1031 Exchange for a Hotel or Motel

Only the land and building go through the exchange; the other asset classes are taxed at the same closing

Hotels and motels are named buildings in Treas. Reg. §1.1031(a)-3, and their elevators, HVAC, fire-suppression systems, in-ground pool and paved parking are on the same lists. Everything else changes hands in a taxable sale: §1031 has covered only real property since 2018, and the regulation's Example 12 holds that a license to operate a business in a building is not real property, which is where a liquor license and a franchise agreement fall.

Because a hotel is a trade or business, Publication 544 treats the sale as a sale of each asset separately, and §1060 requires the residual method for allocating the price. The Form 8594 instructions exempt a group of assets only when the whole group is exchanged; when §1031 covers part, both buyer and seller file Form 8594 for the rest.

• Class I–III: cash, securities, receivables
• Class IV: inventory such as food, beverage and retail stock
• Class V: land, building, furniture, fixtures and equipment
• Class VI: §197 intangibles other than goodwill, including the franchise and any government-issued license or permit
• Class VII: goodwill and going-concern value, which take whatever is left

A $10,000,000 hotel allocated under the residual method, and what reaches the intermediary

Hypothetically, the buyer pays $10,000,000. Inventory is $50,000 (Class IV); land $2,000,000, building $6,000,000 and FF&E $1,000,000 are Class V at their fair market values; the franchise, permits and license are $450,000 (Class VI); and $500,000 is left over for goodwill (Class VII). Only the $8,000,000 of land and building is assigned to the qualified intermediary; the other $2,000,000 is a taxable sale reported on Form 8594 by both sides.

The instructions cap each allocation other than goodwill at fair market value, and the two parties' interests pull in opposite directions: a buyer prefers dollars in FF&E it can depreciate over a few years, while you prefer dollars in the building that can be exchanged and, if taxed, capped at 25%. An appraisal that supports the building and FF&E values before the purchase agreement is signed avoids a dispute the IRS can referee against you.

FF&E gain is ordinary income, and on a mature hotel it is usually the whole FF&E price

Under §1245(a)(1) gain on depreciable personal property is ordinary income to the extent of the depreciation taken. Hotel furniture and fixtures sit in short recovery classes (Publication 946 puts furniture and fixtures at 7 years and retail-and-service assets such as cash registers at 5), so by the time a hotel sells its FF&E basis is often close to zero.

Continuing the example: FF&E cost $1,500,000, $1,300,000 was depreciated, adjusted basis is $200,000, and the $1,000,000 allocation produces $800,000 of gain, all ordinary. The building's straight-line depreciation is unrecaptured §1250 gain at a maximum 25%, and gain on purchased §197 intangibles is §1231 gain except for amortization recaptured as ordinary income, per Publication 544.

None of the FF&E recapture can be deferred because FF&E is not exchange property; only the land-and-building gain rides through the exchange, carrying its §1250 history into the replacement. Inventory sold at cost produces no gain, and anything above cost is ordinary income.

Replacement: another flag with the FF&E bought outside the exchange, or passive property with no operation

Buying another hotel repeats the split in reverse. Furniture acquired with the replacement is non-like-kind property and gain is recognized up to its value: the example in TD 9935 recognizes $100,000 of gain when $100,000 of office furniture comes with a $1,000,000 building, even though the furniture is incidental under the 15% rule that keeps the intermediary safe harbor intact. Buy the replacement FF&E with cash outside the exchange and keep the intermediary funds for the real estate.

Leaving operations altogether means net-lease buildings, apartments or DSTs. Hotels themselves rarely fit a DST: Rev. Rul. 2004-86 forbids the trustee from entering new leases or making more than minor non-structural changes, which is incompatible with nightly rentals and brand-mandated renovations, so any hospitality exposure inside a trust runs through a master lease, examined on DST master lease risk. The sectors DSTs usually hold are described on DST asset classes and the triple-net page.

Sequence the contract so the intermediary receives only the real-property price

The purchase agreement should state separate prices and separate closing documents for real property, FF&E, inventory and intangibles, and only the real-property contract is assigned to the qualified intermediary. Prorations, deposits and working-capital adjustments belong on the operating side so they do not reduce the exchange funds or create unintended boot.

Franchise transfer approvals and the state liquor-license process run on their own calendars, so start them at contract signing; the 45- and 180-day exchange periods begin at closing regardless. Ask your CPA or attorney to confirm the allocation, the recapture computation and the intangible treatment before signing; the API Exchange hotel guidance makes the same point that the personal-property components of a hotel do not qualify for deferral.

• Separate purchase prices for real property, FF&E, inventory and intangibles written into the purchase agreement
• Assignment of only the real-property contract to the qualified intermediary
• Franchise application and liquor-license transfer filed at signing, not at closing
• Working capital, deposits and prorations settled outside the exchange account