Although real estate drives most like-kind exchanges, personal and even intangible property may also qualify for like-kind exchange treatment. However, the expansive definition of “like kind” property applicable to real estate does not carry over to exchanges involving personal or intangible property. Such exchanges qualify for tax-deferred exchange treatment under Section 1031 only if the relinquished and replacement properties bear a strong resemblance to one another.
The “similar or related in service or use” test of IRC § 1033(a)(1), which is somewhat restrictive, appears to be the standard called for by Regs. § 1.1031(a)(2) in determining whether personal property is of like-kind to other personal property. Rev. Rul. 82-166 opined that gold bullion and silver bullion are not of like-kind since “silver and gold are intrinsically different metals…used in different ways.” Regs. § 1.1031(a)-2 provides that depreciable tangible personal property qualifies for exchange treatment if the properties are of “like kind” or “like class.” Properties are of “like class” if, on the exchange date, they are of the same (i) “General Asset Class” or (ii) “Product Class.” Regs. § 1.1031(a)-2(b)(2) provide a list of thirteen General Asset Classes. The SIC codes for Product Classes were replaced by the North American Industrial Classification System (NAICS) for exchanges after August 13, 2004. NAICS categories are narrower than the SIC Codes formerly used.
Under Regs § 1.1031(a)(2)(b), a light general purpose truck is not of the same General Asset Class as a heavy general purpose truck. Nor is a computer of the same General Asset Class as office furniture. However, an automobile and a taxi are. The origin of Regs. § 1.1031(a)-2 appears to be Rev. Proc. 87-56, which lists depreciable asset classes. IRC §1031(h)(2) provides that personal property used predominantly in the U.S. is not of like-kind to personal property used predominantly outside the U.S. Predominant use is based on the 2-year period preceding and following the exchange.
Exchanges involving both real and personal property may produce boot. For example, relinquished property may consist of an apartment building containing furniture or other assets. Since real property cannot be exchanged for personal property, the IRS views such transactions as exchanges of multiple assets rather than exchanges of one economic unit. Accordingly, the properties transferred and received must be separated into “exchange groups,” by matching properties of like-kind or like-class to the extent possible. After matching, boot gain may result if if non-like kind assets remain. Regs. § 1.1031(j)-1. In practice, this problem can be minimized if in the contract of sale the parties agree to allocate little consideration to the personal property being transferred.
In Peabody v. Com’r, 126 T.C. No. 14 (2006), a coal mine was exchanged for real estate. The IRS asserted that a coal supply contract, rather than the mine supplying the coal, possessed most of the value of relinquished property. Therefore, upon the receipt of a gold mine as replacement property, although a good exchange occurred, boot gain resulted, since the supply contract and gold mine were not of like-kind. The Tax Court disagreed, holding that the right to mine and sell coal are inherent in fee ownership, and the two cannot be separated. Thus, there was no boot.
Like-kind exchanges involving intangible personal property, consisting of customer lists, going concern value, and good will, although less common, may also occur. An exchange of business assets requires the transaction to be separated into exchanges of its component parts. Rev. Rul. 57-365. No “like classes” are provided by the Regs. for intangible personal property, and the liberal rules with respect to exchanges of real estate are of course inapplicable. Therefore, whether such exchanges qualify relates back to the question of whether the exchanged properties are of “like kind” under Section 1031 itself. Regs. §1.1031(a)-2(c) provide some guidance, stating that whether intangible personal properties are of like kind depends on the nature and character of (i) the rights involved and (ii) the underlying property to which the intangible personal property relates.
The Regs. take the position that the goodwill or going concern value of two businesses can never be of like-kind. Therefore, such exchanges will always produce boot. The Regs. state that a copyright on a novel is of like kind to a copyright on another novel, but is not of like kind to a song since, although the rights are identical, the nature of the underlying properties are substantially different. With this in mind, a taxpayer contemplating an exchange of businesses should first demonstrate that the intangible assets being swapped do not consist of goodwill. Then it must be demonstrated that the rights involved and the underlying properties are the substantially the same.
TAM 200035055 stated that the exchange of a radio license for a television license qualified under IRC § 1031 since the rights, and the property to which the rights related, involved differences only in “grade or quality,” rather than in “nature or character.” Both licenses enabled the licensee to broadcast over the electromagnetic spectrum, making the rights “essentially the same.” The underlying property related to the use of the transmitting apparatus rather than the apparatus itself. Therefore, although the bandwidth of radio and television broadcasts are different, those differences are only in grade or quality, rather than in nature or character.
TAM 200602034 takes a restrictive view intangible exchanges, stating the standard for such exchanges is “still more rigorous” than for those involving tangible personal property. However, the rationale for this conclusion appears questionable.