Statutory Limitations on Like-Kind Exchanges, 77365-77383 [2020-26313]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 85, Number 232 (Wednesday, December 2, 2020)]
[Rules and Regulations]
[Pages 77365-77383]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-26313]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9935]
RIN 1545-BP02


Statutory Limitations on Like-Kind Exchanges

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations providing guidance 
under section 1031 of the Internal Revenue Code (Code) to implement 
recent statutory changes to that section. More specifically, the final 
regulations amend the current like-kind exchange regulations to add a 
definition of real property to implement statutory changes limiting 
section 1031 treatment to like-kind exchanges of real property. The 
final regulations also provide a rule addressing a taxpayer's receipt 
of personal property that is incidental to real property the taxpayer 
receives in an otherwise qualifying like-kind exchange of real 
property. The final 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 
under section 1031.

DATES: 
    Effective date: These final regulations are effective on December 
2, 2020.
    Applicability dates: These regulations generally apply to exchanges 
beginning after December 2, 2020. See Sec. Sec.  1.1031(a)-1(e)(2), 
1.1031(a)-3(c), and 1.1031(k)-1(g)(9). However, the regulations in 
Sec. Sec.  1.168(i)-1(e)(2)(viii)(A) and 1.168(i)-8(c)(4)(i) apply to 
taxable years beginning after December 2, 2020. See Sec. Sec.  
1.168(i)-1(m)(5) and 1.168(i)-8(j)(5).

FOR FURTHER INFORMATION CONTACT: Edward C. Schwartz at (202) 317-4740, 
or Suzanne R. Sinno at (202) 317-4718 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

I. Overview

    This document amends the Income Tax Regulations (26 CFR part 1, as 
revised April 1, 2020) under section 1031 (current regulations). The 
amendments to the current regulations (final regulations) implement 
statutory amendments to section 1031 made by section 13303 of Public 
Law 115-97, 131 Stat. 2054 (2017), 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 final regulations 
limit the application of the like-kind exchange rules under section 
1031 to exchanges of real property, add a definition 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). The legislative history to the TCJA amendments to section 
1031 provides that Congress ``intended that real property eligible for 
like-kind exchange treatment under present law will continue to be 
eligible for like-kind exchange treatment under the [amended] 
provision.'' H.R. Conf. Rept. 115-466, at 396, fn. 726 (2017) 
(Conference Report). However, left unchanged by the TCJA, section 
1031(b) provides that a taxpayer must recognize gain to the extent of 
money and non-like-kind property the taxpayer receives in an exchange.

III. Current Regulations Regarding ``Like Kind''

    The need to determine whether the relinquished real property 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. The 
fact that any real property involved is improved or unimproved is not 
material in determining whether real property is of like kind. Under 
current Sec.  1.1031(a)-1(c), examples of exchanges of real property of 
a like kind include an exchange 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 of like-kind to the 
relinquished property unless, within 45 days after the taxpayer's 
transfer of the relinquished real property, the real property is 
identified as replacement real property to be received in the exchange. 
Current Sec.  1.1031(k)-1(c)(4) provides a limit on the number of 
properties, or the fair market value of the properties, a taxpayer may 
identify to meet the requirements of section 1031(a)(3). However, under 
current Sec.  1.1031(k)-1(c)(5), property is disregarded in evaluating 
the identification rules if it is incidental to a larger item of 
property and therefore, is not treated as property separate from the 
larger item. Property is incidental to a larger property 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) and (2), if a taxpayer 
actually or constructively receives money or non-like-kind property for 
the relinquished property before the taxpayer receives like-kind 
replacement real property, the transaction is a sale or taxable 
exchange and not a like-kind 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 
results in a taxpayer not being considered in actual or constructive 
receipt of the consideration for the relinquished 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 determination of whether the taxpayer is in actual or 
constructive receipt of money or non-like-kind 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 the agreement 
between the taxpayer and the qualified intermediary

[[Page 77366]]

expressly limits the taxpayer's rights to receive, pledge, borrow, or 
otherwise obtain the benefits of money or non-like-kind property held 
by the qualified intermediary. Current Sec.  1.1031(k)-1(g)(7) lists 
items received in an exchange that are disregarded in determining 
whether a taxpayer's rights to receive, pledge, borrow, or otherwise 
obtain the benefits of money or non-like-kind property are expressly 
limited.

VI. Proposed Regulations

    On June 12, 2020, the Department of the Treasury (Treasury 
Department) and the IRS published a notice of proposed rulemaking (REG-
117589-18) in the Federal Register (85 FR 35835) containing proposed 
regulations under section 1031 (proposed regulations). The Treasury 
Department and the IRS received 21 written comments in response to the 
notice of proposed rulemaking. All comments were considered and are 
available at https://www.regulations.gov or upon request. A public 
hearing on the proposed regulations was neither requested nor held. 
After full consideration of the comments received, this Treasury 
decision adopts the proposed regulations with modifications in response 
to such comments, as described in the Summary of Comments and 
Explanation of Revisions following this Background.

Summary of Comments and Explanation of Revisions

I. Overview

    The final regulations retain the basic approach and structure of 
the proposed regulations, with certain revisions. In particular, the 
final regulations revise the definition of ``real property'' in the 
proposed regulations to provide that property is classified as real 
property for section 1031 purposes if, on the date it is transferred in 
an exchange, the property is real property under the law of the State 
or local jurisdiction in which that property is located. The final 
regulations also revise the proposed definition of real property to 
eliminate, with regard to both tangible and intangible properties, any 
consideration of whether the particular property contributes to the 
production of income unrelated to the use or occupancy of space 
(referred to as the ``purpose or use test,'' as defined in part II.B.1 
of this Summary of Comments and Explanation of Revisions). Finally, in 
Sec.  1.1031(a)-3(a)(7), the final regulations retain the language of 
the proposed regulations clarifying that the rules of these final 
regulations apply only for purposes of section 1031, and that no 
inference is intended with respect to the classification or 
characterization of property for other purposes of the Code.

