The law commonly known as the Tax Cuts and Jobs Act of 2017 (the TCJA) amended section 1031 of the Internal Revenue Code of 1986 (Code) to provide that only exchanges of like-kind real property are eligible for deferral of gain. Following this amendment, the Department of the Treasury determined it was necessary to promulgate regulations establishing which assets qualify as real property under section 1031. Although case law and IRS guidance over the years occasionally have weighed in on the issue, until recently Treasury had not articulated definitive rules for purposes of like-kind exchanges as it had done in the context of real estate investment trusts and cost recovery.
On October 21, 2020, Treasury promulgated a final rule setting forth the definition of real property (the “real property regs” or “new regulations”) for purposes of section 1031. In general, the real property regs provide that an asset is classified as real property for purposes of section 1031 if: (i) on the date it is transferred in an exchange, the asset is considered to be real property under the law of the state or local jurisdiction in which it is located; or (ii) if not so treated, the asset is specifically described in the new regulations or satisfies the new regulations’ facts and circumstances test. Significantly, the new regulations establish that each asset is analyzed without regard to whether it contributes to the production of income unrelated to the use or occupancy of space. This is an important (and taxpayer-friendly) change from the approach of the proposed regulations.
While the real property regs follow Congress’ intent that real property eligible for like-kind exchange treatment under pre-TCJA law would continue to be eligible for like-kind exchange treatment under the amended provision, they clarify the rules and thus provide taxpayers with a more specific roadmap for structuring their exchanges. Unsurprisingly, the new regulations provide that any form of property interest that was ineligible for like-kind exchange treatment prior to the enactment of the TCJA (e.g., partnership interests) will remain ineligible. The new regulations apply to like-kind exchanges that began after December 2, 2020.
The Practical Tax Lawyer
CLICK HERE to read the full article, which was originally published in ALI CLE’s The Practical Lawyer.