Category: 1031 Exchange General

Can Franchise Rights be Exchanged?
Since becoming law in 1921, the rationale for the inclusion of tax deferred exchanges in the IRS code, has been that a taxpayer who is vested with an asset and who receives in exchange other like-kind assets, and no cash, there is a continuity of holding the same or similar assets. Since the same kind of assets were sold and bought and the taxpayer pocketed no cash, the transaction isn’t seen as a taxable event. The gain on the sale of the first assets, the relinquished property , is deferred until the acquired like-kind assets, the replacement property , are sold without a further exchange.
Upon the passage of the Tax Cuts and Jobs Act (TCJA) in 2017, the types of assets qualifying for tax deferral through an exchange changed dramatically. Tax deferral through 1031 exchanges would only be allowed for what is considered real property (land, buildings, etc.) and not for personal property (heavy equipment, cars, franchises. Therefore, since the passage of the TCJA, the actual franchise rights no longer qualify for a like kind exchange to defer taxes on gains. However, should the investor own the underlying real property where the Franchise resides the investor still could qualify for an exchange on the underlying land/building.
What Qualifies for Tax Deferral upon the Sale of a Franchise?
Perhaps the most common inquiries around franchise exchanges are those that involve fast food restaurants. An owner might have one or more franchise locations that have greatly increased in value over time, value that the owner would like to parlay into additional restaurants. The exchange of such a business was formerly a more straightforward matter because the IRS regarded the business as a whole entity that included the value of any underlying assets. This changed shortly before 1991’s exchange regulations, and now the IRS requires that each underlying asset be separated and valued individually.
For owners/investors of franchises this means that the value of the franchise rights are separate from the value of land, buildings and furniture, fixtures and equipment (FF&E). A restaurant franchise valued at $300,000 for the franchise rights and $750,000 for the land/building can separate the sale of the land/building from the sale of the franchise rights. The land/building would then qualify for a like-kind exchange into land/building for a new franchise or a multitude of other real property deemed like-kind such as a multi-family rental building or farmland.
It’s worth noting that any value associated with goodwill, including trademarks and trade names, is not capable of being exchanged, because the regulations state that goodwill is “inherently unique and inseparable from the business.” For this reason, sellers of businesses may wish to minimize the value of the goodwill and increase another component asset of the sale which will be capable of receiving like-kind exchange treatment. Inventory and cash-on-hand are also not part of a franchise exchange since, unlike equipment, these assets are not held for use in a business or trade.
Retaining the Services of a Qualified Intermediary
A qualified intermediary (QI) is necessary for most exchanges in which the relinquished assets are sold to a buyer and the replacement assets are being acquired from a seller, who is not the same as the buyer of the relinquished assets. The taxpayer essentially sells the relinquished assets to the QI, who in turn sells them to the buyer. Similarly, the taxpayer purchases the replacement assets from the QI, who acquires those assets from the seller. In effect, the taxpayer completes an exchange with the QI. Selecting the correct QI is a decision that should not be taken lightly. Read on to learn more about the considerations for

1031 like-kind exchanges or tax deferred exchanges have been part of the United States tax code since 1921, yet they continue to be the subject of a number of misconceptions, some of which are addressed below.
Myth: 1031 like-kind exchanges are only for the wealthy
This misconception arises from the visibility that high-profile companies or individuals have when exchanging a large office building or rental property and deferring the tax on the sale of that property. What is being missed is that average everyday people are utilizing like-kind exchanges as well.
A small business owner who owns his 25,000 sq ft warehouse can defer gain on the sale of that space when he uses the proceeds to purchase another building or even a piece of land. An individual who defers tax on selling a small rental property when she buys a replacement property is also taking advantage of Section 1031 of the tax code. These sorts of transactions made by small businesses and middle class investors are frequent, even if they don’t make the headlines.
I had the opportunity to meet a teacher recently in Denver, Colorado who, upon learning about our company, related her own like-kind exchange story. She had purchased a rental home four years ago for a terrific price, and when the market went up, she was able to enter into a contract to sell it for a profit. She was lucky to have a smart accountant who advised her to structure the transaction as an exchange with a qualified intermediary enabling her to reinvest all of the proceeds in another rental, thereby deferring tax on the sale. She did so and has now profited enough to secure a down payment on three rental properties, about which she remarked, “On a teacher’s salary, without 1031s, I would never have been able to own three rentals.”
Myth: A 1031 exchange must be simultaneous
When the tax code was first added in 1921, all exchanges were simultaneous. Over time, the 1031 exchange deadlines, but the 180-day completion period allows for non-simultaneous exchanges. It is even possible, in a stimulate economic growth. They are an

