Mergers Acquisitions and 1031 Exchanges

(Listen Here 8:34 min)

Today’s podcast is entitled “Mergers Acquisitions and 1031 Exchanges.” Many people conducting mergers, acquisitions and the purchase and sale of businesses have so many things in the air to keep track of, that they often lose sight of the important tax efficiencies under section 1031.

The Most Tax Efficient Way to Sell Business Property

Remember, if we convert a transaction from a sale to an exchange, under section 1031, we can defer all the taxes on the disposition of like kind property indefinitely. The fundamental requirements of section 1031are as follows:  The relinquished property that is given up must have been held for investment or for use in a trade or business,  it must be exchanged for like-kind property that must also be held for an investment or for use in a trade or business. By characterizing the transaction as an exchange, as opposed to a sale, we get to defer or have the gain go unrecognized indefinitely.

1031 Exchange Rules

Now, let’s talk about how we can mold 1031 into a sale of a business:

Imagine we are selling a restaurant chain. Each of those restaurants sits on real estate and have some buildings or improvements that are considered real estate. Real estate is very easy to implement a 1031 exchange on. As a matter of fact, when most people think of 1031 exchanges, they often think of commercial real estate because commercial real estate is frequently exchanged as opposed to sold.

In addition to the real estate, we may also have items of personal property or chattel. These are movable items such as stoves, refrigerators and other accoutrement that would be used in the restaurant business. Guess what?! 1031 applies to personal property as well as real estate! The thing to remember is, in the realm of personal property, the like-kind requirements are far more stringent. In real estate, a condo can be considered like-kind with raw land, an office / industrial property can be considered like kind with residential. Just about any real estate in the United States that is held for “investment” or “used in a trade or business”, will be considered like-kind with other United States real estate that is also held for an investment or used in a trade or business. Now, in personal property, the like kind requirements are a bit more exacting. In personal property (Personalty or chattel) exchanges, a “heavy duty truck” could be exchanged for another “heavy duty truck”, a combine used in agricultural purposes could be exchanged for other agricultural equipment. The like kind requirements are just more precise and exact.

Some Property will Not Qualify for 1031 Exchanges or Deferral of Taxes

There is another category in a business that cannot be exchanged under Section 1031. This category deals with the “going concern” or “good will” of a business. Remember that the good will of one business will never be considered like-kind to another business’s good will. This comes out of the treasury regulations [1.1031(a)-2(c)], so unfortunately part of the sale of the business will likely be subject to some tax. It’s a good idea to set out in your asset purchase and sale agreement, some value for good will. Attribute your value to it, pay your taxes on it; but as to the other components, the real estate and personal property, you want to layer in a 1031 exchange to get the most tax efficient disposition of the business as a whole.

Hotels and Motels Make a Good Exchange of Businesses

Let’s talk about a category of business that is ripe for 1031 exchanges: the hotel and motel industry. Often, the operators of hotels and motels have about a 5-7 year hold time before they want to exchange into something different, another bigger and better hotel. 1031 exchanges can be layered into a hotel transaction very easily and hotels make a great example of both personal property (the bed, furnishings, etc.) and the real estate (the dirt the hotel sits on, plus the improvements / the building that sit on the real estate). Remember, 1031 exists to encourage people to continue to invest into another like kind property. In my experience, hotel operators like to buy more of what they know and understand; they want to expand into bigger better hotels to compound and build their hotel portfolios over time.

What Else Makes a Good 1031 Exchange?

Let’s talk about some other business where we could layer in 1031 exchanges.

1031 Work Very Well for TV and Radio Stations

The sale of television or radio broadcast stations often times have a FCC license, which can be exchanged for another FCC license in a bigger better market. Also included in the sale of a TV or radio station would be some other items, the transmitter tower, and personal property that goes along with the radio station, as well as some real estate, the buildings and improvements that the business operates in.

1031 Apply to the Sale Sports Franchises

The sale of a major sports franchise is another good example. In a sports franchise, you have the major league sports contracts (that’s personalty) as well as other improvements and buildings that the sports franchise operates out of. If you move out of a minor league sports franchise, into a bigger league sports franchise, we could conduct that as an exchange. We could dispose of the old sports franchise and with both a real property and a personal property exchange, we could exchange into a bigger better (sports) market.

Focus on the Tax Incentives in Brokering a Sale of a Business

In summary, let’s remember when we are structuring the sale of a business, to always contemplate how we can do this in the most tax efficient manner. 1031 is a valuable tool for folks selling their business. Remember the like-kind requirements of real estate are very broad, so if I’m getting out of the grocery business and want to put my investments on auto-pilot, I could exchange into a management free (real estate) investment and still preserve my capital by deferring the recognition of all of the capital gains tax from my old grocery store buildings and real estate.

Mind the Personalty …Chattel and Movable Items!

Another important 1031 tip, is 1031 is broader than just real estate and we can conduct exchanges of personalty. That means personal property of things, such as: artwork, coin collections, breeding stock, racing horses, gold coins, business equipment, agriculture equipment, aircraft, collector cars that are held for investment; the list of personal property you can conduct exchanges on is immense!

About the Author:

Jeff Peterson (AKA: "Professor 1031") is a Qualified Intermediary and Serves as an Adjunct-Professor for the William Mitchell College of Law (Where He Teaches About Federal Income Tax). Jeff Works With People From All Over the USA to Save Money on Federal Capital Gains Taxes.

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