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

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Could you explain the process and requirements for identifying replacement property within the 45-day identification period in a 1031 exchange, including any specific documentation or actions needed to ensure compliance with IRS regulations?