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January 12, 2021

IRS releases final IRC Section 1031 like-kind exchange regulations with some changes

The Treasury and IRS released final regulations (TD 9935) (Final Regulations) defining real property for the purpose of like-kind exchanges under IRC Section 1031. The Final Regulations depart from the Proposed Regulations by (1) allowing state and local laws to be used in defining real property and (2) eliminating the consideration whether tangible or intangible property contributes to the production of income related to the use or occupancy of space (purpose or use test).

The Final Regulations apply to exchanges beginning on or after the date they are published in the Federal Register (December 2, 2020).


As most recently amended under the Tax Cuts and Jobs Act (TCJA), IRC Section 1031(a) states the general rule that no gain or loss is recognized on the exchange of "real property" held for productive use in a trade or business or held for investment. If money or other non-like-kind property (e.g., personal property) is received in the exchange, IRC Section 1031(b) clarifies that gain is recognized to the extent of the money and the fair market value of the non-like-kind property received, up to the realized gain from the transfer of the real property.

Before amendment by the TCJA, IRC Section 1031 also applied to exchanges of tangible personal property and certain intangible personal property. TCJA modified IRC Section 1031 by limiting its application solely to exchanges of real property, effective for exchanges completed after December 31, 2017 (with a transition rule). As a result of the amendment, the determination of whether property constitutes real property, as contrasted with personal or intangible property, has taken on greater importance. Previously, neither IRC Section 1031 nor the existing regulations defined real property for IRC Section 1031 purposes.

Proposed regulations

The Proposed Regulations provided a comprehensive definition of "real property" for IRC Section 1031 purposes (see Tax Alert 2020-1573).

As part of the definition, the Proposed Regulations stated that state and local law definitions were not controlling for purposes of determining whether an item constituted real property, except for determining whether shares in a mutual ditch, reservoir or irrigation company qualify as real property.

The Proposed Regulations also stated that property that is in the nature of machinery or is essentially an item of machinery or equipment is not an inherently permanent structure and thus, not real property, unless it qualifies as a structural component of an inherently permanent structure.

Final regulations

The Final Regulations make two main changes from the Proposed Regulations:

  • Property is classified as real property under IRC Section 1031 if, on the date of the exchange, the property is defined as real property under the law of the state or local jurisdiction in which that property is located.
  • The "purpose or use test" is eliminated for both tangible and intangible properties.

State and local law

Under the Final Regulations, property is classified as real property for purposes of IRC Section 1031 if the property is:

  • Classified as such under the state and local law where the property is located, subject to certain exceptions
  • Specifically listed as real property in the Final Regulations


  • Considered real property based on all the facts and circumstances under the factors in the Final Regulations

The Preamble to the Final Regulations stated that the Proposed Regulations had carved out shares in a mutual ditch, reservoir or irrigation company as the only type of real property to be defined by state or local law because this was the example set forth in the Conference Report to the TCJA amendments to IRC Section 1031. Responding to comments that this was merely one example, and state and local law definitions of real property were often determinative in whether the property qualified as real or personal property under IRC Section 1031, the Treasury and IRS changed the Final Regulations to encompass all state and local law determinations, with certain restrictions. The Final Regulations, however, continue to exclude real property that was ineligible before the TCJA, such as the intangible assets listed in IRC Section 1031(a)(2).

Purpose or use test

The Final Regulations eliminated the "purpose or use test" for tangible property. Under the Final Regulations, property qualifies as an inherently permanent structure and thus real property for IRC Section 1031 purposes if (1) it is permanently affixed to real property and (2) will ordinarily remain affixed indefinitely, regardless of the purpose or use of the property or whether it contributes to the production of income.

Incidental-property rule

Most exchanges of real property involve deferred exchanges that are facilitated through the assistance of a qualified intermediary (QI) and structured to satisfy the QI safe harbor of Treas. Reg. Section 1.1031(k)-1(g)(4). If an exchange satisfies the QI safe harbor, the QI is not treated as an agent of the taxpayer and the taxpayer is not considered in constructive receipt of the exchange funds (i.e., the proceeds from the disposition of the relinquished property) held by the QI — events that would otherwise result in the exchange being treated as a taxable sale.

The QI safe harbor requires that the taxpayer's exchange agreement with the QI expressly "limit the taxpayer's rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property held by the QI" as provided in Treas. Reg. Section 1.1031(k)-1(g)(6), which generally restricts the taxpayer's rights until the end of the 180-day exchange period (with certain exceptions). Treas. Reg. Section 1.1031(k)-1(g)(7) disregards the receipt of certain described items (e.g., prorated rents and property taxes) in determining whether an exchange satisfies Treas. Reg. Section 1.1031(k)-1(g)(6).

The Final Regulations clarify that the receipt of certain incidental personal property will not violate the QI safe harbor. Specifically, the Final Regulations revise Treas. Reg. Section 1.1031(k)-1(g)(7) to add "[p]ersonal property generally resulting in gain recognition under [IRC S]ection 1031(b) that is incidental to real property acquired in an exchange" to the list of items that are disregarded in determining whether an exchange satisfies Treas. Reg. Section 1.1031(k)-1(g)(6). This proposed revision could also protect a taxpayer from potentially violating the qualified escrow account and qualified trust safe harbors of Treas. Reg. Section 1.1031(k)-1(g)(3).

For these purposes, the Final Regulations did not change the Proposed Regulations' treatment of the receipt of personal property that is incidental to the taxpayer's replacement real property in an exchange (the incidental-property rule). Under the Final Regulations, personal property is treated as incidental if: (1) the personal property is typically transferred with the real property in standard commercial transactions and (2) the aggregate fair market value of the incidental personal property transferred with the real property does not exceed 15% of the aggregate fair market value of the replacement real property.


The Final Regulations are important because they reduce uncertainties under existing law by providing a framework for determining whether a particular property (or component thereof) constitutes real property for purposes of IRC Section 1031. In contrast to the Proposed Regulations, the Final Regulations make it clear that local law is one of the factors in determining whether property is real property for IRC Section 1031 purposes.

In addition, the definition of real property is similar (but not identical) to the definition of real property applicable to real estate investment trusts (REITs) in Treas. Reg. Section 1.856-10, which was published in August 2016.

Finally, the retention of the Proposed Regulations' language that receiving certain incidental personal property in an exchange will not violate the QI safe harbor in Treas. Reg. Section 1.1031(k)-1(g)(4) is welcome news for taxpayers. Taxpayers should recall, however, that the receipt of such personal property will result in taxable "boot" treatment in the exchange and thus, depending on the circumstances, will either trigger taxable gain dollar-for-dollar in regards to the relinquished real property, up to the realized gain, or will be treated as taxable consideration received for other non-like-kind property disposed of in the exchange.


Contact Information
For additional information concerning this Alert, please contact:
Real Estate Group
   • Mark Fisher (
   • Glenn Johnson (
   • Annet M. Thomas (
   • Andrea Whiteway (