[Federal Register Volume 85, Number 114 (Friday, June 12, 2020)]
[Proposed Rules]
[Pages 35835-35846]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-11530]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-117589-18]
RIN 1545-BP02
Statutory Limitations on Like-Kind Exchanges
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: These proposed regulations provide guidance under the Internal
Revenue Code (Code) to implement recent changes enacted in the Tax Cuts
and Jobs Act. The proposed regulations amend the existing regulations
to add a definition of real property to reflect statutory changes
limiting section 1031 to exchanges of real property. The proposed
regulations also provide a rule addressing a taxpayer's receipt of
personal property that is incidental to real property the taxpayer
receives in the exchange. The proposed regulations affect taxpayers
that exchange business or investment property for other business or
investment property and that must determine whether the exchanged
properties are real property for purposes of section 1031.
DATES: Written or electronic comments and requests for a public hearing
must be received by August 11, 2020. Requests for a public hearing must
be submitted as prescribed in the ``Comments and Requests for a Public
Hearing'' section.
ADDRESSES: Commenters are strongly encouraged to submit public comments
electronically. Submit electronic submissions via the Federal
eRulemaking Portal at https://www.regulations.gov (indicate IRS and
REG-117589-18) by following the online instructions for submitting
comments. Once submitted to the Federal eRulemaking Portal, comments
cannot be edited or withdrawn. The IRS expects to have limited
personnel available to process public comments that are submitted on
paper through mail. Until further notice, any comments submitted on
paper will be considered to the extent practicable. The Department of
the Treasury (Treasury Department) and the IRS will publish for public
availability any comment submitted electronically, and to the extent
practicable on paper, to its public docket. Send hard copy submissions
to: CC:PA:LPD:PR (REG-117589-18), Room 5203, Internal Revenue Service,
P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Edward C. Schwartz, (202) 317-4740; concerning submissions of comments
and outlines of topics, or requests for a public hearing, Regina L.
Johnson, (202) 317-5177 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
I. Overview
This document contains proposed amendments to the Income Tax
Regulations (26 CFR part 1, as revised April 1, 2019) under section
1031 of the Code (current regulations). The proposed amendments to the
current regulations (proposed regulations) implement statutory
amendments to section 1031 made by section 13303 of Public Law 115-97
(131 Stat. 2054), commonly referred to as the Tax Cuts and Jobs Act
(TCJA). Section 13303(c) of the TCJA amended section 1031 to limit its
application to exchanges of real property for exchanges completed after
December 31, 2017, subject to a transition rule for certain exchanges
in which property had been transferred before January 1, 2018. To
implement these statutory changes, the proposed regulations would limit
the application of the like-kind exchange rules under section 1031 to
exchanges of real property and adapt an existing incidental property
exception to apply to a taxpayer's receipt of personal property that is
incidental to real property the taxpayer receives in the exchange.
II. Section 1031 After the TCJA
As amended by the TCJA, section 1031(a) provides that no gain or
loss is recognized on the exchange of real property held for productive
use in a trade or business or for investment (relinquished real
property) if the relinquished real property is exchanged solely for
real property of a like kind that is to be held either for productive
use in a trade or business or for investment (replacement real
property). However, left unchanged by the TCJA, section 1031(b)
provides that a taxpayer must recognize gain on the receipt of money
and non-like-kind property in an exchange.
III. Current Regulations Regarding ``Like Kind''
Although the TCJA removed personal and certain intangible property
from eligibility for like-kind exchange treatment, the need to
determine whether the relinquished real property
[[Page 35836]]
and the replacement real property are of a like kind continues to exist
after the changes to section 1031 made by the TCJA. Current Sec.
1.1031(a)-1(b) provides that ``like kind'' refers to the nature or
character of the real property and not to its grade or quality. Real
property of one kind or class may not, under section 1031, be exchanged
for real property of a different kind or class. The fact that any real
property involved is improved or unimproved is not material, for that
fact relates only to the grade or quality of the real property and not
to its kind or class. Under current Sec. 1.1031(a)-1(c), examples of
exchanges of real property of a like kind include an exchange: By a
non-dealer of city real estate for a farm or ranch; of improved real
estate for unimproved real estate; and of a leasehold interest in a fee
with 30 years or more to run for real estate.
IV. Identification of Exchanged Properties
Under section 1031(a)(3), unchanged by the TCJA, real property a
taxpayer receives in an exchange is not like-kind property unless,
within 45 days of the taxpayer's transfer of the relinquished real
property, the real property is identified as replacement real property
to be received in the exchange. Under current Sec. 1.1031(k)-1(c)(4),
the maximum number of properties a taxpayer may identify as replacement
real property is three properties, without regard to the fair market
value of the properties, or any number of properties as long as the
aggregate fair market value of the properties does not exceed 200
percent of the aggregate fair market value of the relinquished real
property. Current Sec. 1.1031(k)-1(c)(5) provides that, for purposes
of the identification rules, property that is incidental to a larger
item of property is not treated as property separate from the larger
item if, in standard commercial transactions, the property is typically
transferred with the larger item of property, and the aggregate fair
market value of all of the incidental property does not exceed 15
percent of the aggregate fair market value of the larger item of
property.
V. Recognition of Gain or Loss on Actual or Constructive Receipt of
Non-Like-Kind Property
Under current Sec. 1.1031(k)-1(f)(1), if a taxpayer actually or
constructively receives money or property that is not of a like kind to
the taxpayer's relinquished real property (other property) before the
taxpayer receives like-kind replacement real property, gain or loss may
be recognized. In addition, if the money or other property the taxpayer
receives is in the full amount of the consideration for the
relinquished real property, the transaction is a sale and not a
deferred exchange, even though the taxpayer may ultimately receive
like-kind replacement real property.
Current Sec. 1.1031(k)-1(g)(2) through (5) provides safe harbors,
the use of which result in a taxpayer not being considered in actual or
constructive receipt of money or other property. Under current Sec.
1.1031(k)-1(g)(4)(i), in the case of a taxpayer's transfer of
relinquished property involving a qualified intermediary, the qualified
intermediary is not considered the agent of the taxpayer for purposes
of section 1031(a) and the determination of whether the taxpayer is in
actual or constructive receipt of money or other property is made as if
the qualified intermediary is not the agent of the taxpayer. However,
current Sec. 1.1031(k)-1(g)(4)(i) applies only if, pursuant to the
requirements of current Sec. 1.1031(k)-1(g)(6)(i), the agreement
between the taxpayer and the qualified intermediary expressly limits
the taxpayer's rights to receive, pledge, borrow, or otherwise obtain
the benefits of money or other property held by the qualified
intermediary.
Under current Sec. 1.1031(k)-1(g)(7), in determining whether a
taxpayer's rights to receive, pledge, borrow, or otherwise obtain the
benefits of money or other property are expressly limited as provided
in current Sec. 1.1031(k)-1(g)(6), the taxpayer's receipt of or right
to receive items that a seller may receive as a consequence of the
disposition of property and that are not included in the amount
realized from the disposition of property (for example, prorated rents)
are disregarded. Also disregarded are transactional items that relate
to the disposition of the relinquished property or to the acquisition
of the replacement property and appear under local standards in the
typical closing statements as the responsibility of a buyer or seller,
such as commissions, prorated taxes, recording or transfer taxes, and
title company fees.
Explanation of Provisions
I. Definition of Real Property
A. Approach of the Proposed Regulations
The determination of whether property is real property has taken on
additional significance as a result of the TCJA amendments limiting
like-kind exchange treatment under section 1031 to exchanges of real
property. Prior to enactment of the TCJA, neither the Code nor the
Income Tax Regulations provided a definition of the term ``real
property'' for purposes of section 1031. The Treasury Department and
the IRS have determined that regulations providing guidance on whether
property is real property under section 1031 are needed because
taxpayers need certainty regarding whether any part of the replacement
property received in an exchange is non-like-kind property subject to
the gain recognition rules of section 1031(b).
The legislative history to the TCJA provides that real property
eligible for like-kind exchange treatment under pre-TCJA law should
continue to be eligible for like-kind exchange treatment after the
enactment of the TCJA. The legislative history further provides that
real property under section 1031 includes shares in a mutual ditch,
reservoir, or irrigation company described in section 501(c)(12)(A) of
the Code if the state in which the company is organized views the
shares of the company as real property. Similarly, improved real estate
and unimproved real estate are generally considered to be property of a
like kind. H. Rept. 115-466, at 396, fn. 726 (2017) (Conference
Report). These proposed regulations define the term ``real property''
for purposes of section 1031 in a manner consistent with the scope
described by Congress in the Conference Report.
