If you are selling your business as well as real estate property, it is important to understand what qualifies for tax deferral treatment under IRC Section 1031. The IRS allows only Real Property to be exchanged which is defined as Land and Building. It is crucial to have a Real Estate Purchase & Sale Agreement showing the proper allocations of funds in the transaction. Allocations should be discussed and determined with your CPA or Tax Advisor when structuring the contract for your sale property. Make sure to allocate in the Real Estate contract the value of the Real Property being sold as separate from the other assets involved in the sale. Things like business assets, goodwill, equipment, machinery, inventory, and personal property must be kept outside the exchange and directed to the seller. The portion allocated as Real Property will go to the exchange and be reinvested into Replacement Property.
Example: Fine Petroleum LLC is planning to sell their business as well as their real estate, in this case a Gas Station, for a total of $3,500,000. Before structuring the Purchase & Sale Agreement the seller consults their CPA who advises them of the proper allocations to be inputted into the contract. Allocations are made showing the value of the Land & Building (Real Property) as separate from the other assets being sold which are not real property.
Allocations:
Real Property: $2,000,000
Business Assets: $1,200,000
Goodwill: $200,000
Inventory: $100,000
As you can see the allocations were made and added to the contract keeping a clear and concise accounting of the different types of assets and their values. Sellers should notify the Escrow Agent or Settlement Attorney of the allocations to be reflected in the Settlement Statement. Ultimately the Settlement Statement should include a separate line item for the Real Property Exchange Proceeds going to the Qualified Intermediary.
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