II. Definition of Real Property

A. State or Local Law Definitions of Real Property

1. Approach of the Proposed Regulations
    Section 1031 does not provide a definition for the term ``real 
property.'' As noted in part II of the Background section, the 
Conference Report provides that Congress intended real property that 
was eligible for like-kind exchange treatment prior to the enactment of 
the TCJA to continue to be eligible for like-kind exchange treatment 
after its enactment. See Conference Report, at 396, fn. 726. 
Specifically, with regard to the applicability of State law for real 
property determinations, the Conference Report sets forth the following 
example: ``a like-kind exchange of real property includes an exchange 
of shares in a mutual ditch, reservoir, or irrigation company described 
in section 501(c)(12)(A) [of the Code] if at the time of the exchange 
such shares have been recognized by the highest court or statute of the 
State in which the company is organized as constituting or representing 
real property or an interest in real property'' (Conference Report 
Example). Id. Accordingly, due to the absence of a statutory definition 
for the term ``real property'' in section 1031, the Treasury Department 
and the IRS based the proposed definition of real property upon the 
Conference Report Example.
    Under proposed Sec.  1.1031(a)-3(a)(1), State law controls whether 
shares in a mutual ditch, reservoir, or irrigation company are real 
property for purposes of section 1031. Aside from those enumerated 
asset types, the proposed regulations provide that State or local law 
definitions were not controlling for purposes of determining whether 
property is real property for section 1031 purposes. See proposed Sec.  
1.1031(a)-3(a)(1). The intent of the Treasury Department and the IRS in 
proposing a rule that expressly applied State or local law in this 
manner was to provide a definition of real property for purposes of 
section 1031 ``in a manner consistent with the scope described by 
Congress in the Conference Report.'' See the preamble to the proposed 
regulations at 85 FR 35836.
2. Consideration of Comments and Revision of ``Real Property'' 
Definition
    Commenters generally critiqued the apparent scope of the 
application of State and local law in the proposed regulations for 
purposes of defining real property. These commenters contended that, 
prior to enactment of the TCJA, State and local law classification of a 
property often was the determining factor in characterizing property as 
real or personal under section 1031. With regard to the Conference 
Report Example, the commenters asserted that the reference to ``shares 
in a mutual ditch, reservoir, or irrigation company'' merely 
constituted a set of examples that Congress provided to broadly 
indicate that real property eligible for like-kind treatment under law 
prior to enactment of the TCJA will continue to be eligible following 
the TCJA's amendment to section 1031. Consequently, the commenters 
recommended that the final regulations conform to that intent by 
expanding the rules to rely significantly, or wholly, on State-law 
classifications for all assets, rather than limiting such reliance to 
shares in a mutual ditch, reservoir, or irrigation company. 
Additionally, commenters suggested that the final regulations should 
include multiple examples of instances in which taxpayers may rely on 
State or local law for purposes of classifying property as real or 
personal.
    In light of these comments, the Treasury Department and the IRS 
have reconsidered the degree to which State or local law determinations 
of real property should be controlling for defining real property for 
section 1031 purposes. As a result of that reconsideration, the final 
regulations provide generally that property is real property for 
purposes of section 1031 if, on the date it is transferred in an 
exchange, that property is classified as real property under the law of 
the State or local jurisdiction in which that property is located 
(State and local law test). The State and local law test applies to 
both tangible and intangible property classifications.
    However, consistent with Congressional intent that ``real property 
eligible for like-kind exchange treatment'' under the law in effect 
prior to enactment of the TCJA will continue to be eligible for like-
kind exchange treatment after enactment of the TCJA, property 
ineligible for like-kind exchange treatment prior to enactment of the 
TCJA remains ineligible, including real property that was excluded from 
the application of section 1031. See Conference Report at 396, fn. 726. 
Prior to amendment by the TCJA, former section 1031(a)(2) explicitly 
excluded certain assets from the application of section 1031. 
Accordingly, the final regulations exclude from the definition of real

[[Page 77367]]

property the intangible assets listed in section 1031(a)(2) prior to 
its amendment by the TCJA, regardless of the classification of the 
property under State or local law, because such property never was 
``real property eligible for like-kind exchange treatment'' prior to 
enactment of the TCJA. Conference Report at 396, fn. 726 (emphasis 
added).
    In summary, under the final regulations, property is classified as 
real property for purposes of section 1031 if the property is (i) so 
classified under the State and local law test, subject to certain 
exceptions, (ii) specifically listed as real property in the final 
regulations, or (iii) considered real property based on all the facts 
and circumstances under the various factors provided in the final 
regulations. A determination that property is personal property under 
State or local law does not preclude the conclusion that property is 
real property as specifically listed in Sec.  1.1031(a)-3(a)(2)(ii) or 
(a)(2)(iii)(B) or under the factors listed in Sec.  1.1031(a)-
3(a)(2)(ii)(C) or (a)(2)(iii)(B).
3. Chief Counsel Advice (CCA) 201238027
    Multiple commenters who objected to the scope of State and local 
law determinations under the proposed regulations also asserted that 
the approach in the proposed regulations replicated the analysis in CCA 
201238027 (April 17, 2012), particularly with regard to one of the fact 
patterns addressed therein regarding a steam turbine (Case 3). In Case 
3, the Chief Counsel Advice disregarded State law that characterized 
the steam turbine as real property and held that the steam turbine was 
not of like kind to land because it did not have the same nature or 
character as land. Commenters objected to this conclusion, contending 
that the State law classification of the steam turbine as real property 
should be respected and, based on that classification, the steam 
turbine and the undeveloped land should be considered like-kind 
property.
    These final regulations do not address whether exchanged properties 
are of like kind to one another. As a consequence of expressly 
including the State and local law test in the final regulations, the 
final regulations do not adopt the reasoning of CCA 201238027 to the 
extent it suggests that State or local law is disregarded in 
determining whether property is real property under section 1031.
4. Additional Comments Regarding the Application of State and Local Law
    In connection with the State and local law test under the final 
regulations, the Treasury Department and the IRS have considered 
numerous additional comments. For instance, one commenter recommended 
that any asset determined to be essentially the same as an asset 
classified as a real property for purposes of section 1031 also should 
automatically be treated as real property for purposes of section 1031. 
For example, if one asset (Property A) is classified as real property 
under the State or local law of State X, an asset located in a 
different jurisdiction (Property B) that is essentially the same as 
Property A also should be classified as real property for section 1031 
purposes, irrespective of whether Property B is classified as real 
property under (i) the law of the State or local jurisdiction in which 
Property B is located or (ii) the real property definition and factors 
under the proposed regulations.
    The final regulations do not adopt this suggestion. First, the 
Treasury Department and the IRS have determined that the ``essentially 
the same'' standard recommended by the commenter would be difficult for 
taxpayers to apply and the IRS to administer with certainty. In 
addition, the analysis advocated by the commenter is conceptually 
similar to the analysis applied by CCA 201238027, which, based on 
several other comments, the Treasury Department and the IRS have 
determined to be inconsistent with the State and local law test 
provided in the final regulations.
    A commenter also requested that the final regulations classify as 
real property all property that was treated as real property for 
section 1031 purposes at any time between May 22, 2008, and the 
effective date of the TCJA. May 22, 2008, is the effective date of 
former section 1031(i), which treats shares in certain mutual ditch 
companies as real property for section 1031 purposes. The commenter 
reasoned that, because the treatment of mutual ditch company shares has 
been preserved by the proposed regulations following the enactment of 
the TCJA, all property classified as real property as of May 22, 2008, 
also should be classified as real property under the final regulations.
    The final regulations do not adopt the commenter's suggestion. The 
Treasury Department and the IRS have determined that a rule that fixes 
property classifications under State or local laws as of a date certain 
would add complexity as the post-enactment period of the TCJA continues 
to lengthen. Given that the final regulations have broadened the 
applicability of State and local real property classification for 
purposes of section 1031 qualification, the Treasury Department and the 
IRS have determined that the perpetually increasing complexity of such 
a rule would significantly outweigh any potential benefits of the 
commenter's suggestion.