Various Income Tax Regulations provide definitions of real property
for purposes of applying Code sections other than section 1031. For
example, Sec. 1.263(a)-3(b) generally defines real property for
purposes of the requirement to capitalize amounts paid to acquire,
produce, or improve tangible property under section 263(a) by reference
to Sec. Sec. 1.48-1(c) and (d). Section 1.263A-8(c) provides a
definition of real property for purposes of determining whether
interest expense relating to the production of designated property must
be capitalized under the rules in Sec. 1.263A-8. Section 1.1250-
1(e)(3) defines real property for purposes of determining depreciation
or amortization recapture upon the disposition of certain property.
Specifically, Sec. 1.1250-1(e)(3) uses section 48 principles for the
definition of real property through its reference to the rules in Sec.
1.1245-3(c). Section 1.856-10 provides a definition of real property
for determining whether a corporation qualifies as a real estate
investment trust (REIT) under sections 856 through 859 of the Code.
Section 1.897-1(b) defines real property for purposes of section 897,
which treats gain or loss from a foreign person's disposition of a U.S.
real property
[[Page 35837]]
interest as income effectively connected with a U.S. trade or business.
Although there are many similarities in the way various sections of
the Code, and the regulations under those sections, define ``real
property,'' there are also differences in those definitions that
reflect the different purposes underlying those provisions. Certain
sections of the Code and Income Tax Regulations apply broad definitions
and sets of rules for the definition of real property, while others
apply narrower definitions. For example, Sec. 1.1250-1(e)(3) uses a
narrow definition of real property, which is relied upon for purposes
of applying section 168 and former section 38. Under section 168, a
tangible asset that is personal property, as opposed to real property,
generally is depreciated at a faster rate than real property is
depreciated. See section 168(c) and (g)(2)(C). Under former section 38,
the investment tax credit applied to qualified investment in
depreciable property (section 38 property) described in former section
48(a), which primarily included tangible personal property and excluded
real property. See Sec. Sec. 1.48-1(c) and (d). In contrast, section
897 uses a broad definition of real property that includes items of
personal property that are associated with the use of real property.
See section 897(c)(6)(B) (real property includes movable walls,
furnishings, and other personal property associated with the use of the
real property). Under section 897, an item of property may be treated
as a U.S. real property interest under the Foreign Investment in Real
Property Act provisions, notwithstanding that it is characterized as
personal property for other purposes of the Code. In the context of
REITs under sections 856 through 859, the regulations defining real
property set forth a broader definition for purposes of satisfying the
REIT quarterly asset test. The regulations under section 856 were based
in part on the particular policies underlying the REIT provisions, and
apply only for purposes of the REIT provisions.
The Treasury Department and the IRS have concluded that it would
not be appropriate to adopt wholesale as the definition of real
property for purposes of section 1031 an existing definition of real
property from another section of the Code or regulations due to the
varying purposes of each of the provisions of the Code, and the intent
of Congress that real property eligible for like-kind exchange
treatment under pre-TCJA law should continue to be eligible for like-
kind exchange treatment in years beginning after 2017. Using the
definition of real property in Sec. 1.263(a)-3(b), Sec. 1.263A-8(c),
Sec. 1.1250-1(e), or other regulations discussed in this Explanation
of Provisions, would be inappropriate because, for example, certain
shares in a mutual ditch, reservoir, or irrigation company are real
property eligible for like-kind exchange treatment under pre-TCJA law,
but would not be real property under some of the other regulations.
Similarly, Sec. 1.856-10 provides that property having an active
function such as producing, manufacturing, or creating a product is not
real property under section 856, but nothing in pre-TCJA section 1031
law suggests that real property held for productive use in a trade or
business or for investment should necessarily be excluded from the
definition of real property because of an active rather than passive
function.
Thus, instead of a wholesale adoption of an existing real property
definition used in another Code or regulations section, these proposed
regulations incorporate certain aspects from existing regulatory
definitions of real property that are consistent with the legislative
history underlying the TCJA amendment to section 1031 indicating that
real property eligible for like-kind exchange treatment under pre-TCJA
law should continue to be eligible for like-kind exchange treatment
after the enactment of the TCJA. See, for example, Sec. Sec. 1.263(a)-
3(b)(3) and 1.856-10 defining the term ``real property'' to mean land
and improvements to land such as buildings and other inherently
permanent structures, and their structural components, and providing
that local law is not controlling for purposes of determining whether
property is real property under that section; Sec. 1.263A-8(c)
providing that real property includes unsevered natural products of
land such as growing crops and plants, mines wells and other natural
deposits; and Sec. 1.856-10(c) providing, in relevant part, that the
term ``land'' includes ``water and air space superjacent to land.
B. Proposed Definition of Real Property
Under the proposed regulations, 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. The proposed regulations also
provide that local law definitions generally are not controlling in
determining the meaning of the term ``real property'' for purposes of
section 1031. This real property definition language is very similar to
the language in most of the other regulatory provisions previously
mentioned, including the regulations under section 48, section 263(a),
and section 263A. The definition under the proposed regulations,
however, includes differences necessary for the proper application of
section 1031.
These 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. Items that are specifically listed in these
proposed regulations as buildings and other inherently permanent
structures are distinct assets. Assets and systems specifically listed
in these proposed regulations as types of structural components also
are treated as distinct assets. Other distinct assets are identified
using factors provided by these proposed regulations. All listed
factors must be considered, and no one factor is determinative. These
rules are based on similar rules concerning distinct assets in Sec.
1.856-10(e).
The proposed regulations provide that inherently permanent
structures include any building or other structure that is permanently
affixed to real property and that will ordinarily remain affixed for an
indefinite period of time. For this purpose, the proposed regulations
define a ``building'' as any structure or edifice enclosing a space
within its walls, and usually covered by a roof, the purpose of which
is, for example, to provide shelter or housing, or to provide working,
office, parking, display, or sales space. ``Buildings'' also include
the following distinct assets if 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 definition of building and the examples of buildings in the
proposed regulations are derived from Sec. 1.48-1(e)(1) and Sec.
1.856-10(d)(2)(ii)(B).
The proposed regulations also provide a list of structures that
qualify as inherently permanent structures. If property is not included
in the list of inherently permanent structures, the proposed
regulations provide factors that must be used to determine whether the
property is an inherently permanent structure for purposes of section
1031. These factors are similar to the factors in Sec. 1.856-
10(d)(2)(iv).
Under the proposed regulations, property that is in the nature of
[[Page 35838]]
machinery or is essentially an item of machinery or equipment is
generally not an inherently permanent structure and not real property
under section 1031. In the case, however, of a building or inherently
permanent structure that includes property in the nature of machinery
as a structural component, 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. These rules regarding machinery are very similar to the rules in
Sec. 1.263A-8(c)(4) and Sec. 1.856-10(d)(3).
Under the proposed regulations, structural components of inherently
permanent structures are improvements to land and thus real property
for purposes of section 1031. A structural component is any distinct
asset that is a constituent part of, and integrated into, an inherently
permanent structure. If interconnected assets work together to serve an
inherently permanent structure (for example, systems that provide a
building with electricity, heat, or water), the assets are analyzed
together as one distinct asset that may qualify as a structural
component. For example, a gas line that provides fuel to a building's
heating system comprises a part of the structural component that is the
heating system, and therefore qualifies as real property for section
1031 purposes. However, if the purpose of a gas line is to provide fuel
to business equipment in a building, such as fryers and ovens in a
building utilized as a restaurant, the gas line is not a constituent
part of an inherently permanent structure and therefore not real
property for section 1031 purposes. Comments are requested on whether
the function of a distinct asset that is not machinery is appropriate
to use as the basis for determining whether the asset qualifies as real
property for section 1031 purposes.
A structural component may qualify as real property only if the
taxpayer holds its interest in the structural component together with a
real property interest within the physical space of the inherently
permanent structure served by the structural component. If a distinct
asset is customized in connection with the rental of space in or on an
inherently permanent structure to which the asset relates, the
customization does not affect whether the distinct asset is a
structural component.
The proposed regulations also contain a list of properties that are
structural components for purposes of section 1031. For components not
included in the list, the proposed regulations provide factors for
determining whether the component is a structural component of a
building or inherently permanent structure and thus real property for
section 1031 purposes. The proposed regulations also address tenant
improvements to a building that are inherently permanent or otherwise
classified as real property and property produced for sale that is not
real property in the hands of the producing taxpayer or a related
person. The rules in the proposed regulations relating to structural
components are similar to the rules in many of the other regulations
discussed in this preamble.
