First thing to keep in mind is the IRS only allows real property to be exchanged. If you are selling a business use 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 we typically see their value allocations reflected in the real estate contract and closing settlement statement. Ultimately the settlement statement shows 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 various assets being included in the sale.
Allocations included in the Contract and 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 (personal property; taxable boot to seller)
$4,500,000 (real property; goes to exchange)
Abc, LLC’s replacement value for their exchange is $4,500,000. They identify 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.
Generally both the purchaser and seller of the business use property must file Form 8594 and attach it to their income tax returns when there is a transfer of a group of assets that makes up a trade or business. Exceptions: You are not required to file Form 8594 if a group of assets that makes up a trade or business is exchanged for like-kind property in a transaction to which section 1031 applies. Click here to see Form 8594 and Instructions.