Proposed regulations published on June 12 provide guidance for like-kind exchanges under IRC Section 1031 as a result of changes enacted by the Tax Cuts and Jobs Act of 2017 (TCJA). Under pre-TCJA law, an income deferral under Section 1031 generally was available for any exchange of property provided the property received was of similar nature. The TCJA significantly limited transactions eligible for like-kind exchange treatment. Under the TCJA, income deferral provided under Section 1031 applies only in the case of an exchange of real property for transactions occurring after Dec. 31, 2017.
The proposed regulations focus on defining what constitutes real property solely for purposes of determining whether the property qualifies for like-kind exchange treatment under Section 1031. They also provide relief for incidental personal property received in a like-kind exchange, which otherwise could have made the entire transaction ineligible for income deferral.
Under the proposed regulations, the determination of whether a distinct asset is real property is based on an analysis of whether it customarily is sold as a single unit, whether it is separable, and whether it is interdependent.
Qualifying as real property
In general, real property is defined in the proposed regulations as one of the following:
- Land
- Inherently permanent structures affixed to real property, including buildings of various types and improvements such as paved parking areas or fences
- Structural components that constitute a part of and are integrated into an inherently permanent structure, such as walls, plumbing systems, or elevators
- Natural products of land, such as crops, timber, or natural deposits, provided they have not yet been severed, extracted, or removed from the land
- Other intangible assets, to the extent they are related solely to an interest in real property and don’t themselves contribute to the production of income aside from the use of space, such as a license for the use of land or an option to acquire land
The proposed regulations identify specific assets that meet the definition of an inherently permanent structure. In addition, the rules provide that taxpayers should assess if a property is real property based on how the asset is affixed, how permanent its placement is intended to be, whether it is designed to be removed, and the expense and damage caused by removing it.
Machinery and equipment generally are not considered real property. However, in certain cases these types of assets can be considered real property provided they are part of and serve an inherently permanent structure and do not otherwise contribute to the production of income. Tenant improvements may be considered real property as well to the extent they are inherently permanent or structural components of an inherently permanent asset.