The proposed regulations provide that unsevered natural products of
land generally are treated as real property under section 1031. This
includes growing crops, plants, and timber; mines; wells; and other
natural deposits. Natural products and deposits, such as crops, timber,
water, ores, and minerals, cease to be real property when they are
severed, extracted, or removed from the land.
The proposed regulations also address instances in which intangible
property is considered real property under section 1031. An intangible
asset is real property or an interest in real property for purposes of
section 1031 to the extent 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 consideration for the use or occupancy
of space. For instance, a license, permit, or other similar right that
is solely for the use, enjoyment, or occupation of land or an
inherently permanent structure, and that is in the nature of a
leasehold, easement, or fee ownership, generally is an interest in real
property for purposes of section 1031.
Under the proposed regulations, a license or permit to engage in or
operate a business on real property is not real property or an interest
in real property for purposes of section 1031 if the license or permit
produces or contributes to the production of income other than
consideration for the use and occupancy of space. The rules in the
proposed regulations relating to intangible assets are similar to the
rules in Sec. 1.856-10(f) and are consistent with pre-TCJA law
concerning whether an intangible asset is real property for section
1031 purposes. See Commissioner v. Crichton, 122 F.2d 181 (5th Cir.
1941), concluding that an interest in mineral rights is real property
for section 1031 purposes, Peabody Natural Resources Co. v.
Commissioner, 126 T.C. 261 (2006), holding that coal supply contracts
were real property for section 1031 purposes, and Rev. Rul. 68-331,
1968-1 C.B. 352, holding that the interest of a lessee in a producing
oil lease is an interest in real property for section 1031 purposes.
These proposed regulations define real property only for purposes
of section 1031. Consequently, the proposed regulations provide that no
inference should be drawn from the section 1031 definition of real
property for any purpose outside of section 1031, including for the
classification of property for depreciation, whether depreciation
recapture applies, or defining an asset for disposition purposes under
section 168 and the regulations under section 168.
The Treasury Department and the IRS request comments regarding the
definition of real property set forth in these proposed regulations. In
particular, the Treasury Department and the IRS request comments
regarding the proposed relevant factors and analysis for determining
the qualification of an item as real property.
II. Incidental Personal Property
The Treasury Department and the IRS are aware that taxpayers have
questioned the effect of the receipt of personal property that is
incidental to the taxpayer's replacement real property in an intended
section 1031 exchange. For example, taxpayers have asked whether an
exchange fails to meet the requirements of Sec. 1.1031(k)-1(g)(6)(i)
if funds from the transfer of relinquished property held by the
qualified intermediary are used to acquire an office building,
including the personal property in the office building. Taxpayers and
qualified intermediaries are concerned that a taxpayer would be
considered to be in constructive receipt of all of the exchange funds
held by the qualified intermediary if the taxpayer is able to direct
the qualified intermediary to use those funds to acquire property that
is not of a like kind to the taxpayer's relinquished property. Under
Sec. 1.1031(k)-1(a), if a taxpayer actually or constructively receives
the funds held by a qualified intermediary before receiving the
replacement property, the transaction is a sale and not a section 1031
like-kind exchange.
In response to these inquiries, the proposed regulations add to the
items in Sec. 1.1031-1(g)(7) that are disregarded in determining
whether the agreement between the taxpayer and the qualified
intermediary expressly limits the taxpayer's rights to receive, pledge,
borrow, or otherwise obtain the benefits of money or other property
held by the qualified intermediary. The proposed
[[Page 35839]]
regulations provide that personal property that is incidental to
replacement real property is disregarded in determining whether a
taxpayer's rights to receive, pledge, borrow, or otherwise obtain the
benefits of money or other property held by a qualified intermediary
are expressly limited as provided in Sec. 1.1031(k)-1(g)(6). Personal
property is incidental to real property acquired in an exchange if, in
standard commercial transactions, the personal property is typically
transferred together with the real property, and the aggregate fair
market value of the incidental personal property transferred with the
real property does not exceed 15 percent of the aggregate fair market
value of the replacement real property. This incidental property rule
in the proposed regulations is based on the existing rule in Sec.
1.1031(k)-1(c)(5), which provides that certain incidental property is
ignored in determining whether a taxpayer has properly identified
replacement property under section 1031(a)(3)(A) and Sec. 1.1031(k)-
1(c).
The Treasury Department and the IRS request comments regarding the
proposed treatment of a taxpayer's receipt of personal property that is
incidental to the taxpayer's replacement real property in an intended
section 1031 exchange. In addition, the Treasury Department and the IRS
request comments regarding the two-factor analysis for determining
whether personal property is incidental to real property acquired in
such an exchange. In particular, comments are requested with regard to
the appropriateness of the proposed 15-percent fair market value limit
set forth in that test for personal property transferred with real
property.
III. Outdated Regulations
The Treasury Department and the IRS request comments regarding
whether existing regulations under section 1031 that apply to tax years
before the TCJA amendments to section 1031 limiting its application to
exchanges of real property should be removed.
Proposed Applicability Date
These proposed regulations apply to exchanges beginning on or after
the date the regulations are published as final regulations in the
Federal Register. Pending issuance of the final regulations, a taxpayer
may rely on these proposed regulations, if followed consistently and in
their entirety, for exchanges of real property beginning after December
31, 2017, and before the final regulations are published.
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
Executive Orders 12866, 13563 and 13771 direct agencies to assess
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits (including (i) potential economic, environmental, and
public health and safety effects, (ii) potential distributive impacts,
and (iii) equity). Executive Order 13563 emphasizes the importance of
quantifying both costs and benefits, reducing costs, harmonizing rules,
and promoting flexibility.
These regulations have been designated as significant under
Executive Order 12866 pursuant to the Memorandum of Agreement (April
11, 2018) (MOA) between the Treasury Department and the Office of
Management and Budget (OMB) regarding review of tax regulations. The
Office of Information and Regulatory Affairs has designated these
regulations as significant under section 1(b) of the MOA. Accordingly,
the OMB has reviewed these regulations.
A. Background
1. Like-Kind Exchange
Prior to the amendment of section 1031 by the TCJA, certain
exchanges of personal, intangible, or real property held for use in a
trade or business or for investment qualified for nonrecognition under
section 1031. Section 13301 of the TCJA generally limits the
application of like-kind exchange treatment to exchanges of real
property after December 31, 2017, subject to a transition rule
applicable to exchanges not completed by January 1, 2018. Specifically,
section 1031 provides that 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 a like kind that is to be held either for productive
use in a trade or business or for investment.
2. Proposed Regulations
The proposed rules provide a definition of real property to
distinguish it from personal property, as the TCJA limited the
nonrecognition of gain or loss in the case of like-kind exchange to
exchanges of real property. The legislative history to the TCJA
provides that real property eligible for like-kind exchange treatment
prior to the TCJA should continue to be eligible for like-kind exchange
treatment. H. Rept. 115-466, at 396, fn. 726 (2017). Therefore, the
Treasury Department and the IRS propose to extract certain portions of
the definition of real property from various existing regulations that
are consistent with the legislative history underlying the TCJA
amendment to section 1031. See, for example, Sec. Sec. 1.263(a)-
3(b)(3) and 1.856-10 defining the term ``real property'' to mean land
and improvements to land such as buildings and other inherently
permanent structures, and their structural components, and providing
that local law is not controlling for purposes of determining whether
property is real property; Sec. 1.263A-8(c) providing that real
property includes unsevered natural products of land such as growing
crops and plants, mines wells and other natural deposits; and Sec.
1.856-10(c) providing, in relevant part, that the term ``land''
includes ``water and air space superjacent to land.'' Consistent with
these existing regulations, the proposed regulations define real
property to include 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.
The proposed regulations also include a separate rule relating to
personal property in an exchange that is incidental to the real
property exchanged. Under this rule, personal property is incidental to
real property acquired in an exchange if, in standard commercial
transactions, the personal property is typically transferred together
with the real property, and the aggregate fair market value of the
incidental personal property transferred with the real property does
not exceed 15 percent of the aggregate fair market value of the
replacement real property. This incidental property rule in the
proposed regulations is based on an existing rule in the regulations
under 1031, which provides that certain incidental property is ignored
in determining whether a taxpayer has properly identified replacement
property.
