assist you to locate suitable replacement property.  Please contact Laurie if you need additional information regarding like-kind requirements, or if you would like our assistance in locating replacement property.

B. Personal Property Exchanges.

Like-kind exchanges are an effective investment strategy for nearly all personal property, including but not limited to aircraft, fleet vehicles and intangible personal property.  While the range of real property exchanges that can satisfy the "like-kind" requirement is fairly broad, the rules are more rigorous for personal property exchanges.  The regulations state that personal property will meet the like-kind requirement if it is of the same general asset class or the same product class.  In addition, the requirement can be met if the assets are deemed to be of like kind under general principles.

Same General Asset Classes.

Properties are of like class if they are included in the same General Asset Class in IRS Revenue Procedure 87-56 as supplemented.  This IRS document classifies properties for depreciation purposes and groups various sorts of tangible personal property in a series of General Asset Classes.  For example, office furniture, fixtures and equipment are included in one General Asset Class while information systems such as computers and peripheral equipment are grouped in another General Asset Class. Similarly, all automobiles fall into the same General Asset Class and light trucks form a separate Class. 

Same Product Classes.

Properties are also of like class (an therefore satisfy the like-kind requirement) if they fall within the same "Product Class." However, the like-kind requirement may not be satisfied by reference to Product Class if the property is set forth in a General Asset Class.  The Product Class status of property not listed in a General Asset Class is determined by referring to Division D of the Standard Industrial Classification (SIC) Codes set forth in the Office of Management and Budget SIC Manual.

Like-Kind Determination for Other Assets.

Certain assets, such as intangible personal property do not belong to either a General Asset Class or a Product Class. Such property may, nonetheless, satisfy the like-kind requirement.  Under the regulations, the determination of whether non-classified property is generally of like-kind is made based on all of the facts and circumstances. IRS Reg. § 1.1031(a)-2(c)(1).

Another group of assets to which the facts and circumstances test may apply are certain investment assets such as collectibles and works of art.  The IRS has issued a number of rulings with respect to precious metals but there is very little authority dealing with works of art. Collectibles and Art Exchanges should be considered by those involved in selling such assets who intend to use the proceeds to purchase other such assets.

The facts and circumstances test will also apply if one asset is described in the General Asset Class and the other asset is found in the Product Class.  One example of such a situation is an aircraft used for corporate business purposes and a charter aircraft, which might be the case in an Aircraft Exchange.

Foreign Use Property.

Personal property used predominantly within the US is not considered like-kind with personal property used predominantly outside the US.  These rules are very complex. If you have assets that may be affected by these rules, please contact us.

Summary.

The point that must be kept in mind when dealing with personal property exchanges is that there is a narrower range of properties that will be treated as being like-kind in personal property exchanges as compared to real property exchanges.  In sum, you should obtain appropriate advice from a tax professional concerning the like-kind requirement before engaging in an exchange.  This is particularly true for exchanges involving personal property.