Prior to the enactment of the legislation known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, the rules in Sec. 1031, which allow taxpayers to defer recognition of gain on a like-kind exchange (the exchange of property used in a trade or business or for investment for property of a like kind to be used in a trade or business or investment), applied to both personal property and real property. Common like-kind exchanges of personal property prior to the TCJA included those of aircraft, boats, automobiles, trucks, and machinery or equipment. The TCJA amended Sec. 1031 to apply only to exchanges of real property. Because of this change, the exchange of personal property for other personal property of like kind is now a taxable event.
On the other hand, maintaining the ability to defer the gain on a sale of real property via a like-kind exchange remains key to taxpayers who sell real estate. The gain deferral allows real estate sellers to invest in new real estate, as opposed to paying taxes, which, in turn, increases their purchasing power. The question now is how to handle personal property, such as furniture and fixtures, associated with the sale of real property that qualifies as a like-kind exchange. (For the basic mechanics and other requirements of like-kind exchanges, see Sec. 1031 and associated Treasury regulations.)
ALLOCATION OF SALES PROCEEDS
It is recommended for the sale of real estate to allocate the sales proceeds among the categories of land, building, land improvement, and personal property, based on a qualified appraisal. A qualified appraiser can determine the value of the real estate and how to allocate to each bucket based on comparable sales, the income approach, or the replacement-cost approach. If a qualified appraisal is not obtained, a couple of other alternatives can be used to allocate the sales proceeds, such as using the values reported on the real estate tax bill or the residual net book value of the property. For a sale of a business, usually, the buyer and seller will allocate and agree upon the purchase price and the allocation of the sales proceeds to a group of assets by filing Form 8594, Asset Acquisition Statement Under Section 1060. But, for the sale of real estate, the buyer and seller do not have to agree on a sales price allocation at the time of the sale. The buyer and seller may have different plans for the property, which could alter the sales price allocation among the categories of land, building, land improvement, and personal property.
Most often, sales proceeds are not allocated to personal property with the sale of real estate, since personal property is not the driver of the sale. Rather, the intent of the buyer is to purchase the real property, such as the building and land. Having a minimal to zero amount of sales proceeds allocated to personal property will alleviate the issue of no longer being able to defer the gain on personal property via a like-kind exchange.
ABANDONMENT AND CHARITABLE CONTRIBUTION
Another option is to treat the disposition of personal property as an abandonment prior to, and not as a part of, the like-kind exchange. An abandonment is considered a disposition of property in which the property is voluntarily and permanently given up with the intention of ending ownership but without passing it on to anyone else. Generally, an abandonment of property is not considered a sale or exchange. An example would be taking the furniture and fixtures and simply throwing them out or discarding them. If adjusted basis remains on the personal property that is abandoned, this would normally be treated as an ordinary loss prior to the sale of real estate.
Similarly, the seller can choose to donate the personal property to an organization described in Sec. 170(c) and benefit from a charitable contribution deduction prior to the like-kind exchange. If the deduction claimed for the donated property exceeds $5,000, then a qualified written appraisal from a qualified appraiser must be obtained to support the donation.
Overall, each of these strategies intends to remove personal property from the equation prior to the like-kind exchange, since the gain on personal property can no longer be deferred. At the same time, taxpayers can generate an ordinary deduction for the removal of the personal property if it is either abandoned or donated.
ADJUSTING TO THE NEW LAW
The TCJA amended Sec. 1031 to apply only to real property, eliminating the option to defer gain on a like-kind exchange of personal property. To minimize the gain recognition and a potential taxable event from the exchange of personal property, several options may be considered. They include the special allocation of sales proceeds, as well as the abandonment or charitable contribution of the personal property. Prior to the like-kind exchange, tax planning should be done to create the most tax-advantageous outcome.
Editor's note: This column is adapted from "Tax Clinic: Like-Kind Exchanges and Personal Property," The Tax Adviser, October 2019.
Brenda Graat, CPA, MBA, is a senior tax manager with Baker Tilly Virchow Krause LLP in Milwaukee.
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