3. No-Action Baseline
The Treasury Department and the IRS have assessed the benefits and
costs of these proposed regulations relative to a no-action baseline
reflecting anticipated Federal income tax-related behavior in the
absence of these proposed regulations.
4. Economic Analysis of Regulation
In general, the proposed regulations use existing definitions of
real property
[[Page 35840]]
in the Income Tax Regulations to define real property under section
1031 so that like-kind exchanges of real property that took place prior
to the TCJA would qualify for like-kind exchange treatment after the
passage of the TCJA, which is consistent with the legislative history
of the TCJA. In addition, taxpayers are familiar with the approach in
the proposed regulations concerning incidental personal property, which
is consistent with rules regarding identification of replacement
property under existing section 1031 regulations.
The statutory changes made by the TCJA to section 1031 limit like-
kind exchanges to real property. Consistent with longstanding
regulations under section 1031, in determining whether a taxpayer has
actual or constructive receipt of money or other property held by a
qualified intermediary, the proposed regulations disregard certain
incidental personal property. Specifically, the proposed regulations
disregard incidental personal property that (1) in standard commercial
transactions is typically transferred together with the real property,
and (2) does not exceed 15 percent of the aggregate fair market value
of the replacement real property. Nonetheless, under section 1031(b), a
taxpayer must recognize gain on the receipt of the incidental personal
property, which is non-like-kind property. The proposed 15-percent
limitation is responsive to ordinary-course exchanges that often
commingle personal property and real property as part of the aggregate
exchanged property.
With regard to a limitation in excess of 15 percent, the Treasury
Department determined that a higher limit might induce taxpayers to
bundle more personal property with their exchanged property. Such a
result would lead to increased amounts of personal property exchanged
with real property under section 1031 and effectively unlock a class of
personal property that would no longer be ``incidental'' to the real
property. With regard to a lower limit, the Treasury Department has
determined that the burden of accurately measuring the separate costs
of comingled personal and real property would increase.
In addition, the proposed 15 percent incidental personal property
limitation would reduce the cost of investing in real property, when
compared to no exchanges for incidental personal property. Raising this
limit, however, would further increase the tax incentives for investing
in such property, although most taxpayers will be indifferent when
exchanging incidental property, plants, and equipment with a
depreciable life of 20 years or less that is eligible for 100 percent
additional first year depreciation, commonly referred to as ``bonus
depreciation.'' Under 100 percent bonus depreciation, gains from the
sale of property can be offset by deductions for investment in other
qualifying property. Qualifying property acquired after September 27,
2017, and placed in service after September 27, 2017, and generally
before January 1, 2023, qualifies for full bonus depreciation. The
bonus depreciation rate is phased down 20 percent a year for property
placed in service after this date. In the absence of 100 percent bonus
depreciation, expanding incentives for like-kind exchange through a
higher incidental personal property limitation could also distort
investment decisions within and across industries leading to over-
investment in like-kind properties relative to consistent treatment
across properties. The Treasury Department requests comments and
information that would help further inform the analysis underlying the
proposed 15-percent limitation for incidental personal property.
The Treasury Department and the IRS have determined that these
rules will not have a significant effect on the market for like-kind
exchanges of real property. Finally, these proposed regulations do not
significantly affect compliance burdens as the regulations are
substantially similar to existing regulations affecting like-kind
exchanges for real property.
II. Paperwork Reduction Act
The collection of information in these proposed regulations is
reflected in the collection of information for Form 8824, Like-Kind
Exchanges, which has been reviewed and approved by the Office of
Management and Budget in accordance with the Paperwork Reduction Act
(44 U.S.C. 3507(c)) under control numbers 1545-0074. The number of
respondents to Form 8824 for tax year 2018 is estimated at 125,000-
220,000. The estimated burden for individual taxpayers filing this form
is approved under OMB control number 1545-0074 and is included in the
estimates shown in the instructions for their individual income tax
return. The estimated burden for taxpayers who file Form 8824, which
has not changed as a result of these proposed regulations, is shown
below.
Recordkeeping--10 hr., 16 min.
Learning about the law or the form--1 hr., 59 min.
Preparing the form--2 hr., 14 min.
Form 8824 is used by taxpayers engaging in section 1031 like-kind
exchanges. Beginning after December 31, 2017, section 1031 like-kind
exchange treatment applies only to exchanges of real property held for
use in a trade or business or for investment, other than real property
held primarily for sale. Before the law change, section 1031 also
applied to certain exchanges of personal or intangible property. These
proposed regulations provide a definition of real property for purposes
of section 1031 and a rule for the receipt of personal property that is
incidental to real property received in an exchange, and makes
conforming changes to the regulations. The law change reflected in the
proposed regulations will result in fewer taxpayers engaging in section
1031 like-kind exchanges. This decrease in burden will be reflected in
the updated burden estimates for the Form 8824. The requirement to
maintain records to substantiate information on the Form 8824 is
already contained in the burden associated with the control numbers for
those forms and remains unchanged. For purposes of the Paperwork
Reduction act, no burden estimates specific to the proposed regulations
are currently available. The Treasury Department has not estimated the
burden, including that of any new information collections, related to
the requirements under the proposed regulations. Those estimates would
capture both changes made by the TCJA and those that arise out of
discretionary authority exercised in the proposed regulations.
The current status of the Paperwork Reduction Act submissions
related to 1031 is provided in the following table. The 1031 provisions
are included in aggregated burden estimates for OMB control number
1545-0074, which represents a total estimated burden time, including
all related forms and schedules, of 1.784 billion hours and total
estimated monetized costs of $31.764 billion ($2017). The burden
estimates provided in the OMB control numbers below are aggregate
amounts that relate to the entire package of forms associated with the
OMB control number, and will in the future include but not isolate the
estimated burden of only the 1031 requirements. These numbers are
therefore unrelated to the future calculations needed to assess the
burden imposed by the proposed regulations. The Treasury Department and
IRS urge readers to recognize that these numbers are duplicates and to
guard against over-counting the burden that tax provisions imposed
prior to the Act. The Treasury Department and the
[[Page 35841]]
IRS request comments on all aspects of information collection burdens
related to the proposed regulations. In addition, when available,
drafts of IRS forms are posted for comment at www.irs.gov/draftforms.
------------------------------------------------------------------------
------------------------------------------------------------------------
Form 8824..................... Individual (NEW Sixty-day notice
Model) 1545-0074. published in the
Federal Register on
9/30/19 (84 FR
51712). Public
Comment period
closed on 11/29/19.
Thirty-day notice
published in the
Federal Register on
12/18/19 (84 FR
69458). Comment
period closed on 1/
17/20. Approved by
OMB through 1/31/
2021.
------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2019/12/18/2019-27285/agency-information-collection-activities-submission-for-omb-review-comment-request-us-individual.
------------------------------------------------------------------------
Form 8824 is also used by members of the executive branch of the
Federal Government and judicial officers of the Federal Government to
elect to defer gain under section 1043 on certain sales of property due
to potential conflicts of interest arising from their status as
government officials. These proposed regulations do not address or
affect the deferral of gain on sales under section 1043.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid OMB control number.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
return information are confidential, as required by 26 U.S.C. 6103.
III. Regulatory Flexibility Act
It is hereby certified that these proposed regulations will not
have a significant economic impact on a substantial number of small
entities within the meaning of section 601(6) of the Regulatory
Flexibility Act (5 U.S.C. chapter 6).
These proposed regulations update existing regulations under
section 1031 to reflect statutory changes made to section 1031 by the
TCJA. Section 1031 provides that a taxpayer exchanging investment
property or property held for productive use in a trade or business for
other investment or trade or business property recognizes gain only to
the extent of money or other non-like-kind property received in the
exchange, and recognizes no loss on the exchange. Under the TCJA
amendments to section 1031, for years after 2017, section 1031 applies
only to exchanges of real property and no longer applies to exchanges
of personal property and certain intangible property. The proposed
regulations provide a definition of real property to be used in
determining whether a taxpayer has met the requirements of section
1031. In so doing, the proposed regulations follow the legislative
history underlying the TCJA amendment to section 1031 providing that
real property eligible for like-kind exchange treatment under pre-TCJA
law continues to be eligible for like-kind exchange treatment in years
beginning after 2017. Consequently, the proposed regulations use
certain aspects from existing regulatory definitions of real property
that are consistent with the legislative history underlying the TCJA
amendment to section 1031 requiring that the definition of real
property remain the same both before and after enactment of the TCJA.