B. Purpose or Use Test

1. Approach of the Proposed Regulations
    Under proposed Sec.  1.1031(a)-3(a)(1), real property includes land 
and improvements to land, and improvements to land include both 
inherently permanent structures and the structural components of 
inherently permanent structures. Inherently permanent structures are 
buildings or other structures that are permanently affixed to real 
property and that will ordinarily remain affixed for an indefinite 
period of time. See proposed Sec.  1.1031(a)-3(a)(2)(ii)(A). A list of 
structures that qualify as buildings or as other inherently permanent 
structures is provided in proposed Sec.  1.1031(a)-3(a)(2)(ii)(B) and 
(C). A structural component is any distinct asset, as defined in the 
proposed regulations, that is a constituent part of, and integrated 
into, an inherently permanent structure. See proposed Sec.  1.1031(a)-
3(a)(2)(iii)(A). Proposed Sec.  1.1031(a)-3(a)(2)(iii)(B) provides 
examples of items that are structural components under section 1031.
    The proposed regulations also consider the function of property in 
determining whether the property is real property for section 1031 
purposes (purpose or use test). In particular, neither tangible 
property, such as machinery or equipment, nor intangible property, such 
as licenses or permits, is classified as real property under the 
proposed regulations if the property contributes to the production of 
income unrelated to the use or occupancy of space, irrespective of any 
other factor under the proposed regulations. See proposed Sec. Sec.  
1.1031(a)-3(a)(2)(ii)(D) (regarding machinery and equipment) and 
1.1031(a)-3(a)(5) (regarding intangible property). For example, a gas 
line installed for the sole purpose of providing fuel to fryers and 
ovens in a restaurant is not a constituent part of an inherently 
permanent structure and therefore not real property under the proposed 
regulations. See also proposed Sec.  1.1031(a)-3(b)(12) (providing a 
similar

[[Page 77368]]

example with regard to a license to operate a casino business, which is 
an intangible property). The proposed regulations requested comments on 
whether the purpose or use test is appropriate to use as the basis for 
determining whether property qualifies as real property for section 
1031 purposes.
2. Summary of Comments Received
    Commenters uniformly disagreed with the purpose or use test and 
advocated that it be omitted from the final regulations. According to 
these commenters, the purpose or use test improperly narrows the scope 
of the definition of real property for section 1031 purposes and, if 
adopted in the final regulations, would treat certain types of property 
that have historically been treated as real property for section 1031 
purposes as personal property contrary to the directive of Congress in 
the Conference Report. See Conference Report, at 396, fn. 726.
    In addition, commenters contend that machinery and equipment should 
not be disqualified as an inherently permanent structure, and thus as 
real property, merely because the machinery or equipment is used in the 
production of income unrelated to use or occupancy of space. Instead, 
the commenters asserted that if such property is inherently permanent, 
the property should be treated as real property for purposes of section 
1031, regardless of its purpose or use or the type of income it 
generates. Therefore, according to the commenters, permanently affixed 
items such as gas lines, cooling units, and piping should be treated as 
real property without regard to whether those items comprise part of an 
income-generating structure. The commenters also recommended that the 
final regulations provide revised examples to reflect the position that 
the real property characterization of a particular asset is based on 
the degree to which the item is permanently affixed and not on its 
purpose and use.
    One commenter also emphasized that the purpose or use test would 
prove burdensome for small businesses and individual taxpayers because 
that test would require them to expend resources on cost segregation 
studies to determine which items of machinery and equipment are 
personal and which are real property. According to the commenter, such 
expenses would be eliminated if real property determinations are based 
on permanent affixation and not purpose or use. Finally, the commenter 
noted that inclusion of the purpose or use test in the final 
regulations would be problematic because neither section 1031 nor the 
regulations under section 1031 provide a definition of machinery. 
However, the term ``machinery'' is not necessary if, as this commenter 
recommended, real property determinations for an asset are based on the 
degree to which the asset is permanently affixed and not its purpose or 
use.
3. Elimination of Proposed Purpose or Use Test
    The Treasury Department and the IRS agree with the commenters and 
have revised the final regulations to eliminate a purpose or use test 
for tangible property. Consequently, with regard to tangible property, 
if such property is permanently affixed to real property and will 
ordinarily remain affixed for an indefinite period of time, the 
property is generally an inherently permanent structure and thus real 
property for section 1031 purposes, irrespective of the purpose or use 
of the property or whether it contributes to the production of income. 
A structural component likewise is characterized as real property under 
the final regulations if it is integrated into an inherently permanent 
structure, regardless of whether the structural component contributes 
to the production of income. Accordingly, under the final regulations, 
items of machinery and equipment are characterized as real property if 
they comprise an inherently permanent structure, a structural 
component, or are real property under the State or local law test.
    The Treasury Department and the IRS received no comments regarding 
the application of the proposed purpose or use test to real property 
classifications of intangible property. However, the Treasury 
Department and the IRS have determined that many of the comments 
pertaining to the purpose or use test with regard to tangible property 
equally apply to classifications of intangible property. As a result, 
under the final regulations, whether intangible property produces or 
contributes to the production of income other than consideration for 
the use or occupancy of space is not considered in determining whether 
intangible property is real property for section 1031 purposes. 
However, the purpose of the intangible property remains relevant to the 
real property determination.

