Under prior law, taxpayers could defer the tax liability resulting from their gain on the sale of real, personal or intangible property held for use in a trade or business or for investment (relinquished property) as long as they rolled all of their sales proceeds and equity into like-kind real, personal or intangible property that would also be held for use in a trade or business or for investment (replacement property). This is known as a Sec. 1031 like-kind exchange.
The TCJA modified this provision to limit its application only to real property. Thus, personal property and other intangibles are no longer eligible for tax-free exchange. Note that taxpayers may still want to structure a sale and purchase of personal property (such as a vehicle) as an exchange to minimize the sales tax implications of the transaction or if their state income tax law still allows tax-free exchanges of personal property because the state’s income tax statutes do not conform with current federal statutes.
This exclusion of personal property from tax-free exchange treatment applies even if such personal property is ancillary to the real property being exchanged, as is common with hotels and residential rental properties. In such cases, it will now be necessary to determine the portion of the total sales price for the relinquished property that is attributable to the personal property so taxable gain (or loss) on the sale of that property can be calculated separately and reported as taxable income.
This new limitation generally applies to exchanges completed after December 31, 2017. However, if the taxpayer already disposed of the old property (in a forward exchange) or received the new property (in a reverse exchange) on or before December 31, 2017, the new limitation does not apply to that exchange.
Since the use of like-kind exchanges has been under attack for some time and was expected by some to be completely repealed, having it continue to apply to real property exchanges is a taxpayer win. And despite the exclusion of personal property from the tax deferral benefits of like-kind exchanges, any recognized gain on the sale of personal property can now be partially or even fully offset by the taxpayer’s use of the new 100% expensing provision on the purchase of replacement personal property (for federal income tax purposes, but perhaps not for state income tax purposes). This offset of taxable gain on the sale of personal property by depreciation expense on the acquisition of replacement personal property will obviously be achieved only if the sale and acquisition occur in the same taxable year for the taxpayer. One caveat, however, is that the exclusion of personal property from like-kind exchange treatment is a permanent exclusion, while the 100% expensing provision is only temporary, phasing out for property placed in service beginning in 2023 and then expiring for property placed in service after 2026. The negative impact of the exclusion of personal property from Sec. 1031 exchanges will therefore increase once that phaseout period begins.