Taxpayers already are familiar with these rules, which provide that
real property includes land, improvements to land, unsevered natural
products of land, and water and air space superjacent to land. In
addition, the proposed regulations provide a rule addressing a
taxpayer's receipt of personal property that is incidental to the real
property the taxpayer receives in the exchange that is based on an
existing rule in Sec. 1.1031(k)-1.
Individuals and business entities that own investment real property
or real property held for productive use in a trade or business may
engage in a section 1031 exchange. The provisions of section 1031 apply
in the same manner to all taxpayers, so the effect of the proposed
regulations is the same for taxpayers that are small entities and
taxpayers that are not small entities. The small entities potentially
impacted by these regulations are businesses organized as corporations
(including S corporations), partnerships, and individuals that file a
Form 1040 Schedule C for their respective trades or businesses or Form
1040 Schedule E for their rental real estate.
The number of small entities potentially affected by these proposed
regulations is unknown but likely substantial because like-kind
exchange are entered into by entities of all sizes. Although a
substantial number of small entities is potentially affected by these
proposed regulations, the Treasury Department and the IRS have
concluded that the proposed regulations will not have a significant
economic impact on a substantial number of small entities because the
costs to comply with these proposed regulations are not significant.
This is because for taxpayers still able to engage in section 1031
exchanges, there are no additional forms they are required to file, and
there is no new recordkeeping required, to comply with section 1031 as
amended by the TCJA and these proposed regulations. Thus, taxpayers
that engage in like-kind exchanges of real property in 2018 and later
years won't have any additional burden as compared to taxpayers
engaging in like-kind exchanges in years before 2018. Accordingly, it
is hereby certified that these proposed regulations will not have a
significant economic impact on a substantial number of small entities.
Notwithstanding this certification, the Treasury Department and the
IRS invite comments from the public about the impact of this proposed
rule on small entities.
Pursuant to section 7805(f) of the Code, this notice of proposed
rulemaking will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 requires
that agencies assess anticipated costs and benefits and take certain
other actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a state,
local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. In 2019, that threshold is approximately $164 million. This
proposed rule does not include any mandate that may result in
expenditures by state, local, or tribal governments, or by the private
sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state
[[Page 35842]]
law, unless the agency meets the consultation and funding requirements
of section 6 of the Executive Order. This proposed rule does not have
federalism implications and does not impose substantial, direct
compliance costs on state and local governments or preempt state law
within the meaning of the Executive Order.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS as prescribed in this preamble under the ADDRESSES heading.
The Treasury Department and the IRS request comments on all aspects of
the proposed rules. Any electronic comments submitted, and to the
extent practicable any paper comments submitted, will be made available
at http://www.regulations.gov or upon request.
A public hearing will be scheduled if requested in writing by any
person who timely submits electronic or written comments. Requests for
a public hearing are also encouraged to be submitted electronically. If
a public hearing is scheduled, notice of the date and time for the
public hearing will be published in the Federal Register. Announcement
2020-4, 2020-17 IRB 1, provides that until further notice, public
hearings conducted by the IRS will be held telephonically. Any
telephonic hearing will be made accessible to people with disabilities.
Drafting Information
The principal author of these proposed regulations is Edward C.
Schwartz of the Office of Associate Chief Counsel (Income Tax and
Accounting). However, other personnel from the Treasury Department and
the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
* * * * *
0
Par. 2. Section 1.168(i)-1 is amended by:
0
1. In the last sentence in paragraph (e)(2)(viii)(A), removing ``does
not apply.'' at the end of the sentence and adding ``and the distinct
asset determination under Sec. 1.1031(a)-3(a)(4) do not apply.'' in
its place;
0
2. In the first sentence in paragraph (m)(1), removing the word
``This'' at the beginning of the sentence and adding ``Except as
provided in paragraph (m)(5) of this section, this'' in its place; and
0
3. Redesignating paragraph (m)(5) as paragraph (m)(6) and adding new
paragraph (m)(5).
The addition reads as follows:
Sec. 1.168(i)-1 General asset accounts.
* * * * *
(m) * * *
(5) Application of paragraph (e)(2)(viii)(A). The language ``and
the distinct asset determination under Sec. 1.1031(a)-3(a)(4) do not
apply.'' in the last sentence of paragraph (e)(2)(viii)(A) of this
section applies on or after [EFFECTIVE DATE OF THE FINAL RULE].
Paragraph (e)(2)(viii)(A) of this section as contained in 26 CFR part I
edition revised as of April 1, 2019, applies before the effective date
of the final rule.
0
Par. 3. Section 1.168(i)-8 is amended by:
0
1. In the last sentence in paragraph (c)(4)(i), removing ``does not
apply.'' at the end of the sentence and adding ``and the distinct asset
determination under Sec. 1.1031(a)-3(a)(4) do not apply.'' in its
place;
0
2. At the beginning of the sentence in paragraph (j)(1), removing the
word ``This'' and adding ``Except as provided in paragraph (j)(5) of
this section, this'' in its place;
0
3. Redesignating paragraph (j)(5) as paragraph (j)(6) and adding new
paragraph (j)(5).
The addition reads as follows:
Sec. 1.168(i)-8 Dispositions of MACRS property.
* * * * *
(j) * * *
(5) Application of paragraph (c)(4)(i). The language ``and the
distinct asset determination under Sec. 1.1031(a)-3(a)(4) do not
apply.'' in the last sentence of paragraph (c)(4)(i) of this section
applies on or after [EFFECTIVE DATE OF THE FINAL RULE]. Paragraph
(c)(4)(i) of this section as contained in 26 CFR part I edition revised
as of April 1, 2019, applies before the effective date of the final
rule.
0
Par. 4. Section 1.1031-0 is amended by revising the entry for Sec.
1.1031(a)-1(e) and adding entries for Sec. 1.1031(a)-3 to read as
follows:
Sec. 1.1031-0 Table of contents.
* * * * *
Sec. 1.1031(a)-1 Property held for productive use in a trade or
business or for investment.
* * * * *
(e) Applicability dates.
* * * * *
Sec. 1.1031(a)-3 Definition of real property.
(a) Real property.
(b) Examples.
(c) Applicability date.
* * * * *
0
Par. 5. Section 1.1031(a)-1 is amended by adding paragraph (a)(3) and
revising paragraph (e) to read as follows:
Sec. 1.1031(a)-1 Property held for productive use in trade or
business or for investment.
(a) * * *
(3) Exchanges after 2017. Pursuant to section 13303 of Public Law
115-97 (131 Stat. 2054), for exchanges beginning after December 31,
2017, section 1031 and Sec. Sec. 1.1031(a)-1, 1.1031(b)-2, 1.1031(d)-
1T, 1.1031(d)-2, 1.1031(j)-1, 1.1031(k)-1, and references to section
1031 in Sec. Sec. 1.1031(b)-1, 1.1031(c)-1, and 1.1031(d)-1, apply
only to qualifying exchanges of real property (within the meaning of
Sec. 1.1031(a)-3) that is held for productive use in a trade or
business, or for investment, and that is not held primarily for sale.
* * * * *
(e) Applicability dates--(1) Exchanges of partnership interests.
The provisions of paragraph (a)(1) of this section relating to
exchanges of partnership interests apply to transfers of property made
by taxpayers on or after April 25, 1991.
(2) Exchanges after 2017. The provisions of paragraph (a)(3) of
this section apply to exchanges beginning on or after [EFFECTIVE DATE
OF THE FINAL RULE].
0
Par. 6. Section 1.1031(a)-3 is added to read as follows:
Sec. 1.1031(a)-3 Definition of real property.
(a) Real property--(1) In general. The term real property under
section 1031 and Sec. Sec. 1.1031(a)-1 through 1.1031(k)-1 means land
and improvements to land, unsevered natural products of land, and water
and air space superjacent to land. Under paragraph (a)(5) of this
section, an interest in real property of a type described in this
paragraph (a)(1), including fee ownership, co-ownership, a leasehold,
an option to acquire real property, an easement, or a similar interest,
is real property for purposes of section 1031 and this section. Except
for a state's characterization of shares in a
[[Page 35843]]
mutual ditch, reservoir, or irrigation company described in paragraph
(a)(5)(i) of this section, local law definitions are not controlling
for purposes of determining the meaning of the term real property under
this section.
(2) Improvements to land--(i) In general. The term improvements to
land means inherently permanent structures and the structural
components of inherently permanent structures.
