Tax Strategy: Proposed regs on property for like-kind exchanges
The Tax Cuts and Jobs Act restricted the tax benefits of like-kind exchanges under Code Sec. 1031 to real property, eliminating personal property from eligibility. Prior to the change, the focus under Code Sec. 1031 was what property was considered like-kind to other property. With the TCJA change, the focus has now shifted to what is real property.
In June 2020, the Treasury Department and the IRS issued proposed regulations seeking to define real property for like-kind exchange purposes.
Many of the current regulations discussing what types of real property are like-kind to other types of real property remain valid under the new proposed regulations.
Definition of real property
The proposed regulations state that real property includes land and improvements to land, unsevered crops and other natural products of land, and water and air space superjacent to land. Improvements to land include inherently permanent structures and the structural components of inherently permanent structures. Local law is not determinative in determining what is real property for like-kind exchange purposes.
The proposed regulations provide that each distinct asset must be analyzed separately from any other assets to which the asset relates to determine if the asset is real property, whether as land, an inherently permanent structure, or a structural component of an inherently permanent structure. Distinct assets include buildings and other inherently permanent structures and assets and systems that are listed as types of structural components.
Inherently permanent structures.The proposed regulations provide that an inherently permanent structure includes any building or other structure that is permanently affixed to real property and that will ordinarily remain affixed for an indefinite period of time. A building is defined as any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is to provide shelter or housing, or to provide working, office, parking, display or sales space.
Buildings include the following structures that are permanently affixed: houses, apartments, hotels, motels, enclosed stadiums and arenas, enclosed shopping malls, factory and office buildings, warehouses, barns, enclosed garages, enclosed transportation stations and terminals, and stores.
The proposed regulations also include an extensive list of other inherently permanent structures described as distinct assets, if permanently affixed: in-ground swimming pools; roads, bridges and tunnels; paved parking areas, parking facilities, and other pavements; special foundations; stationary wharves and docks; fences; inherently permanent advertising displays under a Code Sec. 1033(g)(3) election; 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 drilling platforms, derricks, oil and gas storage tanks; grain storage bins and silos; and enclosed transportation stations and terminals.
Other property not listed may be an inherently permanent structure depending on the following factors:
1. The manner in which the distinct asset is affixed to real property, with affixation to real property possible by weight alone;
2. Whether the distinct asset is designed to be removed or to remain in place;
3.The damage that removal of the distinct asset would cause to the item itself or to the real property to which it is affixed;
4. Any circumstances that suggest the expected period of affixation is not indefinite; and,
5.The time and expense required to move the distinct asset.
While machinery and equipment would generally not be considered inherently permanent structures, the proposed regulations indicate that there may be circumstances in which the machinery is real property if it serves the inherently permanent structure and does not produce or contribute to the production of income other than for the use or occupancy of space.
Structural components of inherently permanent structures. These may also qualify as real property. A structural component is any distinct asset that is a constituent part of, and integrated into, an inherently permanent structure. The proposed regulations include items considered structural components of inherently permanent structures, such as systems providing the structure with electricity, heat or water. Structural components also include assets such as permanent wall, floor or ceiling coverings; elevators and escalators; insulation; and chimneys.
Natural products of the land. Natural products of the land such as crops, timber, water, ores and minerals qualify as real property until severed or removed from the land.
Intangible property. Under the proposed regulations, intangible property may constitute real estate if it derives its value from real property or an interest in real property, is inseparable from that real property or interest in real property, and does not produce or contribute to the production of income other than as consideration for the use or occupancy
Examples include a license, permit or other similar right that is solely for the use, enjoyment or occupation of land or an inherently permanent structure.
Incidental personal property. The proposed regulations include a safe harbor providing that a like-kind of exchange of real property may include incidental personal property. Incidental personal property is disregarded if, in standard commercial transactions, it is typically transferred with real property and the aggregate fair market value of the incidental personal property does not exceed 15 percent of the aggregate fair market value of the replacement real property.
While it may qualify as a like-kind exchange, the taxpayer may still have to recognize gain on the receipt of incidental personal property. Appraisals or cost segregation studies may be required in support of meeting the 15 percent requirement.
Taxpayers may rely on the proposed regulations for exchanges made after 2017, provided the proposed regulations are applied in their entirety. Real property that qualified for like-kind exchange treatment under regulations in effect prior to the TCJA continues to qualify for like-kind exchange treatment. Like-kind analysis of types of real property also continue to apply.