Under the Tax Cuts & Jobs Act (“TCJA”), new restrictions to 1031 like-kind exchanges limit property owners' ability to defer capital gains taxes on personal property. For exchanges completed after December 31, 2017, only real property (i.e., land and buildings) remains eligible for like-kind exchange treatment. Personal property can no longer be exchanged for personal property. For example, businesses can no longer exchange machinery and equipment for other machinery and equipment. Property owners must now give special consideration to the potential taxable gain arising from personal property exchanges. Read on to learn more about what this change means to you.
Navigating the Impact of Changes to 1031 Like-Kind Exchanges
Interaction With Temporary 100 Percent Cost Recovery Expensing (Bonus Depreciation) Rules: Prior to 2018, taxpayers could routinely acquire and dispose of personal property used in their trade or business (e.g., fleets of vehicles, airplanes, ships, and machinery) and could acquire replacement personal property in deferred exchanges under Section 1031. Effective in 2018, this deferral is no longer possible.
Under the TCJA, 100% of the cost of qualifying personal property can be immediately expensed upon purchase under the bonus depreciation rules if acquired before January 1, 2023. Beginning in 2023, the expensing provision begins to phase-out and is completely eliminated after December 31, 2026.
Although personal property is no longer eligible for like-kind exchange treatment, the impact can be mitigated by the expensing rules of the new law. The sale of old personal property could lead to a taxable gain, but the write-off of the new property would offset this gain in whole or in part.
While the bonus depreciation provision completely expires after 2026, the change to Section 1031 is permanent. Therefore, after 2026 taxpayers could be faced with potentially large gains from the disposition of depreciated personal property, without a means to mitigate it with the expensing provision.
Timing Considerations: Timing of personal property dispositions and acquisitions has become more important. If a taxpayer disposes of personal property at a taxable gain in one tax year and purchases the replacement property eligible for bonus depreciation expensing in the following tax year, the timing could be problematic. The taxable gain and offsetting bonus depreciation deduction would occur in different years.
Ancillary Personal Property as Boot: In a Section 1031 exchange of real property that also includes ancillary personal property (e.g., washers, dryers, dishwashers, stoves, landscaping equipment, office equipment and furniture), the personal property received would be considered boot, creating a taxable gain. To the extent personal property is relinquished, a portion of the sales proceeds would need to be allocated to the personal property, creating a taxable gain or loss.
While Section 1031 exchanges will continue to be an effective means of deferring gain on certain real estate dispositions, owners should be cautious of potential taxable gains arising from exchanges involving personal property — particularly after 2026, when the bonus depreciation provisions completely expire. For more information on how to navigate the like-kind exchange provisions under the TCJA, contact Steven Bokiess, CPA, Partner at 212.897.6427 or firstname.lastname@example.org.