1031 like-kind exchanges or tax deferred exchanges have been part of the United States tax code since 1921, yet they continue to be the subject of a number of misconceptions, some of which are addressed below.
Myth: 1031 like-kind exchanges are only for the wealthy
This misconception arises from the visibility that high-profile companies or individuals have when exchanging a large office building or rental property and deferring the tax on the sale of that property. What is being missed is that average everyday people are utilizing like-kind exchanges as well.
A small business owner who owns his 25,000 sq ft warehouse can defer gain on the sale of that space when he uses the proceeds to purchase another building or even a piece of land. An individual who defers tax on selling a small rental property when she buys a replacement property is also taking advantage of Section 1031 of the tax code. These sorts of transactions made by small businesses and middle class investors are frequent, even if they don’t make the headlines.
I had the opportunity to meet a teacher recently in Denver, Colorado who, upon learning about our company, related her own like-kind exchange story. She had purchased a rental home four years ago for a terrific price, and when the market went up, she was able to enter into a contract to sell it for a profit. She was lucky to have a smart accountant who advised her to structure the transaction as an exchange with a qualified intermediary enabling her to reinvest all of the proceeds in another rental, thereby deferring tax on the sale. She did so and has now profited enough to secure a down payment on three rental properties, about which she remarked, “On a teacher’s salary, without 1031s, I would never have been able to own three rentals.”
Myth: A 1031 exchange must be simultaneous
When the tax code was first added in 1921, all exchanges were simultaneous. Over time, the 1031 exchange deadlines, but the 180-day completion period allows for non-simultaneous exchanges. It is even possible, in a stimulate economic growth. They are an

1031 like-kind exchanges or tax deferred exchanges have been part of the United States tax code since 1921, yet they continue to be the subject of a number of misconceptions, some of which are addressed below.
Myth: 1031 like-kind exchanges are only for the wealthy
This misconception arises from the visibility that high-profile companies or individuals have when exchanging a large office building or rental property and deferring the tax on the sale of that property. What is being missed is that average everyday people are utilizing like-kind exchanges as well.
A small business owner who owns his 25,000 sq ft warehouse can defer gain on the sale of that space when he uses the proceeds to purchase another building or even a piece of land. An individual who defers tax on selling a small rental property when she buys a replacement property is also taking advantage of Section 1031 of the tax code. These sorts of transactions made by small businesses and middle class investors are frequent, even if they don’t make the headlines.
I had the opportunity to meet a teacher recently in Denver, Colorado who, upon learning about our company, related her own like-kind exchange story. She had purchased a rental home four years ago for a terrific price, and when the market went up, she was able to enter into a contract to sell it for a profit. She was lucky to have a smart accountant who advised her to structure the transaction as an exchange with a qualified intermediary enabling her to reinvest all of the proceeds in another rental, thereby deferring tax on the sale. She did so and has now profited enough to secure a down payment on three rental properties, about which she remarked, “On a teacher’s salary, without 1031s, I would never have been able to own three rentals.”
Myth: A 1031 exchange must be simultaneous
When the tax code was first added in 1921, all exchanges were simultaneous. Over time, the 1031 exchange deadlines, but the 180-day completion period allows for non-simultaneous exchanges. It is even possible, in a stimulate economic growth. They are an

