Code Section 1031
The IRS has issued final regs to implement recent statutory changes to Code §1031 regarding like-kind exchanges. The final regs amend the current like-kind exchange regs to add a definition of “real property” to implement statutory changes limiting Code §1031 treatment to like-kind exchanges of only real property (i.e., v. tangible personal property). The final regs also provide a rule addressing a taxpayer’s receipt of personal property that is “incidental to real property” the taxpayer receives in an otherwise qualifying like-kind exchange of real property.
Final regs: The final regs adopt the proposed regs with the following modifications.
– Property classified as real property: Prop. Reg. §1.1031(a)-3(a)(1) provided that State or local law definitions were, in general, not controlling for purposes of determining whether property is “real property” for Code §1031 purposes. The final regs reverse this and provide generally that property will be considered “real property” for purposes of Code §1031 if, on the date it is transferred in an exchange, that property is classified as real property under the law of the State or local jurisdiction in which that property is located (i.e., “State and local law test”). The State and local law test applies to both tangible and intangible property.
The Preamble to TD 9935 provides a summary of how property is classified under the final regs. Property is classified as “real property” for purposes of Code §1031 if the property is:
- So classified under the State and local law test, subject to certain exceptions;
- Specifically listed as real property in the final regs; or
iii. Considered real property based on all the facts and circumstances under the various factors provided in the final regs.
– Purpose or use test: The proposed regs considered the function of property in determining whether the
property is real property (i.e., “purpose or use test”). In particular, neither tangible property, such as machinery or equipment, nor intangible property, such as licenses or permits, was classified as “real property” under the proposed regs if the property “contributed to the production of income unrelated to the use or occupancy of space,” irrespective of any other factor under the proposed regs.
The final regs eliminate the “purpose or use test” for tangible property. Consequently, with regard to tangible property, if such property “is permanently affixed to real property and will ordinarily remain affixed for an indefinite period of time,” the property is generally an “inherently permanent structure” and therefore real property for Code §1031 purposes, irrespective of the “purpose or use” of the property or whether it “contributes to the production of income.” A “structural component” likewise is characterized as real property under the final regs if it is integrated into an “inherently permanent structure,” regardless of whether the structural component contributes to the production of income. As a result, under the final regs, items of machinery and equipment are characterized as real property if they comprise an inherently permanent structure, a structural component, or are real property under the State or local law test.
Authored by:
Dr. John Connors, JD, CPA, LLM
Tax Educator’s Network, LLC
For subscription information on Dr. John Connors’ educational materials, click here.
