One requirement of tax-deferred exchanges of property has always been that the property acquired, the Replacement Property, be of a “like-kind” to the property sold, the Those certain items of real and/or personal property described in the relinquished property contract and qualifying as “relinquished property” within the meaning of Treasury Regulations Section 1.1031(k)-1(a); The "Old Asset”, property or properties given up or conveyed by a taxpayer as part of a 1031 exchange. Relinquished Property , even as far back as 1921 when IRC Section 1031 was added to the tax code. The basis for this requirement is the “continuity of investment” doctrine, which reasons that where a taxpayer is merely continuing its investment from one property into a similar kind of property without receiving any cash profit from the sale, no tax should be triggered. Of course, this tax liability is only deferred, not eliminated. So, given that it is such an essential element of any tax-deferred exchange, what exactly does “like-kind” mean?
Fortunately, in the context of real property, the analysis is simple. For 1031 exchange purposes, all real property is generally “like-kind” to all other real property, and, despite many misconceptions out there about the nature of this requirement, the asset class or specific type of property is irrelevant. In other words, if a taxpayer is selling an apartment building, she does not have to acquire another apartment building. Rather, she can acquire any other type of real estate as replacement property, like raw land, an office building, an interest in a Delaware Statutory Trust, etc., provided that the replacement property is considered real property under applicable rules and that she intends to hold it for a qualified purpose, i.e.business or investment use, and properly identified within the 45-day identification period. (Note: the “like-kind” analysis was not always so simple in the personal property context (i.e. anything that isn’t real property), but in 2018 the Tax Cuts and Jobs Act amended the law and personal property exchanges are no longer eligible for tax deferral under Section 1031).
This begs the obvious question: what is “real property” for purposes of Section 1031?
Examples of Real Estate Interests that are Like-Kind
Most real property consists of a piece of land with or without a structure on it. It doesn’t matter what type of structure, they are all like-kind. Even vacant land can be held for rental or simply held for appreciation. Real estate does not have to be rental in nature to qualify. There are also many other types of real estate interests that might not readily come to mind but are considered like-kind to any other real property interest. Below is a list of some of them:
Inclusion of other types of property as Real Property
In December 2020, the IRS issued new regulations that further defined real property in the Code of Federal Regulations. It did not change the fact that all real estate is like-kind to all other real estate. Rather, it provided additional clarification as to certain types of “inherently permanent structures” and “structural components” of those inherently permanent structures are considered part of the real estate, and thus eligible for exchange treatment.
By way of example, some “inherently permanent structures” that are considered real property and thus exchangeable are:
Other inherently permanent structures. Inherently permanent structures under paragraph (a)(2)(ii) of this section include the following distinct assets, if permanently affixed: In-ground swimming pools; roads; bridges; tunnels; paved parking areas, parking facilities, and other pavements; special foundations; stationary wharves and docks; fences; inherently permanent advertising displays for which an election under section 1033(g)(3) is in effect; inherently permanent outdoor lighting facilities; railroad tracks and signals; telephone poles; power generation and transmission facilities; permanently installed telecommunications cables; microwave transmission, cell, broadcasting, and electric transmission towers; oil and gas pipelines; offshore platforms, derricks, oil and gas storage tanks; and grain storage bins and silos . . . . See 26 CFR §1.1031(a)-3(a)(2)(ii)(C).
As for “structural components” that are likely to qualify as real property, the following examples appear in the regulations:
Walls; partitions; doors; wiring; plumbing systems; central air conditioning and heating systems; pipes and ducts; elevators and escalators; floors; ceilings; permanent coverings of walls, floors, and ceilings; insulation; chimneys; fire suppression systems, including sprinkler systems and fire alarms; fire escapes; security systems; humidity control systems; and other similar property . . . . See 26 CFR §1.1031(a)-3(a)(2)(iii)(B)
There is a lot more detail in these regulations and although this may seem like a lot of minutiae, but these assets, where present, can sometimes have a significant effect on transaction value which can also be included as part of the real estate for §1031 exchange purposes. In any event, taxpayers now have the benefit of additional IRS guidance that clarifies the components of real property, or other interests related to real property, that qualify for exchange treatment.
Foreign Real Estate Is Not Considered Like-Kind
Section 1031(h) of the Tax Code provides that real estate located within the United States and real estate located outside of the United States are not considered like-kind. With some limited exceptions, most U.S. territories are not considered property in the U.S. United States taxpayers who wish to trade foreign property for foreign property may do so and it is considered like-kind and can receive §1031 exchange treatment.
For all exchanges, in addition to meeting the like-kind requirements above, potential replacement property needs to be formally identified within 45 days of the sale of relinquished property and an identified property has to be acquired within 180 days of the sale. As referenced above, Section 1031(a) provides that property received by a taxpayer that was not identified or received within these timeframes is not considered like-kind.
Many people, and in some cases, even professional advisers, think that the like-kind requirement means that the taxpayer must trade into the same kind of property she has sold. Since the basis for Section 1031 tax deferral has always been continuity of investment, a consequence of that concept is that the properties had to be the same nature or character, i.e., like-kind. During most of the period when Section 1031 has been part of the Tax Code, exchanges could be done for assets including personal property, intangible property, and real estate. All those asset types were subject to the like-kind requirement and like-kind meant something different for each of them.
As of 2018, only real estate can be exchanged under Section 1031, and essentially the determination of what kind of real estate was like-kind to other type of real estate has been unchanged. All real estate is like-kind to other types of real estate.