Hillerich & Bradsby Co., the manufacturer of Louisville Slugger baseball bats and owner of a baseball museum, made a notable trade in 2005-the company exchanged a Ty Cobb bat, original photographs of Mickey Mantle and some other sports memorabilia for a bat used by Joe DiMaggio during his 1941 56-game hitting streak. The trade was worth nearly $350,000 at the time, but the company managed to defer around $80,000 in capital gains taxes because of section 1031 of the tax code.
IRC 1031 allows taxpayers to defer capital gains taxes when business or investment assets are exchanged with similar property. Generally associated with real estate transactions, other types of property may also qualify under Section 1031, including Hillerich & Bradsby Co.’s historic baseball bats.
Property of “Like-Kind”
Properties are considered of like-kind if they are of the same nature or character; their respective quality is irrelevant. For example, an office building is of like-kind to a vacant lot. All that is required for real property exchanges to qualify under section 1031 is that both properties in the exchange be held for investment or use in a trade or business.
The rules pertaining to like-kind exchanges of personal property are far more restrictive. Treasury Regulation 1.1031(a)-2 provides a list of “general asset classes” and references “product classes” to help determine property of like-kind. A product that fits into one of these classes is not of like-kind to a product that fits into a different class. Examples are provided in those regulations.
Since 2009 intangibles such as trademarks and trade names may qualify as like-kind property under section 1031 if they can be valued apart from a business’s goodwill (CCA 200911006, February 12, 2009).
Note that there is an increasing level of scrutiny where a “like-kind” exchange of art, luxury vehicles and collectible items that some individuals hold for true investment purposes and others for personal enjoyment.
Property not eligible for a like-kind exchange
Under IRC 1031(a)(2), there are six types of property that are not eligible for a like-kind exchange: (1) Stock in trade or other property held for sale (inventory); (2) stock, bonds, and notes; (3) other securities and debts; (4) partnership interests; (5) certificates of trust or beneficial interests; and (6) choses in action (the right to sue).
Livestock of different sexes do not qualify for like-kind exchange under IRC 1031(e).
Foreign real and personal property
There are some special rules regarding foreign real and personal property:
Real property located within the United States is not of like-kind to property located outside the U.S. – IRC 1031 (h)(1)
Personal property used predominantly within the U.S. for the last 2 years is not of like-kind to property used predominantly outside the U.S. for the last 2 years – IRC 1031 (h)(2)
There are exceptions for certain foreign property, which is treated as used predominantly in the U.S. This includes motor vehicles, vessels and shipping containers owned by U.S. taxpayers operated to and from the U.S. and a foreign country, certain property owned by domestic corporations, cable and communications satellites owned by U.S. persons, among other things – IRC 1031(h)(3) and IRC 168(g)(4)
Highest quality tax representation
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Our next post in this series will cover the pros and cons of 1031 exchanges.