Section 1031 is well known for its advantageous tax deferral for the sale of business or investment use real property, it is less well known for its tax advantages for the sale of business use personal property.
Trains, planes and automobiles are not just transportation modalities but are also classified as personal property eligible for Section 1031 tax deferred treatment. The definition of business use personal property is very broad and it requires that a “like-kind” test be strictly adhered to utilize the tax deferral status under Section 1031 at sale. The personal property must be either “like-class” or “like-code” to qualify. “Like-class” means that the property falls within the same General Asset Class or within the same Product Code sharing the same 6-digit North American Classification System (NAICS) code. The Product Codes are found in Sectors 31-33 of the same NAICS system. Other categories are trailers and containers, restaurant equipment, barges and commercial fishing vessels, buses, agricultural equipment, office furniture, construction equipment, copyrights, coin collections, artwork and collectibles and franchise licenses. Sounds confusing, but in reality, it is quite strait forward.
If your company owns log skidding equipment and it makes more economic sense to convert that equipment to excavators, they both fall into the same Construction Machinery Product Class identified under NAICS code 33120 and would be considered “like-kind” for Section 1031 treatment. If your company owns an airplane, it could be exchanged for a helicopter since they are both in the same General Asset Class.
The gain from the sale of real property is comprised of two components, 1) appreciation of the asset over its original purchase price and 2) recapture of any previously taken depreciation. The sale of personal property will usually result in tax being assessed on the previously taken depreciation at ordinary income tax rates, which are considerably higher than capital gains rates. Since many business assets can be fully depreciated in as little as five years, the resulting tax basis can be zero.
There is no reason to pay any tax that can be deferred; there will always be more cash to reinvest in new equipment if the tax is deferred with a Section 1031 Personal Property Exchange.
