In order for an exchange of property to qualify under the Code Section 1031 rules, the replacement property acquired in an exchange must be of a “like kind” to the property relinquished (Code Section 1031(a)(1)). In determining if property was “acquired,” courts will look at whether the taxpayer acquired the benefits and burdens of ownership in the assets involved in the transaction (Exelon Corporation v. Commissioner, 147 Tax Court Number 9 (2016), Affirmed, 2018 PTC 338 (7th Circuit 2018)). The words “like kind” refer to the nature and character of the property and not to its grade or quality. An exchange of one kind or class of property for a different kind or class is not a like-kind exchange (Regulation Section 1.1031(a)-1(b)). Thus, in determining whether property is exchanged for property of a like kind within the meaning of Code Section 1031(a), the exchanged properties are compared to determine whether the nature and character of the transferred rights in and to the respective properties are substantially alike. In making this comparison, courts consider the respective interests in the physical properties, the nature of the title conveyed, the rights of the parties, the duration of the interests, and any other factor bearing on the nature or character of the properties as distinguished from their grade or quality (Peabody Natural Resource Co. v. Commissioner, 126 Tax Court 261 (2006); Koch v. Commissioner, 71 Tax Court 54 (1978)). In Exelon v. Commissioner, 147 Tax Court Number 9 (2016), Affirmed, 2018 PTC 338 (7th Circuit 2018), the Tax Court held that the essence of a transaction characterized as a like-kind exchange was really an exchange of power plants for an interest in financial instruments. Thus, the transaction did not satisfy the requirements of Code Section 1031 and gain had to be recognized.
However, in Private Letter Ruling 201706009, the IRS ruled that cellular towers that a communications services provider uses in its business are of like-kind to cable telecommunication signal distribution property that the service provider intends to receive in exchange for the cellular towers. The IRS found the property qualified for Code Section 1031 treatment because the towers and the cable distribution systems (1) transmit or support the transmission of telecommunication signals across distances; (2) are not used for other activities; and (3) are, or are intended to be, permanently affixed to land.
Real property: All qualifying real property located in the United States, improved or unimproved, is like-kind property (Regulation Section 1.1031(a)-1(b)). However, real property located in the United States is not of like-kind to property located outside the United States (Code Section 1031(h); Private Letter Rulingss 200041027, 200201007).
Practitioners should watch for hidden personal property in a like-kind exchange of real property, particularly appliances and furniture included in apartment buildings or rental homes, kitchen delivery and office equipment in commercial buildings or motels, and single purpose agricultural structures in farm land swaps. Practitioners should also inquire about any cost segregation studies that may have been done in which building costs have been reallocated to Code Section 1245 assets.
The IRS issued final regulations (T.D. 9935) that implement the TCJA limitation of like-kind exchange treatment to exchanges of real property, generally effective for exchanges completed after December 31, 2017. Given the added significance of determining whether property is real property as a result of the TCJA amendments to Code Section 1031, the final regulations provide guidance on whether property is real property for purposes of the like-kind exchange rules.
Observation: The final regulations specify that the definition of “real property” applies only for purposes of Code Section 1031, and no inference is intended with respect to the classification or characterization of property for other purposes, such as depreciation and Code Section 1245 and Code Section 1250.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
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(Updated 03/19/2021 08:05)