First thing to keep in mind is the IRS only allows real property to be exchanged. If you are selling a business use property you may be selling more than just your real property. There could be other assets included in the sale such as personal property, inventory, cash, securities, goodwill, intangibles, and FF&E (furniture, fixtures and equipment). These items are considered taxable boot and not exchangeable therefore they must be kept outside of the exchange. When assets other than real property are included in a sale the best practice is to have the value allocations reflected in the real estate contract and closing settlement statement. Ultimately the settlement statement should show separate line items for the real property and personal/business property assets being sold. Proceeds allocated for anything other than real property will go to the seller as taxable boot while proceeds allocated as real property will go to the exchange.
Example:
Abc, LLC wants to sell their business use real property (a Hotel) as well as their business entity for $5,000,000. They accept a buyers offer and agree to enter into contract to sell the hotel. When structuring the contract, the seller and buyer agree on different value allocations for the different assets being included in the sale.
Allocations included in the Contract and on Settlement Statement:
$4,500,000 allocated as Real Property (goes to exchange)
$100,000 allocated as FF&E (taxable boot to seller)
$100,000 allocated as Inventory (taxable boot to seller)
$300,000 allocated as Business Goodwill (taxable boot to seller)
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Total Sale Price: $5,000,000
$500,000 (taxable boot to seller)
$4,500,000 (real property goes to exchange)
Abc, LLC’s replacement value is $4,500,000 for their exchange. They locate a replacement property worth $6,000,000 and reinvest all exchange proceeds as well as their own funds into the new property to complete the purchase.
Abc,LLC completes a successful “partial exchange” meaning they deferred a majority of their gains while taking a limited amount in taxable boot.