(ii) Inherently permanent structures--(A) In general. The term
inherently permanent structures means any building or other structure
that is a distinct asset within the meaning of paragraph (a)(4) of this
section and is permanently affixed to real property and that will
ordinarily remain affixed for an indefinite period of time.
(B) Building. A building is any structure or edifice enclosing a
space within its walls, and covered by a roof, the purpose of which is,
for example, to provide shelter or housing, or to provide working,
office, parking, display, or sales space. Buildings include the
following distinct assets if permanently affixed: Houses, apartments,
hotels, motels, enclosed stadiums and arenas, enclosed shopping malls,
factories and office buildings, warehouses, barns, enclosed garages,
enclosed transportation stations and terminals, and stores.
(C) Other inherently permanent structures. Inherently permanent
structures under this paragraph (a)(2)(ii) include the following
distinct assets, if permanently affixed: In-ground swimming pools;
roads; bridges; tunnels; paved parking areas, parking facilities, and
other pavements; special foundations; stationary wharves and docks;
fences; inherently permanent advertising displays for which an election
under section 1033(g)(3) is in effect; 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.
Affixation to real property may be accomplished by weight alone. If
property is not listed as an inherently permanent structure in this
paragraph (a)(2)(ii)(C), the determination of whether the property is
an inherently permanent structure under this paragraph (a)(2)(ii) is
based on the following factors--
(1) The manner in which the distinct asset is affixed to real
property;
(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.
(D) Machinery. Property that is in the nature of machinery or is
essentially an item of machinery or equipment is generally not an
inherently permanent structure and not real property for purposes of
this section. In the case, however, of a building or inherently
permanent structure that includes property in the nature of machinery
as a structural component, the machinery is real property provided 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.
(iii) Structural components--(A) In general. The term structural
component means any distinct asset, within the meaning of paragraph
(a)(4) of this section, that is a constituent part of, and integrated
into, an inherently permanent structure. If interconnected assets work
together to serve an inherently permanent structure (for example,
systems that provide a building with electricity, heat, or water), the
assets are analyzed together as one distinct asset that may be a
structural component. A structural component may qualify as real
property only if the taxpayer holds its interest in the structural
component together with a real property interest in the space in the
inherently permanent structure served by the structural component. If a
distinct asset is customized, the customization does not affect whether
the distinct asset is a structural component. Tenant improvements to a
building that are inherently permanent or otherwise classified as real
property within the meaning of this paragraph (a)(2)(iii) are real
property under this section. However, property produced for sale, such
as bricks, nails, paint, and windowpanes, that is not real property in
the hands of the producing taxpayer or a related person, as defined in
section 1031(f)(3), but that may be incorporated into real property by
an unrelated buyer, is not treated as real property by the producing
taxpayer.
(B) Examples of structural components. Structural components
include the following items, provided the item is a constituent part
of, and integrated into, an inherently permanent structure: Walls;
partitions; doors; wiring; plumbing systems; central air conditioning
and heating systems; pipes and ducts; elevators and escalators; floors;
ceilings; permanent coverings of walls, floors, and ceilings;
insulation; chimneys; fire suppression systems, including sprinkler
systems and fire alarms; fire escapes; security systems; humidity
control systems; and other similar property. If a component of a
building or inherently permanent structure is a distinct asset and is
not listed as a structural component in this paragraph (a)(2)(iii)(B),
the determination of whether the component is a structural component
under this paragraph (a)(2)(iii) is based on the following factors--
(1) The manner, time, and expense of installing and removing the
component;
(2) Whether the component is designed to be moved;
(3) The damage that removal of the component would cause to the
item itself or to the inherently permanent structure to which it is
affixed; and
(4) Whether the component is installed during construction of the
inherently permanent structure.
(3) Unsevered natural products of land. Unsevered natural products
of land, including growing crops, plants, and timber; mines; wells; and
other natural deposits, generally are treated as real property for
purposes of this section. Natural products and deposits, such as crops,
timber, water, ores, and minerals, cease to be real property when they
are severed, extracted, or removed from the land.
(4) Distinct asset--(i) In general. A distinct asset is 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. Buildings and other inherently permanent
structures are distinct assets. Assets and systems listed as a
structural component in paragraph (a)(2)(iii)(B) of this section are
treated as distinct assets.
(ii) Facts and circumstances. The determination of whether a
particular separately identifiable item of property is a distinct asset
is based on all the facts and circumstances. In particular, the
following factors must be taken into account--
(A) Whether the item is customarily sold or acquired as a single
unit rather than as a component part of a larger asset;
[[Page 35844]]
(B) Whether the item can be separated from a larger asset, and if
so, the cost of separating the item from the larger asset;
(C) Whether the item is commonly viewed as serving a useful
function independent of a larger asset of which it is a part; and
(D) Whether separating the item from a larger asset of which it is
a part impairs the functionality of the larger asset.
(5) Intangible assets--(i) In general. To the extent an intangible
asset 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 consideration for the use or occupancy of space, the
intangible asset is real property or an interest in real property. Real
property includes shares in a mutual ditch, reservoir, or irrigation
company described in section 501(c)(12)(A) if, at the time of the
exchange, the shares have been recognized by the highest court of the
State in which the company was organized, or by a State statute, as
constituting or representing real property or an interest in real
property.
(ii) Licenses and permits. A license, permit, or other similar
right that is solely for the use, enjoyment, or occupation of land or
an inherently permanent structure and that is in the nature of a
leasehold or easement generally is an interest in real property under
this section. However, a license or permit to engage in or operate a
business on real property is not real property or an interest in real
property if the license or permit produces or contributes to the
production of income other than consideration for the use and occupancy
of space.
(6) No inference outside of section 1031. The rules provided in
this section concerning the definition of real property apply only for
purposes of section 1031. No inference is intended with respect to the
classification or characterization of property for other purposes of
the Code, such as depreciation and sections 1245 and 1250. For example,
a structure or a portion of a structure may be section 1245 property
for depreciation purposes and for determining gain under section 1245,
notwithstanding that the structure or the portion of the structure is
real property under this section. Also, a taxpayer transferring
relinquished property that is section 1245 property in a section 1031
exchange is subject to the gain recognition rules under section 1245
and the regulations under section 1245, notwithstanding that the
relinquished property or replacement property is real property under
this section. In addition, the taxpayer must follow the rules of
section 1245 and the regulations under section 1245, and section 1250
and the regulations under section 1250, based on the determination of
the relinquished property and replacement property being, in whole or
in part, section 1245 property or section 1250 property under those
Code sections and not under this section.
(b) Examples. The following examples illustrate the provisions
of this section.
(1) Example 1: Natural products of land. A owns land with
perennial fruit-bearing plants that A harvests annually. The
unsevered plants are natural products of the land within the meaning
of paragraph (a)(3) of this section and thus are real property for
purposes of section 1031. A annually harvests fruit from the plants.
Upon severance from the land, the harvested fruit ceases to be part
of the land and therefore is not real property. Storage of the
harvested fruit upon or within real property does not cause the
harvested fruit to be real property.
(2) Example 2: Water space superjacent to land. B owns a marina
comprised of U-shaped boat slips and end ties. The U-shaped boat
slips are spaces on the water that are surrounded by a dock on three
sides. The end ties are spaces on the water at the end of a slip or
on a long, straight dock. B rents the boat slips and end ties to
boat owners. The boat slips and end ties are water space superjacent
to land and thus are real property within the meaning of paragraph
(a)(1) of this section.
(3) Example 3: Indoor sculpture. (i) C owns an office building
and a large sculpture in the atrium of the building. The sculpture
measures 30 feet tall by 18 feet wide and weighs five tons. The
building was specifically designed to support the sculpture, which
is permanently affixed to the building by supports embedded in the
building's foundation. The sculpture was constructed within the
building. Removal would be costly and time consuming and would
destroy the sculpture. The sculpture is reasonably expected to
remain in the building indefinitely.
(ii) The sculpture is not an inherently permanent structure
listed in paragraph (a)(2)(ii)(C) of this section, and, therefore, C
must use the factors provided in paragraphs (a)(2)(ii)(C)(1) through
(5) of this section to determine whether the sculpture is an
inherently permanent structure. The sculpture--
(A) Is permanently affixed to the building by supports embedded
in the building's foundation;
(B) Is not designed to be removed and is designed to remain in
place indefinitely;
(C) Would be damaged if removed and would damage the building to
which it is affixed; and
(D) Is expected to remain in the building indefinitely; and
(E) Would require significant time and expense to move.