Most people are aware that the federal tax law changed at the beginning of 2018 due to the passage of the Tax Cuts & Jobs Act. Some of the significant changes included reducing the capital gain rates and lowering tax rates on corporations. Among other things June of 2020, the IRS put out proposed regulations on the subject. Essentially, each component had to be analyzed separately to determine whether it was land, an inherently permanent structure, or a structural component of an inherently permanent structure. Land was rather clear but some of the other determinations were difficult to make. For instance, in regard to a component of a structure, the determination was largely based upon function. An example in the regulations referenced different treatment for a gas line that serviced the property generally for heating purposes, compared to a gas line that was used for cooking food that was served by the business. The former was considered part of the real estate for exchange purposes and the latter being used towards the “production of income” and therefore not so. Furthermore, the proposed regulations suggested that reference to local law characterization would not be taken into consideration. This was a departure from prior analyses where local law was a significant part of the determination.
In any event, the IRS took into consideration the significant amount of feedback received and changed the final regulations in favorable ways. Under the final regulations, the asset is considered real estate if (i) it is specifically listed as such in the regulations or (ii) if it is real estate under state or local law and last (iii) if it is “considered real property based on all the facts and circumstances under the various factors provided in the final regulations.”
It should be worth noting that the classification of an asset for exchange purposes is not determinative of its classification for other purposes such as taking of depreciation. The asset can be considered real estate for one purpose and personal property for another.
The final regulations introduced another favorable rule. After personal property exchanges were disallowed, if exchange funds were directed to a closing for the purchase of replacement property whose purchase price included a personal property component, the exchange could be put at risk. This was seen as an unpermitted use of exchange funds on the part of the taxpayer which, in turn, violated the entire exchange. To provide a solution to this dilemma, the service borrowed on a provision from the original exchange regulations regarding the identification of personal property that was typically incidental to the real property. Examples are office furnishings in the purchase of an office building or hotel furnishings with the purchase of the hotel. This rule, known as the “incidental property rule” states that the personal property did not have to be separately identified from the real property but must be incidental to the real replacement property, having an aggregate fair market value not greater than 15% of the fair market value of the real estate, and must typically be transferred with the real property in a standard commercial transaction. Under the final regulations should part of the purchase price of the real estate include the value of personal property fitting this definition, it will not be considered “actual or constructive” receipt of the funds by the taxpayer otherwise compromising the exchange.
Again, it should be noted that this rule pertains to avoiding a taxpayer getting boxed in when a real estate purchase includes some customary personal property that is not being paid for separately. However, that is not to say that it is disregarded nor considered part of the real estate for gain purposes. It still retains its character as non like-kind property compared to the original sale of real estate.
If you have questions about an exchange that includes property as described above, please get in touch with one of our subject matter experts to discuss your situation specifically.
 

https://cta-redirect.hubspot.com/cta/redirect/6205670/959852e4-dc2a-419… alt=”Questions about an exchange? Contact us.” class=”hs-cta-img” id=”hs-cta-img-959852e4-dc2a-4190-b67f-4cc1ed13478a” src=”https://no-cache.hubspot.com/cta/default/6205670/959852e4-dc2a-4190-b67…; style=”border-width:0px;” />https://js.hscta.net/cta/current.js”> hbspt.cta.load(6205670, ‘959852e4-dc2a-4190-b67f-4cc1ed13478a’, {});

Most people are aware that the federal tax law changed at the beginning of 2018 due to the passage of the Tax Cuts & Jobs Act. Some of the significant changes included reducing the capital gain rates and lowering tax rates on corporations. Among other things June of 2020, the IRS put out proposed regulations on the subject. Essentially, each component had to be analyzed separately to determine whether it was land, an inherently permanent structure, or a structural component of an inherently permanent structure. Land was rather clear but some of the other determinations were difficult to make. For instance, in regard to a component of a structure, the determination was largely based upon function. An example in the regulations referenced different treatment for a gas line that serviced the property generally for heating purposes, compared to a gas line that was used for cooking food that was served by the business. The former was considered part of the real estate for exchange purposes and the latter being used towards the “production of income” and therefore not so. Furthermore, the proposed regulations suggested that reference to local law characterization would not be taken into consideration. This was a departure from prior analyses where local law was a significant part of the determination.
In any event, the IRS took into consideration the significant amount of feedback received and changed the final regulations in favorable ways. Under the final regulations, the asset is considered real estate if (i) it is specifically listed as such in the regulations or (ii) if it is real estate under state or local law and last (iii) if it is “considered real property based on all the facts and circumstances under the various factors provided in the final regulations.”
It should be worth noting that the classification of an asset for exchange purposes is not determinative of its classification for other purposes such as taking of depreciation. The asset can be considered real estate for one purpose and personal property for another.
The final regulations introduced another favorable rule. After personal property exchanges were disallowed, if exchange funds were directed to a closing for the purchase of replacement property whose purchase price included a personal property component, the exchange could be put at risk. This was seen as an unpermitted use of exchange funds on the part of the taxpayer which, in turn, violated the entire exchange. To provide a solution to this dilemma, the service borrowed on a provision from the original exchange regulations regarding the identification of personal property that was typically incidental to the real property. Examples are office furnishings in the purchase of an office building or hotel furnishings with the purchase of the hotel. This rule, known as the “incidental property rule” states that the personal property did not have to be separately identified from the real property but must be incidental to the real replacement property, having an aggregate fair market value not greater than 15% of the fair market value of the real estate, and must typically be transferred with the real property in a standard commercial transaction. Under the final regulations should part of the purchase price of the real estate include the value of personal property fitting this definition, it will not be considered “actual or constructive” receipt of the funds by the taxpayer otherwise compromising the exchange.
Again, it should be noted that this rule pertains to avoiding a taxpayer getting boxed in when a real estate purchase includes some customary personal property that is not being paid for separately. However, that is not to say that it is disregarded nor considered part of the real estate for gain purposes. It still retains its character as non like-kind property compared to the original sale of real estate.
If you have questions about an exchange that includes property as described above, please get in touch with one of our subject matter experts to discuss your situation specifically.
 