C. Revisions to the Definition of Inherently Permanent Structure

    Proposed Sec.  1.1031(a)-3(a)(2)(ii)(A) defines the term 
``inherently permanent structures'' to mean ``any building or other 
structure that is a distinct asset (within the meaning of [proposed 
Sec.  1.1031(a)-3(a)(4)]) and is permanently affixed to real property 
and that will ordinarily remain affixed for an indefinite period of 
time.'' One commenter highlighted that the proposed regulations do not 
define the phrases ``permanently affixed'' or ``indefinite period of 
time'' for purposes of defining ``inherently permanent structure,'' 
other than providing that affixation to real property may be 
accomplished by weight alone. See proposed Sec.  1.1031(a)-
3(a)(2)(ii)(C). The commenter noted that Sec.  1.856-10(d)(2)(i) 
provides that, ``[i]f the affixation is reasonably expected to last 
indefinitely based on all the facts and circumstances, the affixation 
is considered permanent.'' As a result, the commenter recommended that 
the final regulations clarify the meaning of these terms, including by 
adding the above-quoted language in Sec.  1.856-10 to explain the 
phrase ``permanently affixed.''
    The Treasury Department and the IRS agree with the commenter's 
suggestion to incorporate the language provided in Sec.  1.856-
10(d)(2)(i) to provide additional clarity regarding the meaning of 
``permanently affixed'' and have revised the final regulations 
accordingly.

D. Comments Regarding Offshore Platforms and Pipelines, and Related 
Example

    Proposed Sec.  1.1031(a)-3(a)(2)(ii)(C) specifically lists offshore 
drilling platforms and oil and gas pipelines as inherently permanent 
structures, and therefore such property is defined as real property. 
The proposed regulations also provide an example addressing a pipeline 
transmission system comprised of underground pipelines, isolation 
valves and vents, pressure control and relief valves, meters, and 
compressors. See proposed Sec.  1.1031(a)-3(b)(10) (Example 10). 
Example 10 concludes that the meters and compressors are not real 
property because (i) they are not time consuming and expensive to 
install and remove from the pipelines, (ii) they are not designed 
specifically for the particular pipelines for which they are a part, 
and (iii) their removal does not cause damage to the asset or the 
pipelines if removed. Based on the same analysis, Example 10 concludes 
that isolation valves and vents, and pressure control and relief valves 
are real property for section 1031 purposes.
    One commenter suggested that the final regulations should remove 
the adjective ``drilling'' from ``offshore drilling platform'' as 
listed as an inherently permanent structure in proposed Sec.  
1.1031(a)-3(a)(2)(ii)(C). For support, the commenter stated that an

[[Page 77369]]

offshore platform used for production is structurally similar to an 
offshore platform used for drilling, and therefore the term should be 
appropriately broadened. As so modified, the term ``offshore platform'' 
would cover both offshore drilling platforms and offshore production 
platforms.
    The commenter also provided additional recommendations regarding 
assets used in an oil and gas business. For example, the commenter 
suggested that the final regulations should explicitly provide that 
underground and above-ground pipelines are real property for section 
1031 purposes. The commenter recommended that the final regulations 
characterize meters and compressors as real property. In contending 
that Example 10 provided an incorrect conclusion, the commenter 
explained that meters and compressors generally require substantial 
amounts of time and money to prepare, construct, and place in service 
due to unique circumstances affecting individual pipelines.
    The Treasury Department and the IRS have clarified the final 
regulations based on the commenter's recommendations. As an initial 
matter, the final regulations delete ``drilling'' from the term 
``offshore drilling platform,'' as listed in proposed Sec.  1.1031(a)-
3(a)(2)(ii)(C). The Treasury Department and the IRS agree that an 
offshore platform used for production likewise should be characterized 
as an inherently permanent structure because such property is 
structurally similar to an offshore platform used for drilling.
    In addition, the final regulations contain a revised version of 
Example 10, renumbered as Example 9, to clarify the analysis and 
conclusions in the proposed example. With regard to an above-ground 
pipeline, an oil and gas pipeline is listed property in proposed Sec.  
1.1031(a)-3(a)(2)(ii)(C) and is therefore real property, regardless of 
whether above or below ground. Whether particular meters or compressors 
are real property must be determined by their unique facts and 
circumstances. If under different circumstances the meters or 
compressors described in proposed Example 10, now Example 9, required 
substantial amounts of time and money to prepare, construct, and place 
in service due to unique circumstances affecting individual pipelines, 
the components would be real property for section 1031 purposes. 
Example 9 in the final regulations illustrates these rules.

