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Final 1031 Regulations Provide Much Needed Guidance

By JOHN BLAKE, CPA

December 29, 2020

The impact of the COVID-19 pandemic continues to reverberate across the nation. Many businesses have been forced to make changes to operations, product/service offerings, vendors, financing, and capital investments. The real estate industry has been especially impacted as businesses have shifted to a remote workforce, and consumers have turned to online shopping. The change has led to a reduction in demand for both retail and commercial real estate. In New Jersey, Class A retail rent has dropped $.47 per square foot while commercial rents are falling with subleases on the rise. The sharp changes have prompted many real estate companies to diversify holdings. Yet, a key challenge is how to manage the tax implications associated with large transactions?

Princeton and the surrounding area, including Hamilton and Trenton, have relied on 1031 like-kind exchanges as a powerful method for deferring gains for years. However, the Tax Cuts and Jobs Act (tax reform) changed the rules, only allowing real property to be eligible. The inconsistencies in the tax code and lack of guidance forced many to explore other options. The good news is the IRS issued 1031 final regulations, which provides long-awaited guidance.

Final Regulations for 1031 Exchanges

The most significant change in the final regulations concerns the definition of real property. Since there are different definitions, the real estate industry had difficulty consistently interpreting the rules of what qualified for a 1031 exchange. Now, the rules are clear. The final regulations also provide information on how to treat structural components attached to real property.

Real property eligible for like-kind exchanges include the following:

  • Land – This includes water and air space superjacent to the land.
  • Inherently Permanent Structures – This includes buildings, houses, apartments, hotels, warehouses or barns, parking garages, pools, fences, outdoor lighting, and oil and gas pipelines, among other permanent structures.
  • Structural Components (also a type of improvement to land) – The regulations define these as a distinct asset if integral to an inherently permanent structure. It only qualifies as real property if it cannot be separated from the permanent structure’s physical space.
  • Unsevered Crops – Examples include crops, plants, timber, mines, wells, and other natural deposits. It is important to note these items are disqualified if they are removed from the land.
  • Certain Intangible Property – This includes some licensing agreements. To qualify, the intangible property cannot contribute to income other than to grant ownership of a space. This includes fee ownership or co-ownership, a leasehold, the option to acquire real property, easement, or other similar interest.
  • Other Real Property – The regulations allow for shares in mutual ditches, reservoir, or irrigation businesses if the company’s headquartered state recognizes such shares as real property.

Structural Components – Guidance

To determine if a structural component qualifies for a 1031 exchange, evaluate the asset against the following:

  • Whether it is designed to be removed or to stay in place.
  • How the asset is affixed to the property.
  • How much damage would be caused to the property or the asset if the asset were removed.
  • Any circumstances that may suggest the period for the attached asset is limited.
  • Time and expense required to move the asset.

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The final regulations provide the lacking guidance that had been deterring many from leveraging like-kind exchanges. Since the new rules are quite involved, it is important to consult with a knowledgeable tax advisor to guide you through the process. If you have questions about the information outlined above or need assistance with tax structuring on your next transaction, Klatzkin can help. For additional information, click here to contact us. We look forward to speaking with you soon.

©2020 Klatzkin & Company LLP. The above represents our best understanding and interpretation of the material covered as of this post’s date and should not be construed as accounting, tax, or financial advice. Please consult your tax advisor concerning your specific situation.

About the Author

John focuses on helping with the tax needs of real estate, technology and manufacturing, distribution, and wholesale companies. He works with management and business owners to review their business plan, tax planning process, identify additional saving opportunities, and ensure compliance and reporting deadlines are met. Also, John helps educate clients about the new opportunities available...

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