For the past 20 years, software has slowly risen to become one of the highest valued industries in the world. With global potential and minimal starting costs, tech entrepreneurs everywhere have made millions of dollars with the development and deployment of software.
While many choose to sell software as a service (SaaS), other free software like apps and online marketplaces can sell advertisements for ongoing revenue streams. As a successful product on the market, software owners have the choice of either maintaining their service or selling the company that the software supports.
When choosing to sell, software can yield enormous cash flows for the purchase of cutting-edge or popular technologies. With this, considerable taxation is usually applied, some of which can be avoided with a 1031 exchange.
In this article, we will explain how to 1031 exchange software. With this, we will explore like-kind properties such as mineral rights and royalties for maximum returns on the software sale.
How to Sell Software
Before you can 1031 exchange software, you will first need to sell it. There are hundreds of thousands of jobs for software sales in the United States, although most of these are based around user acquisition. If you are the owner of a piece of software (i.e. you built it or bought it, then you have every right to sell your intellectual property, hardware, userbase, and more in a full transfer of ownership.
Depending on the quality of your product, it is generally not difficult to find buyers. In fact, many software developers in the startup universe simply built products just to sell them for enormous profits at later dates. If your “company” is nothing more than some of the best code ever written, then you will likely be selling simply the software’s “IP” in the event that there are no employees or pieces of hardware necessary to maintain the program.
Determining the Value of Software
Software and software companies are constantly being sold on the open market at an immense range of valuations. National and local headlines in tech industry blogs often cover software sales, so it is relatively easy to estimate the approximate worth of your software ware. Of course, the value of software is largely intangible, with an enormous focus being put on the software’s potential, rather than its current condition.
The following attributes should be considered when determining the value of software:
- Current availability (on-market or off-market)
- Number of users (if applicable)
- Software cash flow (current and future projects)
- Potential revenue streams
- Integration with purchasing entities systems and IP
- And more
Taxes Paid on Selling Software
Although many will tell you that they’ve been burst by the dot com bubble one too many times, software sales continue to earn developers large amounts of money every year in the United States. If done legally, software sales are subject to significant taxation from the local and national government. For big sales, capital gains taxes may be applied at rates as high as 20% of the transaction value.
How to 1031 Exchange Software
A 1031 exchange of software is an IRS designated transaction that allows taxpayers to defer up to 100% of the capital gains taxes applied to the sale. In order to eliminate every dollar of the capital gains tax, sellers must acquire a new asset of equivalent or greater value in order to 1031 exchange software. Here, the 1031 exchange essentially allows individuals to “trade up” their software for a new property.
Of course, if you sold your software at such a high price that you never have to work another day in your life, it is possible to acquire an asset at a lower valuation. With this, partial capital gains taxes can be deferred.
Software Like-Kind Properties
Despite the fact that software and software companies are largely intangible, the IRS views their IP as simple personal property, just like most of the things that are bought and sold on the open market. Under the 1031 exchange code, software sales must be followed by purchases of “like-kind” property for a valid transaction and tax deferment. Like-kind properties for software or software companies may include:
- Collectibles (cars, toys, etc.)
- Vacation Rentals
- Convenience Stores
- Trailer Parks
- Water and Ditch Rights
- Mineral Rights and Royalties
- And more
Timeline For a 1031 Software Exchange
From the exact day of the sale, sellers have 45 days to identify at least one reasonable property to purchase in a 1031 software exchange to remain eligible for the transaction. Up to two more properties can be considered regardless of their value, and purchase must be made within 180 days of the sale.
For additional requirements, please see our 1031 Exchange Rules and Requirements Page.
Using an Intermediary to 1031 Exchange Software
It has become increasingly common for investors to utilize specialized 1031 exchange intermediaries when selling high-value software. With an intermediary, it can be much easier to handle all negotiations, paperwork, and exploration for new properties in a 1031 exchange.
What’s the Best 1031 Exchange For a Software?
If you are about to 1031 exchange software, you’ll find a wide variety of new assets to choose from. Although options are limitless for personal assets in the United States, mineral rights are one of the best properties to acquire in a 1031 exchange. As a largely hands-off asset, mineral rights entitle you to the ownership of the natural resources found below the surface of the earth in a designated area.
As a mineral rights owner, oil and gas companies can lease your land to extract and sell valuable resources on the open market. In exchange, you will receive mineral royalty checks as outlined in your mineral rights lease agreement.
When it comes time to sell your software, you can be in for a large influx of cash if your product is worth it. Although it is tempting to go overboard with celebrations, a reinvestment of your capital with a 1031 exchange can not only save you money on the sale of software but also generate a future stream of income.