E. Requests To List Additional Tangible Assets as Real Property

1. Installed Appliances
    One commenter requested that the final regulations expressly list 
as real property installed appliances (also referred to as ``appliances 
in place''), including refrigerators, stoves, dishwashers, and 
microwave ovens. The commenter explained that, in certain regions of 
the United States, residential real property generally is sold with the 
appliances in place as part of the sale. The commenter further stated 
that, in many like-kind exchanges of one-family rental properties, 
sellers (i) consider the appliances, furniture, and electrical fixtures 
remaining in the property to be part of the real property transaction, 
and (ii) count such items of property towards the amount of replacement 
property that must be acquired to avoid gain recognition under section 
1031.
2. Sheds and Carports
    One commenter recommended adding sheds and carports to the list of 
assets that are expressly included as buildings in proposed Sec.  
1.1031(a)-3(a)(2)(ii)(B). The commenter contended that such structures 
generally take the form of buildings and, therefore, a specific listing 
as a building under the final regulations would increase certainty 
regarding exchanges involving such assets.
3. Wi-Fi Systems
    Another commenter suggested that proposed Sec.  1.1031(a)-
3(a)(2)(iii)(A) be revised to specifically list as structural 
components Wi-Fi systems, distributed antenna systems, and other 
integrated systems that may be installed in buildings to transmit and 
receive wireless signals and cellular service. The commenter asserted 
that such integrated systems are installed in buildings and inherently 
permanent structures, and often are as essential to the use of 
buildings as heating and electricity. Additionally, the commenter 
emphasized that such integrated systems generally require that the 
taxpayer hold a real property interest in conjunction with its 
installation of the system, and therefore should satisfy the definition 
of a structural component under the proposed regulations.
4. Trade Fixtures
    One commenter recommended that ``trade fixtures'' be expressly 
listed as real property under the final regulations. The commenter 
noted that such items are semi-permanently affixed to real property and 
perform or support the performance of functions (including 
manufacturing, cooking, and decorative lighting) unrelated to basic 
building functions. Additionally, the commenter asserted that trade 
fixtures have historically been treated as real property for State law 
purposes, except in instances in which there is a plan to remove or 
relocate them to a different property.
5. Final Regulations Do Not Specifically List the Requested Items as 
Real Property
    After consideration of the commenters' recommendations, the 
Treasury Department and the IRS have determined that the final 
regulations should not specifically list any of these suggested assets 
as real property for purposes of section 1031. The final regulations 
are intended to provide tests under which taxpayers can evaluate the 
particular facts and circumstances of the property in question to 
determine with certainty whether particular property is characterized 
as real or personal property. To limit complexity of the final 
regulations, the characterization of the above-listed items in this 
part II.E is most appropriately determined based on the application of 
the State and local law test or the various factors in the final 
regulations.
    Specifically, with regard to installed appliances, whether a seller 
considers an item transferred with real property to be part of the real 
property transaction is not a relevant factor in determining whether 
the item is real property for section 1031 purposes. Movable items, 
such as furniture, are personal property irrespective of the terms of 
the sales contract for the real property that is the subject of the 
sale. Those items, however, may be incidental personal property that, 
under the final regulations, is disregarded in determining whether a 
taxpayer's rights to receive, pledge, borrow, or otherwise obtain the 
benefits of money or non-like-kind property held by a qualified 
intermediary are expressly limited as provided in Sec.  1.1031(k)-
1(g)(6).

F. Requested Clarifications Regarding Carpeting and Wiring

    One commenter requested clarification regarding whether carpeting 
in an office building, or other real property held for productive use 
in a trade or business or for investment, is considered real property 
or personal property under the final regulations. Another commenter 
inquired whether wires installed within the walls of an office building 
are real property for section 1031 purposes if the wires were installed 
specifically for computer workstations that produce income for

[[Page 77370]]

the business. The commenter acknowledged that the proposed regulations 
provide that wiring is a structural component, and therefore real 
property for purposes of section 1031, provided the wiring is a 
constituent part of, and integrated into, an inherently permanent 
structure.
    The Treasury Department and the IRS appreciate the commenters' 
requests for clarification regarding the qualification of carpeting and 
wiring as inherently permanent structures or structural components. 
However, such qualification would be dependent upon a facts-and-
circumstances analysis unique to the specific carpeting or wiring, as 
well as the classification of such items under applicable State or 
local law. As a result, the final regulations do not adopt the 
commenters' suggestions, but instruct taxpayers to apply the State and 
local law test or the various factors in the final regulations.

G. Requests To List Additional Intangible Assets as Real Property

1. Stock in a Cooperative Housing Corporation
    The proposed regulations provide that an interest in real property, 
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. See proposed Sec.  1.1031(a)-
3(a)(1). One commenter suggested that this list of items be revised to 
include stock held by a person as a tenant-stockholder in a cooperative 
housing corporation. The commenter noted that the term ``interests in 
real property'' for purposes of regulations regarding real estate 
investment trusts (REITs) includes stock held by a person as a tenant-
stockholder in a cooperative housing corporation. See Sec.  1.856-3(c).
2. Development Rights
    One commenter requested that rights to develop land be expressly 
listed as real property in final Sec.  1.1031(a)-3(a)(1). For support, 
the commenter emphasized that the IRS has published a private letter 
ruling that an exchange of a fee interest in real estate for 
development rights in real estate qualified as a like-kind exchange 
under section 1031. Accordingly, the commenter concluded that 
development rights should be specifically listed as real property in 
the final regulations.
3. Final Regulations Expressly List the Requested Items as Real 
Property
    The Treasury Department and the IRS agree with the commenters' 
recommendations regarding stock in a cooperative housing corporation 
and land development rights. The intangible assets described in this 
part II.G have historically been characterized as real property. 
Accordingly, the final regulations have been revised to expressly list 
those intangible assets.
4. Licenses and Permits
    Under the proposed regulations, 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 
section 1031. See proposed Sec.  1.1031(a)-3(a)(5)(ii). One commenter 
contended that this language is too restrictive because it addresses 
only leaseholds and easements.
    In response to this comment, the final regulations provide that 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, an easement, or a similar 
right generally is an interest in real property and thus is real 
property under section 1031.

H. Requested Clarifications Regarding Easements and Leaseholds

    Proposed Sec.  1.1031(a)-3(a)(5)(ii) provides that 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.'' One commenter requested that final Sec.  1.1031(a)-
3(a)(5)(ii) add the word ``perpetual'' or ``permanent'' before 
``easement'' to communicate that an easement must have a term exceeding 
30 years as of the date of the exchange to be consistent with Sec.  
1.1031(a)-1(c). Under that regulation, examples of exchanges of real 
property of a like kind include an exchange of a leasehold interest in 
a fee with a term of 30 years or more to run for real estate.
    On this aspect of easements and leaseholds, however, the comments 
received were not uniform. For example, another commenter requested 
that final Sec.  1.1031(a)-3(a)(5)(ii) specify that leaseholds or 
easements of any duration are an interest in real property under 
section 1031. As a conforming revision, the commenter also recommended 
that the final regulations remove the reference in Sec.  1.1031(a)-1(c) 
to leaseholds with 30 years or more to run to provide parity among all 
interests in real property eligible for like-kind exchanges under 
section 1031. In addition, a separate commenter recommended that the 
final regulations clarify whether a leasehold interest in real property 
must have, as of the date of the exchange, a remaining term of at least 
30 years or more in order to qualify as an interest in real property.
    The Treasury Department and the IRS note, as an initial matter, 
that the proposed and final regulations address solely the 
qualification of an asset as real property for section 1031 purposes, 
and do not specifically address whether an exchange is like kind. 
Duration of an easement or a leasehold is not relevant in determining 
whether the easement or leasehold is real property under Sec.  
1.1031(a)-3(a)(5), and therefore, proposed Sec.  1.1031(a)-3(a)(5)(ii) 
did not include a reference to duration. The commenters, however, 
correctly note that duration may be relevant under Sec.  1.1031(a)-1(c) 
for purposes of determining whether an exchange of an easement or 
leasehold for real property would qualify as like kind. Because like-
kind determinations exceed the scope of the final regulations, the 
commenters' suggestions and requests for clarification regarding like-
kind determinations are not incorporated into these final regulations.