(iii) The factors described in paragraphs (a)(2)(ii)(C)(1)
through (5) of this section all support the conclusion that the
sculpture is an inherently permanent structure within the meaning of
paragraph (a)(2)(ii)(A) of this section. Therefore, the sculpture is
real property.
(4) Example 4: Bus shelters. (i) D owns 400 bus shelters, each
of which consists of four posts, a roof, and panels enclosing two or
three sides. D enters into a long-term lease with a local transit
authority for use of the bus shelters. Each bus shelter is
prefabricated from steel and is bolted to the sidewalk. Bus shelters
are disassembled and moved when bus routes change. Moving a bus
shelter takes less than a day and does not significantly damage
either the bus shelter or the real property to which it was affixed.
(ii) The bus shelters are not permanently affixed enclosed
transportation stations or terminals, are not buildings under
paragraph (a)(2)(ii)(B) of this section, nor are they listed as
types of other inherently permanent structures in paragraph
(a)(2)(ii)(C) of this section. Therefore, the bus shelters must be
analyzed to determine whether they are inherently permanent
structures using the factors provided in paragraphs (a)(2)(ii)(C)(1)
through (5) of this section. The bus shelters--
(A) Are not permanently affixed to the land or an inherently
permanent structure;
(B) Are designed to be removed and not remain in place
indefinitely;
(C) Would not be damaged if removed and would not damage the
sidewalks to which they are affixed;
(D) Will not remain affixed indefinitely; and
(E) Would not require significant time and expense to move.
(iii) The factors described in paragraphs (a)(2)(ii)(C)(1)
through (5) of this section all support the conclusion that the bus
shelters are not inherently permanent structures within the meaning
of paragraph (a)(2)(ii) of this section. Thus, the bus shelters are
not inherently permanent structures within the meaning of paragraph
(a)(2)(ii) of this section and, therefore, are not real property.
(5) Example 5: Industrial 3D Printer. (i) E owns a building that
it uses in its trade or business of manufacturing airplane parts.
The building includes an industrial 3D printer that can print
airplane wings and an electrical generator that serves the building
in a backup capacity. The 3D printer weighs 12 tons and is designed
to remain in place indefinitely once installed in the building. The
3D printer was installed during the building's construction. The
generator also was installed during construction and is designed to
remain in place indefinitely once installed.
(ii) The 3D printer is machinery and, thus, generally not an
inherently permanent structure and not real property under paragraph
(a)(2)(ii)(D) of this section. In addition, although permanently
affixed by virtue of its weight and installed during construction of
E's building, the 3D printer produces income other than for the use
or occupancy of space. Thus, the 3D printer is not property in the
nature of machinery as a structural component within the meaning of
paragraph (a)(2)(ii)(D) of this section and, therefore, is not real
property.
(iii) The electrical generator serves the entire building and
does not generate income
[[Page 35845]]
other than for the use or occupancy of the building. Thus, the
electrical generator is property in the nature of machinery as a
structural component within the meaning of paragraph (a)(2)(ii)(D)
of this section and, therefore, is real property.
(6) Example 6: Generator for Industrial 3D Printer. The facts
are the same as in paragraph (b)(5), Example 5, except that E
installed the electrical generator for the purpose of keeping the
industrial 3D printer operating in the event of a power outage. The
generator, itself machinery, was installed to serve the operation of
machinery and not the building. Thus, the electrical generator is
not a structural component within the meaning of paragraphs
(a)(2)(ii)(D) and (a)(2)(iii)(A) of this section and, therefore, is
not real property.
(7) Example 7: Raised flooring for Industrial 3D Printer. (i)
The facts are the same as in paragraph (b)(5), Example 5, except
that E, when installing its 3D printer, also installed a raised
flooring system for the purpose of facilitating the operation of the
3D printer. The raised flooring system is not designed or
constructed to remain permanently in place. Rather, the raised
flooring system can be removed, without any substantial damage to
the system itself or to the building, and then reused. The raised
flooring was installed during the building's construction.
(ii) The raised flooring system is not integrated into the
building as required by paragraph (a)(2)(iii)(A) of this section
and, therefore, is not listed in paragraph (a)(2)(iii)(B) of this
section. Thus, the raised flooring must be analyzed to determine
whether it is a structural component of E's building (within the
meaning of paragraph (a)(2)(iii) of this section) using the factors
provided in paragraphs (a)(2)(iii)(B)(1) through (4) of this
section. The raised flooring--
(A) Is installed and removed quickly and with little expense;
(B) Is designed to be moved and is not designed specifically for
the particular building of which it is a part;
(C) Is not damaged, and the building is not damaged, upon its
removal; and
(D) Was installed during construction of the building.
(iii) The factors described in paragraphs (a)(2)(iii)(B)(1)
through (4) of this section, considered in the aggregate, support
the conclusion that the raised flooring is not a structural
component of E's building within the meaning of paragraph
(a)(2)(iii) of this section. Although the raised flooring was
installed during construction of the building, that factor does not
outweigh the factors supporting the conclusion that the flooring is
not a structural component. Therefore, the raised flooring is not
real property under this section.
(8) Example 8: Steam Turbine. (i) F owns a building with a large
steam turbine attached as a fixture to the building. The steam
turbine is a component of a system used for the commercial
production of electricity for sale to customers in the ordinary
course of F's business as an electric utility. The steam turbine
also generates electricity for F's building. The steam turbine takes
up a substantial portion of the building and is designed to remain
in place indefinitely once installed in F's building. The steam
turbine was installed during the construction of the building.
(ii) The steam turbine is machinery and, therefore, generally is
not an inherently permanent structure and not real property under
paragraph (a)(2)(ii)(D) of this section. Although the steam turbine
has characteristics of a structural component because it is
permanently affixed, installed during construction of F's building,
and serves F's building, the steam turbine is machinery that
produces income other than for the use or occupancy of space. Thus,
the steam turbine is not an inherently permanent structure within
the meaning of paragraph (a)(2)(ii)(D) of this section and,
therefore, is not real property.
(9) Example 9: Partitions. (i) G owns an office building that it
leases to tenants. The building includes partitions owned by G that
are used to delineate space within the building. The office building
has two types of interior, non-load-bearing drywall partition
systems: a conventional drywall partition system (Conventional
Partition System) and a modular drywall partition system (Modular
Partition System). Neither the Conventional Partition System nor the
Modular Partition System was installed during construction of the
office building. Conventional Partition Systems are comprised of
fully integrated gypsum board partitions, studs, joint tape, and
covering joint compound. Modular Partition Systems are comprised of
assembled panels, studs, tracks, and exposed joints. Both the
Conventional Partition System and the Modular Partition System reach
from the floor to the ceiling. In addition, both are distinct assets
as described in paragraph (a)(4) of this section.
(ii) Depending on the needs of a new tenant, the Conventional
Partition System may remain in place when a tenant vacates the
premises. The Conventional Partition System is integrated into the
office building and is designed and constructed to remain in areas
not subject to reconfiguration or expansion. The Conventional
Partition System can be removed only by demolition, and, once
removed, neither the Conventional Partition System nor its
components can be reused. Removal of the Conventional Partition
System causes substantial damage to the Conventional Partition
System itself, but does not cause substantial damage to the
building.
(iii) Modular Partition Systems are typically removed when a
tenant vacates the premises. Modular Partition Systems are not
designed or constructed to remain permanently in place. Modular
Partition Systems are designed and constructed to be movable. Each
Modular Partition System can be readily removed, remains in
substantially the same condition as before, and can be reused.
Removal of a Modular Partition System does not cause any substantial
damage to the Modular Partition System itself or to the building.
The Modular Partition System may be moved to accommodate the
reconfigurations of the interior space within the office building
for various tenants that occupy the building.
(iv) The Conventional Partition System is comprised of walls
that are integrated into an inherently permanent structure and are
listed as structural components in paragraph (a)(2)(iii)(B) of this
section. Thus, the Conventional Partition System is real property.
(v) The Modular Partition System is not integrated into the
building as required by paragraph (a)(2)(iii)(A) of this section
and, therefore, is not listed in paragraph (a)(2)(iii)(B) of this
section. Thus, the Modular Partition System must be analyzed to
determine whether it is a structural component using the factors
provided in paragraphs (a)(2)(iii)(B)(1) through (4) of this
section. The Modular Partition System--
(A) Is installed and removed quickly and with little expense;
(B) Is designed to be moved and is not designed specifically for
the particular building of which it is a part;
(C) Is not damaged, and the building is not damaged, upon its
removal; and
(D) Was not installed during construction of the building.
