Franchisees Profit from 1031 Exchanges

Franchise owners have long taken advantage of 1031 exchanges when selling their franchise to acquire a more lucrative location, multiple locations or even diversify the type of franchise. An exchange of a franchise includes numerous assets that may qualify for 1031 tax-deferral treatment.

Any tangible or intangible asset held for investment or for use in a trade or business can be exchanged.  When exchanging personal property, the definition of “like-kind” is not as broad and liberal as in a real property exchange. Depreciable personal property is considered “like-kind” if it is within the same product or asset class as the relinquished property given up in the exchange.  For example, equipment can be exchanged for equipment and franchise rights can be exchanged for franchise rights. Real estate holdings can be exchanged for other real estate.

In the sale of a franchise, some of the items that can be exchanged for other like-kind property include:

    • Franchise Agreement/Rights
    • Furniture, fixtures and equipment
    • Customer lists
    • Real estate holdings
    • Leasehold interests (the remaining term of the lease, including options, will determine if the lease can be exchanged for real estate or another leasehold interest)

Some of the items that do not qualify for 1031 treatment include:

    • Stock
    • Goodwill
    • Inventory
    • Covenants not to compete
    • Cash on hand

The franchisee should work with their tax and legal advisors to determine the value of the assets being exchanged and how much replacement property of each class must be acquired. To maximize the tax-deferral, the value of the assets in the replacement franchise(s) must be equal or greater in value and equity.  With planning, 1031 exchanges can provide significant benefits to franchisees including the ability to keep their capital working for them in the replacement franchise.