I. Applicability of Distinct Asset Test to Three-Property Rule in Sec.  
1.1031(k)-1(c)(4)(i)(A)

    The proposed regulations provide that, in general, each distinct 
asset is analyzed separately from each other distinct asset in 
determining whether a distinct asset is real property for section 1031 
purposes. One commenter requested that the final regulations clarify 
that this distinct asset rule does not apply for purposes of Sec.  
1.1031(k)-1(c)(4)(i)(A), which generally limits a taxpayer to the 
identification of three replacement properties (three-property rule). 
In response to the comment, the Treasury Department and the IRS have 
added language to the definition of distinct asset in Sec.  1.1031(a)-
3(a)(4) to clarify that the distinct asset rule applies only for 
purposes of determining whether property is real property for section 
1031 purposes and does not affect the application of the three-property 
rule.

III. Incidental Property Rule

A. Approach of the Proposed Regulations

    Section 1.1031(k)-1(g)(7)(iii) of the proposed regulations 
addresses the receipt of personal property that is incidental to the 
taxpayer's replacement real property in an exchange (incidental 
property rule). The incidental property

[[Page 77371]]

rule provides that, for exchanges involving a qualified intermediary, 
personal property that is incidental to replacement real property 
(incidental personal property) is disregarded in determining whether a 
taxpayer's rights to receive, pledge, borrow, or otherwise obtain the 
benefits of money or non-like-kind property held by the qualified 
intermediary are expressly limited as provided in Sec.  1.1031(k)-
1(g)(6). However, as personal property, incidental personal property is 
non-like-kind property that generally results in gain recognition under 
section 1031(b) on the exchange.
    Personal property is incidental to real property acquired in an 
exchange if (i) in standard commercial transactions, the personal 
property is typically transferred together with the real property, and 
(ii) 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 
(15-percent limitation).

B. Calculation of 15-Percent Limitation

    The Treasury Department and the IRS received several comments 
recommending a change to the calculation of the amount of incidental 
property that a taxpayer may acquire and still meet the requirements of 
the incidental property rule. For example, commenters recommended that 
the value of incidental property under the final regulations be 
permitted to equal up to 15 percent of the total fair market value of 
the replacement real property, as well as the incidental property. For 
support, these commenters highlighted that their suggested 15-percent 
calculation is consistent with sections 856(d)(1)(C) and 
856(c)(9)(A)(ii) of the Code pertaining to REITs. In addition, a 
commenter suggested that final Sec.  1.1031(k)-1(g)(7)(iii) should 
permit the aggregate fair market value of the incidental personal 
property to equal up to 20 percent of the aggregate fair market value 
of the replacement real property.
    The final regulations do not adopt these comments. As explained in 
part II of the Explanation of Provisions section of the preamble to the 
proposed regulations, the proposed incidental property rule 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).'' 85 FR 35839. In addition, the 
Treasury Department has determined that a limitation in excess of 15 
percent ``might induce taxpayers to bundle more personal property with 
their exchanged property,'' which ``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.'' 85 FR 35840. Consequently, the 
Treasury Department and the IRS continue to believe that the proposed 
15-percent limitation, and its calculation, are ``responsive to 
ordinary-course exchanges that often commingle personal property and 
real property as part of the aggregate exchanged property.'' Id.

C. Requests To Identify Incidental Property Rule as a Safe Harbor

    Commenters requested that the incidental property rule be 
specifically identified in the final regulations as a safe harbor. One 
commenter expressed concern that, unless identified as a safe harbor, 
the incidental property rule may be interpreted as a bright-line rule 
under which acquisitions of personal property valued in excess of 15 
percent of the real property will cause the exchange to fail, and the 
transfer of relinquished property to be fully taxable. Additionally, a 
separate commenter requested that the final regulations clarify that 
incidental property may include intangible property such as goodwill.
    The final regulations do not adopt the request that the incidental 
property rule be identified as a safe harbor. The items in current 
Sec.  1.1031(k)-1(g)(1) through (5) consist of safe harbors that help 
taxpayers comply with other rules in Sec.  1.1031(k)-1, and Sec.  
1.1031(k)-1(g)(7)(i) and (ii) are items that are disregarded in 
determining whether one of the existing safe harbors ceases to apply. 
The incidental property rule adds an additional item to Sec.  
1.1031(k)-1(g)(7) that is disregarded in determining whether one of the 
existing safe harbors ceases to apply. Identifying the incidental 
property rule as a safe harbor would thus be confusing because it is an 
item that is disregarded in determining if an existing safe harbor 
applies. Therefore, the incidental property rule operates as part of an 
existing safe harbor. Consequently, acquisitions of personal property 
valued in excess of 15 percent of the replacement real property are not 
disregarded in determining if one of the safe harbors in Sec.  
1.1031(k)-1(g)(3) through (5) ceases to apply and whether the 
taxpayer's rights to receive, pledge, borrow, or otherwise obtain the 
benefits of money or non-like-kind property are expressly limited as 
provided in Sec.  1.1031(k)-1(g)(6), but will not automatically cause 
the exchange to fail section 1031 and the transfer of relinquished 
property to be treated as a sale or taxable exchange.
    Further, the incidental property rule applies to non-real property, 
regardless of whether tangible or intangible. No change to the 
regulations is required to accommodate this suggestion.

