Another change enacted by Tax Cut and Jobs Act was the narrowing of the like kind exchange rules under Code Section 1031.
Code Section 1031(a) provides that, after 2017, no gain or loss is recognized on the exchange of real property held for productive use in a trade or business or for investment if the real property is exchanged solely for real property of like kind which is to be held for productive use in a trade or business or for investment.
In 2019, the IRS issued proposed regulations under Code Section 1031 (Regulation-117589-18) which provided rules for determining whether property was real property for purposes of Code Section 1031.
Under the proposed regulations, state or local law definitions generally (with certain exceptions) were not controlling for purposes of determining whether property is real property for Code Section 1031 purposes. The proposed regulations also included a “purpose or use test” for determining whether property is real property for Code Section 1031 purposes.
The proposed regulations defined real property to include land and improvements to land, and improvements to land included both inherently permanent structures and the structural components of inherently permanent structures. But the proposed regulations also considered the function of property in determining whether property is real property for Code Section 1031 purposes (i.e., the purpose-or-use test). Under the proposed purpose-or-use test, neither tangible nor intangible property would be classified as real property if it contributed to the production of income unrelated to the use or occupancy of space, irrespective of any other factor under the proposed regulations.
Practitioners generally critiqued the scope of the application of state and local law in the proposed regulations for purposes of defining real property and also uniformly disagreed with the purpose or use test. They argued that it improperly narrowed the scope of the definition of real property for Code Section 1031 purposes and would treat certain types of property that have historically been treated as real property for Code Section 1031 purposes as personal property, contrary to Congress’s intent. Particularly with regard to machinery or equipment, practitioners argued that if such property were inherently permanent, it should be treated as real property for purposes of Code Section 1031 regardless of its purpose or use or the type of income it generated.
In December, the IRS published final regulations in Treasury Decision 9935. In response to practitioners’ comments, the IRS reconsidered the degree to which state or local law determinations of real property should be controlling for defining real property for Code Section 1031 purposes. As a result, the final regulations provide generally that property is real property for purposes of Code Section 1031 if, on the date it is transferred in an exchange, the property is classified as real property under the law of the state or local jurisdiction in which the property is located.
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The final regulations also eliminated the purpose-or-use test for tangible property. Instead, under Regulation Section 1.1031(a)-3(a)(2)(ii)(A), if tangible 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 thus real property for Code Section 1031 purposes, irrespective of the purpose or use of the property or whether it contributes to the production of income.
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.
DON FITCH, CPA
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