Issue link: http://winesandvines.uberflip.com/i/400294
p r a c t i c a l w i n e r y & v i n e ya r d n O v e M B e r 2 0 1 4 109 T a X P L a n n i n g —V i n e Y a R D s a L e W hen we consult with clients during the sale of their vine- yards and wineries, one question that always comes up is, "How can you minimize our pend- ing tax liability?" While it is necessary to pay taxes on the sale of an asset that has appreciated in value, in this instance there is usually an option to defer the recognition of gain into the future. Often, a vineyard or winery is sold through an installment sale, where payments are received annually for a spec ified number of years. In an install- ment-sale situation, gain is generally recognized as the cash proceeds are re- ceived annually. The major issue is the taxpayer still triggers their gain in the near-term as cash is received. However, through the use of an Internal Revenue Code (IRC) §1031 exchange, the gain on the sale of property can be continuously deferred through the exchange of "like- kind" property. What is an IRC §1031 like-kind exchange? According to IRC §1031, "no gain or loss is recognized if property held for pro- ductive use in a trade or business or for investment is exchanged solely for prop- erty of a like kind to be held either for productive use in a trade or business or for investment." As such, any gain on a §1031 transaction is deferred until the exchanged property is eventually dis- posed of in a subsequent taxable trans- action. The gain on such property may continue to roll through succeeding §1031 exchanges deferring the unreal- ized gains indefinitely. "Like-kind" refers to the nature or character of the property, not its grade or quality. Property of one kind or class may not be exchanged under §1031 for property of a different kind or class. For example, exchanging land for land would qualify under §1031 since both properties are in the same class. However, an ex- change of a building for equipment would not qualify because the nature or character of these properties is not of like-kind. When it comes to real estate, the rules under §1031 are broad enough where exchanging a building for vine- yard property would be permissible. Property not held for business or in- vestment purposes will not qualify for a §1031 exchange. Additionally, like-kind exchange treatment will not qualify for the following: 1) property held primarily for sale such as inventory; 2) stocks, bonds or notes; 3) partnership interests; 4) other securities or evidence of indebt- edness; 5) actionable claims or receiv- ables; and 6) certificates of trust or beneficial interests. §1031 exchanges can include a group of assets such as a vineyard and winery where land, equipment and intangibles would all be part of the exchange. Not all property transferred in an exchange must be like kind. Other property or money can also be transferred without taking the entire transaction outside of §1031. However, according to §1031(b), the receipt of money (including assumed liabilities) or other non-like-kind prop- erty causes the gain, if any, to be recog- nized to the extent of the sum of the money and the fair market value of the other non-like-kind property received. If depreciable property (§1245 property) is transferred, and only like-kind depre- ciable property is received in exchange, depreciation recapture (taxable ordinary gain) is generally not triggered. To defer the recognition of gain in a vineyard and winery setting where a significant amount of depreciable property exists, the amount of depreciable property re- ceived in the §1031 exchange (the replace- ment property) must be equal to or exceed the amount of depreciable prop- erty sold (the relinquished property). For example, Company X exchanges Vineyard A for Vineyard B in a transac- tion qualifying under §1031. Vineyard A includes vineyard equipment with origi- nal cost basis of $11 million, an adjusted basis of $10 million and a fair market value of $15 million. Vineyard B includes vineyard equipment with an original cost basis of $13 million, an adjusted basis of $11 million and a fair market value of $15 million. Since the replacement property (Vine- yard B) has depreciable property that equals or exceeds the relinquished prop- erty (Vineyard B), no §1245 depreciation recapture is triggered. However, if §1245 depreciable property is exchanged for like-kind non-§1245 property, it is possi- ble for there to be a triggering of depre- ciation recapture. Carryover basis The tax basis of the property acquired in the §1031 exchange is the same as the adjusted tax basis of the property given up. The tax basis is then increased by any additional consideration given up in the transaction or any gain recognized in the transaction. The tax basis is decreased by any money or any non-like-kind proper- ties received in addition to like-kind property. If property previously ex- changed via §1031 is sold in a taxable transaction, the taxable gain is calculated using the calculated carryover tax basis that is calculated upon the previous §1031 transaction (adjusted for any de- preciation or other adjustments to basis). IRC §1031 and vineyards example The sale of a vineyard typically in- cludes a variety of assets such as land, vines, trellises, irrigation equipment, wells, tractors etc. Additionally, there could potentially be intangible assets such as vineyard appellation. According to Regulations §1.1031(j)-1, the various as- sets of a vineyard must be organized into "exchange groups" where each exchange group consists of like-kind assets. The amount of gain that is deferred or recog- nized is then determined for each ex- change group. The carryover basis would also be calculated by exchange group. For example, in Figure 1, real property included in Exchange Group 1 is ex- tremely broad and would include the land itself and any improvements made to the land. In a vineyard exchange, real David G. Pardes, CPA, PwC Private Company Services BY IRC § 1031 like-kind exchanges for vineyards and wineries To defer the recognition of gain in a vineyard and winery setting where a significant amount of depreciable property exists, the amount of depreciable property received in the §1031 exchange (the replacement property) must be equal to or exceed the amount of depreciable property sold (the relinquished property).