D. Application of Section 1031(b) to Receipt of Incidental Personal 
Property

    Several commenters recommended that the final incidental property 
rule provide that a taxpayer's receipt of personal property incidental 
to the real property received in a like-kind exchange be treated as the 
receipt of real property, and thus not give rise to recognized gain 
under section 1031(b). Under section 1031(b), a taxpayer must recognize 
gain on a section 1031 exchange to the extent of money or non-like-kind 
property the taxpayer receives in the exchange. Similarly, one 
commenter suggested that, if the final regulations require recognition 
of gain on the receipt of incidental personal property, the final 
regulations should not include the incidental property rule. That 
commenter contended that inclusion of the incidental property rule in 
the final regulations will result in some taxpayers misinterpreting the 
rule by treating incidental personal property in the same manner as 
real property for purposes of the nonrecognition of gain or loss under 
section 1031.
    The final regulations do not adopt the commenters' recommendations. 
As amended by the TCJA, section 1031(a) is limited to exchanges of real 
property. However, the TCJA did not amend section 1031(b), which 
provides that a taxpayer must recognize gain on an exchange to the 
extent of money and non-like-kind property received in the exchange. 
Personal property received in a like-kind exchange of real property is 
non-like-kind property received in the exchange. Consequently, under 
section 1031(b), gain generally must be recognized to the extent of the 
personal property received in the exchange.
    The final regulations revise proposed Sec.  1.1031(k)-
1(g)(7)(iii)(B) slightly to improve readability; the revision does not 
change the meaning of proposed Sec.  1.1031(k)-1(g)(7)(iii)(B).
    The final regulations include the incidental property rule to 
provide assurance to taxpayers that a qualified intermediary's use of 
exchange proceeds to acquire incidental personal property will not 
cause the taxpayer to fail to meet the requirements of Sec.  1.1031(k)-
1(g)(6)(i), and thus the requirements of section 1031. As explained in 
the preamble to the proposed regulations,

[[Page 77372]]

the incidental property rule was proposed to respond to concerns 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. See generally part II of the Explanation of 
Provisions section in the preamble to the proposed regulations. The 
incidental property rule is intended to help taxpayers comply with the 
requirements of section 1031, particularly the prohibition on a 
taxpayer's ability to actually or constructively receive the proceeds 
from the transfer of relinquished property before receiving like-kind 
replacement property.
    One commenter recommended that the final regulations include 
language specifically providing that the receipt of incidental personal 
property in a section 1031 exchange results in taxable gain to the 
taxpayer. The final regulations adopt this recommendation and add 
language in Sec.  1.1031(k)-1(g)(7)(iii) to clarify this point.

E. Request That 15-Percent Limitation Not Be Applied on a Property-by-
Property Basis

    One commenter recommended that the final regulations clarify that 
the 15-percent limitation for the incidental property rule is not 
applied on a property-by-property basis. For example, assume a taxpayer 
acquires an office building (Building 1) with office furniture, and a 
second office building (Building 2) with no personal property. The 
commenter requested that the final regulations confirm that the 
taxpayer does not exceed the 15-percent limitation if the value of the 
furniture is 15 percent or less of the total value of Building 1 and 
Building 2, even if the value of the furniture exceeds 15 percent of 
the value of just Building 1.
    The Treasury Department and the IRS agree with the commenter's 
recommendation. Accordingly, the final regulations include language to 
clarify that the 15-percent limitation is calculated by comparing the 
value of all of the incidental properties to the value of all of the 
replacement real properties acquired in the same exchange.

F. Suggested Language Changes to Incidental Property Rule

    One commenter recommended a series of language modifications to the 
incidental property rule in the proposed Sec.  1.1031(k)-1(g)(7)(iii). 
For example, the commenter recommended that the rule for determining 
whether personal property is incidental to real property acquired in an 
exchange not reference the term ``commercial transaction.'' For 
support, the commenter asserted that the term might be interpreted to 
include only contracts involving transfers of non-residential property 
such as commercial real estate and not residential rental property. In 
addition, the commenter suggested that, in the final regulations, the 
language ``the personal property is typically transferred together with 
the real property'' be replaced with ``the personal property is 
typically listed in the contract and transferred with the real 
property.''
    The final regulations do not adopt these suggested modifications 
because the Treasury Department and the IRS have determined that 
proposed Sec.  1.1031(k)-1(g)(7)(iii) provides clear guidance for 
determining whether personal property is incidental to real property 
acquired in an exchange. In particular, the term ``commercial 
transactions'' refers to transactions involving business or investment 
property rather than personal-use property. Accordingly, the term 
``commercial'' describes the type of transaction, not the type of 
property. Therefore, a commercial transaction may involve either 
residential or non-residential property.
    The final regulations also do not adopt the commenter's 
recommendation that the language ``the personal property is typically 
transferred together with the real property'' be replaced with ``the 
personal property is typically listed in the contract and transferred 
with the real property.'' Generally, if personal property is 
transferred as part of a transfer of real property, the personal 
property would be listed in the contract relating to the transfer. 
However, if a taxpayer lists the personal property in a contract 
separate from the contract addressing the transfer of real property, 
listing the personal property in a separate contract generally will not 
prevent the taxpayer from using the incidental property rule.

G. Request To Apply Incidental Property Rule Retroactively

    A commenter also requested that, under the final regulations, the 
incidental property rule apply retroactively to exchanges after either 
(i) the 1984 enactment of the deferred exchange rules in section 
1031(a)(3) or (ii) the 1991 effective date of the Sec.  1.1031(k)-1 
deferred exchange final regulations. The commenter observed that the 
concerns that led to the inclusion of the incidental property rule in 
the proposed regulations, which include directing a qualified 
intermediary to use exchange proceeds to acquire non-like-kind 
property, also existed for pre-TCJA exchanges under section 1031. Thus, 
the commenter suggested that the incidental property rule apply to pre-
TCJA exchanges.
    Prior to enactment of the TCJA, personal property was eligible for 
like-kind exchange treatment. Therefore, a rule disregarding the 
receipt of incidental personal property in determining whether a 
taxpayer was in constructive receipt of non-like-kind property prior to 
enactment of the TCJA would function in a very different way than it 
does post-TCJA. Accordingly, these final regulations do not adopt this 
suggestion.

