Editor: Mark Heroux, J.D.
With the enactment of the legislation known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, like-kind exchanges are now limited to real property held for use in a trade or business or for investment. Prior to the TCJA, taxpayers could defer the gain generated by like-kind exchanges of both real property and personal property. Most common like-kind exchanges of personal property included those of aircraft, boats, automobiles, trucks, and machinery or equipment. A taxpayer could benefit from deferring the gain on the like-kind exchange of personal property and adjust the basis of replacement property under the former rule. Because of the change in the TCJA, disposal of personal property and its exchange with 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 is 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 is how to now handle personal property, such as furniture and fixtures, associated with the sale of real property that qualifies as a like-kind exchange.
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 new-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 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. This is because a negligible amount of gain generated by the sale of personal property will require deferral.
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 a residual net book value 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 a Sec. 501(c)(3) charitable organization and benefit from a charitable contribution prior to the like-kind exchange. If the value of the donated property exceeds $5,000, then a qualified appraisal is required to support the donation with the filing of Form 8283, Noncash Charitable Contributions.
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 changed the ability to defer the gain on personal property and instead allows the deferral only on real 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.
Mark Heroux, J.D., is a principal with the Specialty Tax Services Group at Baker Tilly Virchow Krause LLP.
For additional information about these items, contact Mr. Heroux at 312-729-8005 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.