Mixed Class (Unlike) Property of the Exchange
When mixed class, or unlike, property is involved in a tax-deferred exchange, there are rules taxpayers should be aware of before filing with the IRS.
More often than not exchanges of rental real estate (Sec. 1250 property) will include items of personal property (Sec. 1245 property) such as appliances. It is unlikely that the replacement property will be allocated between 1250 and 1245 property and since acquired real property can no longer be depreciated under the component method, the replacement property will generally always be treated as entirely 1250 property. Thus, there is generally no way to accomplish a 1031 exchange for the 1245 property being depreciated with the rental. Furthermore, beginning with 2018 exchanges, Sec 1245 property is not eligible for Sec 1031 exchange treatment.
Generally, when mixed assets are sold, the assets must be allocated by class and identified as such in the sales agreement or by using IRS Form 8883. If the allocation has been made and a portion of the sales price allocated to the Sec 1245 property, it can be properly reported on Form 4797 as a sale and the resulting gain or loss carried over to the 1040. The remaining portion of the sales price is used in computing the Sec 1250 like-kind exchange.
If the 1245 property was not identified in the transaction, there is no standard method to subsequently deal with the Sec 1245 element. Here are approaches to the problem that others have taken:
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Assumed the transaction included only 1250 property, i.e., that 1245 property was de minimis and simply passed on to the buyer at zero value., However, if the 1245 property is not fully depreciated, the disposition for no value will result in a 4797-ordinary loss, which is really not the case.,
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Assumed the Sec 1245 property to be a de minimis portion of the sale and reported the sale of the Sec 1245 property on the 4797 at the same price as the depreciated basis, resulting in no gain or loss.