(vi) The factors described in paragraphs (a)(2)(iii)(B)(1)
through (4) of this section support the conclusion that the Modular
Partition System is not a structural component of G's building
within the meaning of paragraph (a)(2)(iii) of this section.
Therefore, the Modular Partition System is not real property.
(10) Example 10: Pipeline transmission system. (i) H owns a
natural gas pipeline transmission system that provides a conduit to
transport natural gas from unrelated third-party producers and
gathering facilities to unrelated third-party distributors and end
users. The pipeline transmission system is comprised of underground
pipelines, isolation valves and vents, pressure control and relief
valves, meters, and compressors. Each of these distinct assets was
installed during construction of the pipeline transmission system
and each was designed to remain permanently in place.
(ii) The pipelines are permanently affixed and are listed as
other inherently permanent structures in paragraph (a)(2)(ii)(C) of
this section. Thus, the pipelines are real property.
(iii) Isolation valves and vents are placed at regular intervals
along the pipelines to isolate and evacuate sections of the
pipelines in case there is need for a shut-down or maintenance of
the pipelines. Pressure control and relief valves are installed at
regular intervals along the pipelines to provide overpressure
protection. The isolation valves and vents and pressure control and
relief valves are not listed in paragraph (a)(2)(iii) of this
section and, therefore, must be analyzed to determine whether they
are structural components using the factors provided in paragraphs
(a)(2)(iii)(B)(1) through (4) of this section. The isolation valves
and vents and pressure control and relief valves--
(A) Are time consuming and expensive to install and remove from
the pipelines;
(B) Are designed specifically for the particular pipelines for
which they are a part;
(C) Will sustain damage and will damage the pipelines if
removed; and
(D) Were installed during construction of the pipelines.
[[Page 35846]]
(iv) The factors in paragraphs (a)(2)(iii)(B)(1) through (4) of
this section support the conclusion that the isolation valves and
vents and pressure control and relief valves are structural
components of H's pipelines within the meaning of paragraph
(a)(2)(iii) of this section. Therefore, the isolation valves and
vents and pressure control and relief valves are real property.
(v) Meters are used to measure the natural gas passing into or
out of the pipeline transmission system for purposes of determining
the end users' consumption. Over long distances, pressure is lost
due to friction in the pipeline transmission system. Compressors are
required to add pressure to transport natural gas through the
entirety of the pipeline transmission system. Although the meters
and compressors were installed during the construction of the
pipelines, they are not time consuming and expensive to install and
remove from the pipelines; are not designed specifically for the
particular pipelines for which they are a part; and their removal
does not cause damage to the asset or the pipelines if removed.
Thus, the meters and compressors are not structural components
within the meaning of paragraph (a)(2)(iii) of this section and,
therefore, are not real property.
(11) Example 11: Land use permit. J receives a special use
permit from the government to place a cell tower on Federal
Government land that abuts a Federal highway. Government regulations
provide that the permit is not a lease of the land, but is a permit
to use the land for a cell tower. Under the permit, the government
reserves the right to cancel the permit and compensate J if the site
is needed for a higher public purpose. The permit is in the nature
of a leasehold that allows J to place a cell tower in a specific
location on government land. Therefore, the permit is an interest in
real property under paragraph (a)(5) of this section.
(12) Example 12: License to operate a business. K owns a
building and receives a license from State A to operate a casino in
the building. The license applies only to K's building and cannot be
transferred to another location. K's building is an inherently
permanent structure under paragraph (a)(2)(ii)(A) of this section
and, therefore, is real property. However, K's license to operate a
casino is not a right for the use, enjoyment, or occupation of K's
building, but is rather a license to engage in the business of
operating a casino in the building for the production of income.
Therefore, the casino license is not real property under paragraph
(a)(5) of this section.
(c) Applicability date. This section applies to exchanges of real
property beginning on or after [EFFECTIVE DATE OF THE FINAL RULE].
0
Par. 7. Section 1.1031(k)-1 is amended by:
0
1. Removing ``, and'' at the end of paragraph (g)(7)(i) and adding a
semicolon in its place;
0
2. Removing the period at the end of paragraph (g)(7)(ii) and adding
``; and'' in its place;
0
3. Adding paragraph (g)(7)(iii);
0
4. In paragraph (g)(8), designating Examples 1 through 5 as paragraphs
(g)(8)(i) through (v), respectively;
0
5. Further redesignating newly redesignated paragraphs (g)(8)(i)(i) and
(ii) as paragraphs (g)(8)(i)(A) and (B);
0
6. Further redesignating newly redesignated paragraphs (g)(8)(i)(A)(A)
and (B) as paragraphs (g)(8)(i)(A)(1) and (2), respectively;
0
7. Designating the undesignated paragraph immediately following newly
redesignated paragraph (g)(8)(i)(A)(2) as paragraph (g)(8)(i)(A)(3);
0
8. Further redesignating newly redesignated paragraphs (g)(8)(ii)(i)
through (iii) as paragraphs (g)(8)(ii)(A) through (C);
0
9. Further redesignating newly redesignated paragraphs
(g)(8)(ii)(A)(A) through (C) as paragraphs (g)(8)(ii)(A)(1) through
(3);
0
10. Further redesignating newly redesignated paragraphs
(g)(8)(ii)(A)(1)(1) and (2) as paragraphs (g)(8)(ii)(A)(1)(i) and (ii),
respectively;
0
11. In newly redesignated paragraph (g)(8)(ii)(A)(1)(i), removing ``,
or'' at the end of the paragraph and adding ``; or'' in its place;
0
12. Designating the undesignated paragraph immediately following newly
redesignated paragraph (g)(8)(ii)(A)(3) as paragraph (g)(8)(ii)(A)(4);
and
0
13. Further redesignating newly redesignated paragraphs (g)(8)(iii)(i)
through (v) as paragraphs (g)(8)(iii)(A) through (E), respectively;
0
14. Further redesignating newly redesignated paragraphs (g)(8)(iv)(i)
through (iii) as paragraphs (g)(8)(iv)(A) through (C), respectively;
0
15. Further redesignating newly redesiganted paragraphs (g)(8)(v)(i)
through (iii) as paragraphs (g)(8)(v)(A) through (C), respectively;
0
16. In newly redesiganted paragraph (g)(8)(v)(B), removing
``(g)(4))(i)'' and adding ``(g)(4)(i)'' in its place; and
0
17. Adding paragraphs (g)(8)(vi) and (g)(9).
The additions read as follows:
Sec. 1.1031(k)-1 Treatment of deferred exchanges.
* * * * *
(g) * * *
(7) * * *
(iii) Personal property that is incidental to real property
acquired in an exchange. For purposes of this paragraph (g)(7),
personal property is incidental to real property acquired in an
exchange if--
(A) In standard commercial transactions, the personal property is
typically transferred together with the real property; and
(B) The aggregate fair market value of the incidental personal
property transferred with the real property does not exceed 15 percent
of the aggregate fair market value of the replacement real property.
* * * * *
(8) * * *
* * * * *
(vi) Example 6. (A) In 2020, B transfers to C real property with
a fair market value of $1,100,000 and an adjusted basis of $400,000.
B's replacement property is an office building and, as a part of the
exchange, B also will acquire certain office furniture in the
building that is not real property, which is industry practice in a
transaction of this type. The fair market value of the real property
B will acquire is $1,000,000 and the fair market value of the
personal property is $100,000.
(B) In a standard commercial transaction, the buyer of an office
building typically also acquires some or all of the office furniture
in the building. The fair market value of the personal property B
will acquire does not exceed 15 percent of the fair market value of
the office building B will acquire. Accordingly, under paragraph
(g)(7)(iii) of this section, the personal property is incidental to
the real property in the exchange and is disregarded in determining
whether the taxpayer's rights to receive, pledge, borrow or
otherwise obtain the benefits of money or other property are
expressly limited as provided in paragraph (g)(6) of this section.
Upon the receipt of the personal property, B recognizes gain of
$100,000 under section 1031(b), the lesser of the realized gain on
the disposition of the relinquished property, $700,000, and the fair
market value of the non-like-kind property B acquired in the
exchange, $100,000.
(9) Applicability date. Paragraphs (g)(7)(iii) and (g)(8)(vi) of
this section apply to exchanges beginning on or after [EFFECTIVE DATE
OF THE FINAL RULE].
* * * * *
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2020-11530 Filed 6-11-20; 8:45 am]
BILLING CODE 4830-01-P