Tax Guru – Ker$tetter Letter

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Exchanging businesses?

Posted by taxguru on October 7, 2008

Q:

Subject:  Exchange Question

can I exchange a retail business for another retail business?

 

A:

It is a little trickier than just selling one business and reinvesting into another one.

When a business is sold, the sale price is allocated between the different assets being transferred, such as real estate, fixtures, equipment, goodwill, inventory and covenant not to compete.

The profits from some of those assets can be deferred via a Section 1031 exchange if that portion of the proceeds is used to acquire like kind assets of equal or higher value within the statutory 180 day reinvestment period.

For example, if $100,000 of your sale price was allocated to the business real estate, you could defer the gain on your original real estate by acquiring $100,000 or more of new (to you) investment or business real property.

The like kind rules and definitions are also a little tricky.  Real estate has the widest scope of like kind status, with any kind of investment or income producing property being eligible on both sides of the exchange.  Equipment and fixtures have to be the same kind.

Goodwill in one business cannot be classified as like kind for goodwill in any other business; so it is not possible to defer any of that profit.

Same thing for a covenant not to compete.  That will be taxable income as it is received and cannot be exchanged tax free for anything else.

This is why, if you are considering reinvesting business sale proceeds into another business, it is critical that you work with your own professional tax advisor ASAP to have the gains and possible taxes calculate for each type of asset involved and to assist you in negotiating the allocation with the buyer of your old business and seller of your new one.  The allocations you use must be reported consistently on everyone’s books.

This is a quick and dirty answer to your questions   Your own personal professional tax advisor should be able to give you more specific advice with your actual figures.

Good luck.

 Kerry Kerstetter 
 

 

 

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