Ancillary personal property and like-kind exchanges
The TCJA altered the types of property that qualify as like-kind property. Personal and intangible property used in business no longer qualifies for like-kind exchanges completed after Dec. 31, 2017.
The Tax Cuts and Jobs Act of 2017 (TCJA) altered the types of property that qualify for like-kind exchange. For exchanges completed after December 31, 2017 personal and intangible property used in a trade or business or for investment purposes no longer qualifies as like-kind property under I.R.C. §1031. Instead, like-kind exchanges of real property are only allowed for property that is not held for sale or is held for productive use in the taxpayer’s trade or business.
But what about items attached to homes and fixtures? Under the TCJA, ancillary personal property, or property that goes along with it i.e. property attached to real property, included in like-kind real estate exchanges will now be treated as boot--and gain recognition may occur. In that case, a reasonable allocation of the personal property is required, and income must be reported from the disposition of that property.
General rules for like-kind exchanges under TCJA
In like-kind exchanges, gains and losses are not recognized when like-kind property is exchanged. This is known as “nonrecognition” treatment. Before the TCJA was implemented, both the property given up and the property received must be held for investment or for use in the taxpayers’ trade or business to qualify.
Example: Velma has real property with a basis of $225,000. She exchanges her property for Daphne’s qualifying like-kind property with a fair market value of $250,000. Her realized gain is $25,000. Because the exchange qualifies for like-kind treatment, the $25,000 gain is deferred.
However, a TCJA transition rule provides that §1031 will still apply to a qualifying exchange of personal or intangible property if the taxpayer disposed of the exchanged property on or before December 31, 2017 or received replacement property on or before that date.
Other than exchanges made under the TCJA transition rule, however, like-kind exchanges are allowed only for real property that is not held for sale. “Real property” is not statutorily defined for the purposes of like-kind exchanges so other rules must be used to define real property for these purposes.
Boot doesn’t qualify for nonrecognition treatment If a taxpayer receives boot—i.e. money or other property that doesn't qualify for nonrecognition—in an otherwise nontaxable exchange of like-kind real property, gain to the taxpayer is recognized (i.e., is taxable) in an amount not exceeding the value of the boot received, but loss to the taxpayer is never recognized (and so is never deductible).
Example: Velma has real property with a basis of $125,000 and exchanges it for Daphne’s real property with a fair market value of $150,000 and a painting with a fair market value of $50,000. Her realized gain is $75,000 ($200,000 received minus $125,000 basis). She must immediately recognize $50,000 in gain for the painting received as boot because it is personal and not part of the real property. The remaining $25,000 gain is deferred because it is real property and therefore still qualifies for like-kind treatment.
An issue arises when there is other property attached to a home because the taxpayer must determine if it is boot or included as part of the qualifying like-kind exchange.
Federal tax law determines what is real property for like-kind exchanges
The rules for whether items qualify as real property for like-kind exchange purposes looks to many sources. Federal tax law determines what property qualifies, however, the facts and circumstances, including state law classifications, should be considered when determining whether property qualifies for nonrecognition treatment. Keep in mind that state law classifications defining what qualifies as fixtures and personal property are not determinative.
However, courts generally concur that personal property becomes real property if it is affixed in a way that it loses its original condition. Four common tests used to make this determination include:
- The manner in which the item is affixed to the real property;
- The intention of the person who put the item in place;
- The purpose for which the premises are used, and
- Whether the item may be removed from the real estate without damage to either.
In general, in discussions of whether an item is real property, emphasis is placed on the degree to which it is permanently attached. For example, in Reconstruction Finance Corporation, deciding an issue of imposing property tax on federally controlled machinery, the U.S. Supreme Court accepted the State of Pennsylvania’s definition of real property to include, “…all the machinery of a manufactory which is necessary to constitute it, and without which it would not be a manufactory at all, must pass for a part of the freehold…”
The fact that an asset is subject to the depreciation recapture rules under §1245 also doesn’t necessarily determine whether an item is real property for like-kind exchange purposes. §1245 property can include personal property or certain types or components of real property, but the basic underlying nature of the property may be “personal” or “real,” as acknowledged by the language of §1245. If the §1245 asset is an inherently permanent structural component that is affixed to real property, it is likely to be “real property” within the meaning of the term for purposes of §1031.
With these concepts in mind, the following are examples of tangible personal property that do not qualify for a like-kind exchange under §1031 and are considered boot:
- landscaping equipment,
- A/C window units, and
- pool equipment.
Conclusion: Certain tangible property is considered boot
If the asset is an inherently permanent structural component that is affixed to real property, it likely qualifies for the like-kind exchange, but if the asset is not a permanently affixed structural component, it will not qualify for the like-kind exchange; and the inclusion of the item in the exchange is treated as boot.
Editor's note: This article was co-written by Mary Terry.
 Reconstruction Finance Corporation v. County of Beaver (328 U.S. 204, 66 S. Ct. 992)