https://cta-redirect.hubspot.com/cta/redirect/6205670/959852e4-dc2a-419… alt=”Questions about an exchange? Contact us.” class=”hs-cta-img” id=”hs-cta-img-959852e4-dc2a-4190-b67f-4cc1ed13478a” src=”https://no-cache.hubspot.com/cta/default/6205670/959852e4-dc2a-4190-b67…; style=”border-width:0px;” />https://js.hscta.net/cta/current.js”> hbspt.cta.load(6205670, ‘959852e4-dc2a-4190-b67f-4cc1ed13478a’, {});

Most people are aware that the federal tax law changed at the beginning of 2018 due to the passage of the Tax Cuts & Jobs Act. Some of the significant changes included reducing the capital gain rates and lowering tax rates on corporations. Among other things June of 2020, the IRS put out proposed regulations on the subject. Essentially, each component had to be analyzed separately to determine whether it was land, an inherently permanent structure, or a structural component of an inherently permanent structure. Land was rather clear but some of the other determinations were difficult to make. For instance, in regard to a component of a structure, the determination was largely based upon function. An example in the regulations referenced different treatment for a gas line that serviced the property generally for heating purposes, compared to a gas line that was used for cooking food that was served by the business. The former was considered part of the real estate for exchange purposes and the latter being used towards the “production of income” and therefore not so. Furthermore, the proposed regulations suggested that reference to local law characterization would not be taken into consideration. This was a departure from prior analyses where local law was a significant part of the determination.
In any event, the IRS took into consideration the significant amount of feedback received and changed the final regulations in favorable ways. Under the final regulations, the asset is considered real estate if (i) it is specifically listed as such in the regulations or (ii) if it is real estate under state or local law and last (iii) if it is “considered real property based on all the facts and circumstances under the various factors provided in the final regulations.”
It should be worth noting that the classification of an asset for exchange purposes is not determinative of its classification for other purposes such as taking of depreciation. The asset can be considered real estate for one purpose and personal property for another.
The final regulations introduced another favorable rule. After personal property exchanges were disallowed, if exchange funds were directed to a closing for the purchase of replacement property whose purchase price included a personal property component, the exchange could be put at risk. This was seen as an unpermitted use of exchange funds on the part of the taxpayer which, in turn, violated the entire exchange. To provide a solution to this dilemma, the service borrowed on a provision from the original exchange regulations regarding the identification of personal property that was typically incidental to the real property. Examples are office furnishings in the purchase of an office building or hotel furnishings with the purchase of the hotel. This rule, known as the “incidental property rule” states that the personal property did not have to be separately identified from the real property but must be incidental to the real replacement property, having an aggregate fair market value not greater than 15% of the fair market value of the real estate, and must typically be transferred with the real property in a standard commercial transaction. Under the final regulations should part of the purchase price of the real estate include the value of personal property fitting this definition, it will not be considered “actual or constructive” receipt of the funds by the taxpayer otherwise compromising the exchange.
Again, it should be noted that this rule pertains to avoiding a taxpayer getting boxed in when a real estate purchase includes some customary personal property that is not being paid for separately. However, that is not to say that it is disregarded nor considered part of the real estate for gain purposes. It still retains its character as non like-kind property compared to the original sale of real estate.
If you have questions about an exchange that includes property as described above, please get in touch with one of our subject matter experts to discuss your situation specifically.
 

https://cta-redirect.hubspot.com/cta/redirect/6205670/959852e4-dc2a-419… alt=”Questions about an exchange? Contact us.” class=”hs-cta-img” id=”hs-cta-img-959852e4-dc2a-4190-b67f-4cc1ed13478a” src=”https://no-cache.hubspot.com/cta/default/6205670/959852e4-dc2a-4190-b67…; style=”border-width:0px;” />https://js.hscta.net/cta/current.js”> hbspt.cta.load(6205670, ‘959852e4-dc2a-4190-b67f-4cc1ed13478a’, {});