Sales Tax Slice: Does Like-Kind Exchange Treatment Match Up?

Like-kind exchanges under I.R.C. § 1031 are considered exempt transactions for income tax purposes. However, the sales and use tax consequences of like-kind exchanges may be a trap for the unwary because guidance and uniformity are lacking among states. 

Sales or use tax liability is generally a consideration for 1031 exchanges involving moveable property, such as airplanes, motor-vehicles or construction equipment.

Recently, the Indiana Department of Revenue issued a Letter of Findings on whether use tax should be imposed on a like-kind exchange. Under Indiana law, like-kind exchanges are nontaxable for sales and use tax purposes only for transactions in which a swap or barter of property occurs between two parties and the property exchanged is actually owned by the parties at the time of the exchange agreement.

In this situation, a landfill company executed an equipment trade in which it exchanged a CAT grinder, two CAT 627s (tractor-like vehicles) and cash, for an articulated dump truck. The taxpayer sought a use tax exemption for the exchange for the two CAT 627s.

The department disagreed with this characterization, stating that the property must be “of the same kind of character” in order to qualify for the use tax exemption applicable to like-kind exchanges. 

The taxpayer prevailed at the administrative level, after noting that both the CAT 627s and the purchased dump truck were “motorized vehicles used to transport dirt during the operation of the landfill.” Because the transaction met the criteria for a nontaxable like-kind exchange under Indiana law, no use tax was due.

While Indiana exempts like-kind exchange from sales and use tax, the states differ in their approach to taxing or exempting these transactions. For example, Arkansas does not have a specific statutory provision on the sales and use tax consequences of a like-kind exchange. However, Arkansas does have a trade-in statute that deals with similar situations.

Under Arkansas law, no deduction is generally allowed for the value of any trade-in accepted by the seller as a part of the purchase price. The gross proceeds includes the value of all consideration received by the seller. However, the transaction is nontaxable if the traded-in property is subsequently sold and the property was accepted as a trade-in on the sale of other tangible personal property, and if the gross receipts tax was paid on the total consideration for the sale of the other tangible personal property without any deduction or credit for the value of the trade-in.

Additionally, Arkansas law provides a special exception for aircrafts , motor vehicles, trailers and semitrailers. If one of these items is traded-in for the purchase of property that is of a like kind, the credit for the trade-in is deductible from the gross receipts subject to tax.

Differing income and sales tax treatment of like-kind exchanges likely arises from the main ideas underlying the levies. The theory behind the federal income tax exemption is that an exchange pursuant to I.R.C. § 1031 is merely a transfer of property; neither party realizes economic gain at the time of transfer to tax as income. But sales taxes are focused mainly on the amount of consideration received on transfer of title or possession in a retail transaction. As a result, the economic gain realized by the parties is not the concern; instead the focus is on the value of the property sold. Why then, do the states differentiate between different types of consideration (cash, cars, or anything else) used as payment to acquire taxable property in a retail setting?

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn : Should the sales and use tax and income tax be aligned on the issue of like-kind exchanges?

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By: Radha Mohan

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