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Tax Deferred Exchanges of Cell Towers

Determining that assets are like-kind is generally more broad when dealing with real estate than when dealing with personal property.  A regular owning of real estate is known as a fee interest.  Any type of real estate is like-kind to any other type of real estate.  So a parcel of vacant land held for investment would be like-kind to a commercial building, a condominium held for rent is like-kind to an industrial building, and so on.  Some non-traditional asset holdings have also been found to be like-kind to a real estate fee interest such as options, timber and water rights, installment sale agreements, oil and gas rights, co-ops, improvements made upon real estate, and lessee’s interests under long term leases and easements.

Internal Revenue Code Section 1031

Internal Revenue Code (IRC) Section 1031, which pertains to tax deferral for like-kind exchanges of assets, has been a mainstay of the tax code since 1921.  Originally is was thought that exchanges had to be simultaneous and that the taxpayer had to give up the existing property, the “relinquished property,” and receive the new “replacement property” from the buyer of the relinquished property.  The landmark legal decision in Starker v. U.S. held that exchanges did not have to be simultaneous and Internal Revenue Service Regulations: IRC§1031 published in 1991 provided a technique whereby the taxpayer did not have to receive the replacement property from the buyer. In fact, neither the taxpayer’s buyer nor seller need to provide their cooperation in order for the taxpayer to execute an exchange.

What assets are like-kind to one another?

Determining that assets are like-kind is generally more broad when dealing with real estate than when dealing with personal property.  A regular owning of real estate is known as a fee interest.  Any type of real estate is like-kind to any other type of real estate.  So a parcel of vacant land held for investment would be like-kind to a commercial building, a condominium held for rent is like-kind to an industrial building, and so on. 

Some non-traditional asset holdings have also been found to be like-kind to a real estate fee interest such as options, timber and water rights, installment sale agreements, oil and gas rights, co-ops, improvements made upon real estate, and lessee’s interests under long term leases and easements.

Is a landowner’s income stream from a cell phone tower lease exchangeable?

A lessee’s interest in a long term lease (30 or more years) including options has been considered like-kind to real estate for a long time.  The same cannot be said about a property owner’s interest, as lessor, in a lease or long term lease. The value of an ongoing stream of income from a lease, including a cell phone tower lease, is considered rent and not a real estate interest.  However, a private letter ruling (PLR 201149003) put out by the IRS in 2011 suggested a way to effectively convert that stream of income to an interest in real estate that would become like-kind to any other fee interest in real estate. 

How may cell towers be included in a 1031 exchange?

cell tower disguised as a pine treeAs noted above, there is a lot of authority that easements are like-kind to real estate.  Under the PLR, if a cell tower is part of a permanent easement and the value of the easement is based upon the value of the cell tower lease, then a sale of the easement can be exchanged for other fee interests in real estate. Even if the cell phone tower is not located on an easement, the taxpayer may create the easement prior to the sale of the cell tower and effectively sell the cell tower by selling that easement. 

Easement is the right to use the real property of another for a specific purpose. The easement is itself a real property interest, but legal title to the underlying land is retained by the original owner for all other purposes. Typical easements are for access to another property, for utility or sewer lines both under and above ground, use of spring water, entry to make repairs on a fence or slide area, drive cattle across and other uses. Easements can be created by a deed to be recorded just like any real property interest. Easement s generally can be of a limited term or a perpetual term.  The private letter ruling referred to above was based upon a perpetual term easement.  Easement is the right to use the real property of another for a specific purpose. The easement is itself a real property interest, but legal title to the underlying land is retained by the original owner for all other purposes. Typical easements are for access to another property, for utility or sewer lines both under and above ground, use of spring water, entry to make repairs on a fence or slide area, drive cattle across and other uses. Easements can be created by a deed to be recorded just like any real property interest. Easement s can be used for various purposes, such as granting access to property or granting possessory rights in property.  It is possible that the IRS would look at the nature of a particular easement to determine whether, if it were long term, it would be like-kind to a fee interest in real estate.  It may be that a possessory-type, long-term easement would receive the same tax treatment as a permanent easement, but this was not dealt with in the PLR (See also Wiechens vs. US, 228 F. Supp. 2d 1080). Also, it must be kept in mind that, technically, only taxpayers to whom the PLR is provided may rely upon it, though it is very common for other taxpayers to feel a sense of comfort in reading a favorable PLR on a subject with which they are involved.

Retaining the Services of a Qualified Intermediary

A qualified intermediary (QI) is necessary for non-simultaneous exchanges, and the use of one provides a safe harbor for structuring the transaction.  The regulations are purposely liberal on the mechanics of transferring the relinquished property to the QI and receiving title to the replacement property back from the QI.  One such permitted method, which is the industry standard, is to assign rights in the sale and purchase agreements to the QI.  For tax purposes, the QI’s right to receive the property resulting from the assignment of rights is the same as if the QI took title from the taxpayer on the relinquished property and transferred title to the taxpayer on the replacement property.  The taxpayer can still “direct deed” the property to the buyer and receive a deed from the seller.  There are a few other requirements as well to meet this safe harbor.

Prior to the 1991 regulations, if the taxpayer received and held the sale proceeds, the taxpayer was deemed to have made a taxable sale, regardless of whether replacement property was purchased within the 180 day time period.  For a variety of reasons, the other option — allowing the buyer to hold the proceeds until the taxpayer needed to have them applied to the purchase of the replacement property — was a risky proposition.  So the regulations provided an additional safe harbor by allowing the QI to hold the funds or for the funds to be placed into an escrow or trust account. 

Current Requirements of a 1031 Exchange

The 1991 regulations still cover how to complete an exchange to this day.  The following documents are common to exchanges in which a Qualified A person acting to facilitate an exchange under section 1031 and the regulations. This person may not be the taxpayer or a disqualified person. Section 1.1031(k)-1(g)(4)(iii) requires that, for an intermediary to be a qualified intermediary, the intermediary must enter into a written "exchange" agreement with the taxpayer and, as required by the exchange agreement, acquire the relinquished property from the taxpayer, transfer the relinquished property, acquire the replacement property, and transfer the replacement property to the taxpayer. Intermediary is used:

Summary

Not only have tax deferred exchanges been permissible by the IRS since 1921, the ability to effect an exchange has been made much easier as a result of the decision in the Starker case and the regulations that followed.  Those regulations, among other things, provide safe harbors for engaging the services of a QI, with whom the taxpayer completes the exchange and who arranges for the funds to be held securely outside the control of the taxpayer. 

There is an active market in the buying and selling of cell phone towers, and the ability to sell a cell phone tower and receive total tax deferral by trading into a fee interest in real estate is a valuable tool to prospective sellers.  Although the value of the cell phone tower may be the stream of income under the cell phone tower lease, one cannot exchange that income for a direct interest in real estate.  However, if the cell phone tower is situated on a permanent easement, the seller may trade an interest in real estate for a new interest in real estate.  Even if there is no preexisting easement, the taxpayer may create one prior to the intended sale of the cell tower lease.  The 1031 exchange procedures are very form-oriented, and as long as the taxpayer, with the help of a QI, strictly follows the procedures, tax deferral upon the sale of the easement can be realized.

Suggestions for Further Reading

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