… but be aware of the details! 
 
contributions from Carla Hicks, Xcel Energy and Garry Bartecki, Associated Equipment Distributors
 
Companies can defer taxable gains on qualified sales of surplus equipment by taking advantage of like-kind exchange (LKE) transactions as discussed in the cover story of this issue of ASSET 2.0. Taxable gain (or loss) of a surplus asset is determined by subtracting the sale price of the surplus from the adjusted cost basis (original purchase price less accumulated depreciation). If the basis is at or near zero, nearly all of the sales proceeds would be subject to capital gains tax. Because heavy equipment generally has a long operational life, it typically lasts longer than the depreciation. That means you could get taxed heavily on the sale of heavy and process equipment surplus (unless you use a 1031 exchange).
 

Part of the tax Code. Although one utility company reported that “our company accountants have determined that a like-kind exchange violates standard accounting principles and is not legal to do,”

LKEs—also called 1031 exchanges for Title 26, section 1031 of the U.S. Tax Code— if processed properly are certainly legal.
 
If you meet the LKE requirements, you are simply deferring the potential gain to a future date as long as the sales proceeds are used to purchase a qualified replacement. Although not always the best avenue, there is little reason not to consider likekind exchanges as one more disposition option.
 
According to Carla Hicks, Investment Recovery Specialist for Xcel Energy, “We currently use like-kind exchanges for distribution transformers and fleet. Like-kind exchange is simply an avenue of capital gains tax deferment that allows you to temporarily utilize your capital in other areas…a relatively simple process that provides you with immediate, positive results! How sweet is that?”
 
However, some LKE transactions can be quite complicated, and the requirements for qualifying are quite strict. (You didn’t expect the IRS to offer a benefit without a few hoops to jump through, did you?)

The most critical aspect is that the sale and subsequent purchase of the transaction (called “legs”) must both be “qualifying” and “like-kind”: Qualifying Property. In a 1031 exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business.
 
Machinery, buildings, land and trucks are typical examples. Importantly, property held primarily for sale, such as inventories and raw materials, does not qualify. Like-Kind Property. The regulations also state that all items must be of the same general asset class or product class, even if they differ in grade or quality. This is determined by strict guidelines set forth by the government: “Same general asset class” describes the types of property frequently used in many businesses, such as office furniture, fixtures and equipment (asset class 00.11), or electric generation and distribution systems (asset class 00.4). So if you transfer a computer for a printer, the properties exchanged are within the same general asset class and qualify.
 
Same Product Class. Properties also satisfy the like-kind requirement if they fall within the same “product class.” An example would be exchanging a grader for a scraper. Although they are not in the
same general asset class, both are within the same product class and therefore qualify.
 

But wait…there’s more! Having met the “qualifying” and “like-kind” tests, additional rules apply:

45-day identification requirement. Your replacement equipment must be unambiguously identified no later than 45 days after the date of the transfer of your relinquished equipment. 180-day exchange requirement. You must actually receive the like-kind replacement equipment no later than 180 days after the date of the transfer of your relinquished equipment, Christmas, New Year’s or any other holiday notwithstanding. Value requirement. In order to defer all of the gain, your replacement equipment typically should be equal or greater in value than your old, and all of your equity (or proceeds) from the sale should be reinvested into your replacement equipment. exchange
 
Facilitator. A qualified intermediary, escrow holder or other person must hold exchange funds for you in a deferred exchange under the terms of the exchange agreement. Generally, this qualified intermediary has to acquire and convey title to the relinquished property and then acquire and convey
title to the like-kind replacement property. All the parties have to be made aware that their “leg” of the transaction is part of a 1031 exchange.
 

Restricted Sale Proceeds. Another requirement is that the sale proceeds be restricted until they are used to purchase the new unit or pay down equipment-related debt. SUMMARY. Like-kind exchanges can provide a significant benefit in deferring capital gains if used properly. The requirements— although not burdensome—are fairly strict. Make an effort to understand the qualifications and be wary of any transaction in which a qualified intermediary is not part of the process. The details should be reviewed carefully with the Finance Department to make certain that you are gaining the tax advantage this type of exchange allows.