Can you do a 1031 exchange on the sale of business?

Question

Is it possible to utilize a 1031 exchange to defer capital gains taxes when selling a business, specifically focusing on the real property assets involved in the transaction?

ARTE's Answer

When considering a 1031 exchange for the sale of a business, it's important to understand the specific rules and limitations that apply. A 1031 exchange, as outlined in Section 1031 of the Internal Revenue Code, allows for the deferral of capital gains taxes on the exchange of like-kind properties held for productive use in a trade or business or for investment. However, the key here is that the exchange must involve real property, not personal property or business interests.

In the context of a business sale, you cannot directly exchange the business itself under a 1031 exchange. This is because business interests, such as stocks, bonds, or partnership interests, are explicitly excluded from like-kind exchange treatment under Section 1031(a)(2)(D). However, if the business owns real property, you can potentially structure a 1031 exchange for the real estate component of the business.

Here's an example to illustrate how this might work:

  1. Imagine you own a business that includes a piece of commercial real estate, such as an office building. You decide to sell the business, but you want to defer the capital gains tax on the real estate portion of the sale.
  2. You separate the real estate from the rest of the business assets and perform a 1031 exchange on the real estate alone.
  3. Let's say the office building is valued at $500,000. You sell the building and use Deferred.com as your Qualified Intermediary to facilitate the exchange.
  4. We at Deferred.com offer a No Fee Exchange, which can save you money during this process.
  5. You then identify a replacement property (such as another commercial building or a rental property) within 45 days and complete the purchase within 180 days.

By doing this, you can defer the capital gains tax on the $500,000 from the sale of the office building, as long as you reinvest the proceeds into a like-kind property of equal or greater value. The rest of the business assets, such as equipment or goodwill, would not be eligible for a 1031 exchange and would be subject to regular capital gains tax treatment.

It's crucial to work with a tax advisor or CPA to ensure that the transaction is structured correctly and that all IRS requirements are met. At Deferred.com, we can assist you with the exchange process, ensuring compliance with the 1031 exchange rules and helping you maximize your tax deferral benefits.

Have more questions? Call us at 866-442-1031 or send an email to support@deferred.com to talk with an exchange officer at Deferred.

Deferred's AI Real Estate Tax Expert (ARTE) is a free research tool. Trained on 8,000+ pages of US tax law, regulations and rulings, ARTE outperforms human test takers on the CPA exam. This is page has ARTE's response to a common 1031 Exchange question and should not be considered personalized tax advice.

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See more frequently asked questions about 1031 exchanges

Can you do a 1031 exchange on personal property?
Is it possible to utilize a 1031 exchange for personal property, or are these exchanges limited to real property held for investment or business purposes? Could you explain the criteria that determine whether a property qualifies for a 1031 exchange, particularly in the context of personal versus real property?
What can you 1031 exchange into?
What types of properties qualify as like-kind for a 1031 exchange, and what are the criteria for determining whether a property can be exchanged under Section 1031 of the Internal Revenue Code?
Does 1031 exchange apply to foreign property?
Does a 1031 exchange allow for the deferral of capital gains taxes when exchanging foreign real property for U.S. real property, or vice versa? Additionally, are there any specific rules or exceptions that apply to exchanges involving foreign properties under Section 1031 of the Internal Revenue Code?
How does a 1031 exchange help in diversifying a real estate portfolio?
How can utilizing a 1031 exchange facilitate the diversification of a real estate portfolio by allowing an investor to defer capital gains taxes while exchanging properties for different types of real estate assets, thereby enabling the investor to strategically reallocate their investments into various sectors or geographic locations within the real estate market?
When to use 1031 exchange?
When is it advantageous to utilize a 1031 exchange for deferring capital gains taxes on the sale of investment or business-use property, and what are the strategic considerations or scenarios where this tax-deferral mechanism would be most beneficial?