H. Requested Clarifications Regarding Receipt of Personal Property or 
Escrow Funds

    Commenters requested clarification regarding the application of the 
incidental property rule to cash placed in escrow to pay transactional 
and other items in a real estate transfer. The Treasury Department and 
the IRS note that a taxpayer's receipt of escrowed funds that the 
taxpayer placed in escrow for transactional-type items is not a receipt 
of incidental personal property. Therefore, the final regulations do 
not revise the incidental property rule in response to the commenters' 
request. A commenter also requested guidance regarding situations in 
which an exchanging taxpayer acquires a substantial amount of personal 
property due to unforeseen circumstances. The final regulations do not 
address this specific situation. The 15-percent limitation is not a 
bright-line test for determining whether a transaction fails to meet 
the requirements of an exchange under section 1031. All of the facts 
and circumstances of the taxpayer's situation are considered in 
determining if the exchange meets the requirements of section 1031.

IV. Comments That Exceed the Scope of the Final Regulations

A. Application of Section 453 of the Code To Gain on a Transfer of 
Personal Property

    A commenter recommended that the final regulations provide 
clarification regarding the application of section 453 to certain like-
kind exchanges. Specifically, the commenter requested guidance about 
the timing of gain recognition when (i) real property is exchanged for 
both like-kind real property and non-like-kind personal property 
incidental to the real property, and (ii) the exchange is not completed

[[Page 77373]]

until the taxable year succeeding the taxable year of the transfer of 
the relinquished property. The commenter requested that the final 
regulations address whether the gain on the receipt of the personal 
property is recognized in the first or the second taxable year (Tax 
Year 1 and Tax Year 2, respectively) if the like-kind exchange 
straddles two taxable years.
    The commenter also requested guidance regarding a situation 
involving a taxpayer who (i) has a bona fide intent to execute a 
section 1031 exchange, (ii) transfers relinquished real property and 
incidental personal property in Tax Year 1, and (iii) fails to acquire 
replacement property by the 180th day after the transfer of the 
relinquished property, which is in Tax Year 2. Specifically, the 
commenter recommends that the final regulations address whether the 
gain on the transfer of the personal property is recognized in Tax Year 
1 or Tax Year 2.
    The Treasury Department and the IRS appreciate the commenter's 
questions but have determined the commenter's requested guidance 
exceeds the scope of the final regulations. The issues raised by the 
commenter relate to the application of current Sec.  1.1031(k)-1(j)(2), 
which addresses the application of the installment method of accounting 
in section 453 to like-kind exchanges involving the receipt of non-
like-kind property that straddles two taxable years, or that would have 
straddled two taxable years if successfully completed. The scope of the 
final regulations is limited to the definition of real property under 
section 1031 and to incidental property received in a section 1031 
exchange. Accordingly, the final regulations do not address the issues 
relating to the timing of gain recognition raised by the commenter.

B. Application of Current Sec.  1.1031(j)-1 to Post-TCJA Exchanges

    Several commenters inquired about the application of current Sec.  
1.1031(j)-1 to exchanges of multiple properties following the enactment 
of the TCJA. Section 1.1031(j)-1 provides an exception to the general 
rule that section 1031 requires a property-by-property comparison for 
computing the gain recognized and basis of property received in a like-
kind exchange. Section 1.1031(j)-1 applies when there is more than one 
exchange group created, as described in Sec.  1.1031(j)-1(b)(2)(i), or, 
if there is only one exchange group, there is more than one property 
transferred or received within the exchange group. Under Sec.  
1.1031(j)-1, the amount of gain recognized and the basis of the 
properties received by a taxpayer are computed after separating the 
properties transferred and received by the taxpayer in the exchange 
into exchange groups, in accordance with the rules in Sec.  1.1031(j)-
1(b)(3) and (c), respectively. In addition, under Sec.  1.1031(j)-
1(b)(2)(ii), all liabilities assumed by a taxpayer as part of an 
exchange to which Sec.  1.1031(j)-1 applies are offset against all 
liabilities of which the taxpayer is relieved as part of the exchange.
    One commenter asked whether Sec.  1.1031(j)-1 applies to a post-
TCJA exchange of real property and personal property for other real 
property and personal property. Under section 1031 as in effect before 
the TCJA amendments, Sec.  1.1031(j)-1 would have applied to this 
exchange if the relinquished real property was of a like kind to the 
replacement real property, and the relinquished personal property was 
of a like kind to the replacement personal property. Other commenters 
requested the Treasury Department and the IRS to conclude that Sec.  
1.1031(j)-1 will continue to apply in this situation so that taxpayers 
will not have to carry out a property-by-property comparison for 
computing gain on the exchange.
    Another commenter inquired about the application of Sec.  
1.1031(j)-1 to exchanges of both qualifying real property and non-
qualifying property that involve indebtedness encumbering both types of 
properties. Specifically, the commenter asked whether the full amount 
of the indebtedness assumed by the taxpayer would offset the full 
amount of the indebtedness liabilities of which the taxpayer is 
relieved as part of the exchange, even if a portion of that 
indebtedness relates to the personal property in the exchange.
    The Treasury Department and the IRS appreciate the issues raised by 
these commenters but note that the application of Sec.  1.1031(j)-1 to 
transactions to which the TCJA applies exceeds the scope of the final 
regulations. Therefore, the final regulations do not address these 
comments. The Treasury Department and the IRS, however, continue to 
consider potential future guidance on issues relating to Sec.  
1.1031(j)-1.

C. Application of Revenue Rulings 2003-56 and 2004-86

    One commenter suggested that Rev. Rul. 2003-56, 2003-23 I.R.B. 985, 
likely needs to be modified to address post-TCJA exchanges involving 
both real and personal property. The commenter also questioned whether 
Rev. Rul. 2004-86, 2004-33 I.R.B. 191, needs to be updated to address 
the TCJA changes to section 1031.
    Rev. Rul. 2003-56 addresses the consequences under section 752 of 
the Code and Sec.  1.704-2(d) of a section 1031 like-kind exchange that 
straddles two taxable years and involves relinquished and replacement 
property subject to a liability. The revenue ruling addresses whether 
the liabilities are netted and which taxable year the net change in a 
partner's share of partnership liability is taken into account.
    Rev. Rul. 2004-86 addresses whether an interest in a Delaware 
statutory trust (DST) is treated as an interest in the real property 
owned by the DST, and whether a taxpayer may exchange real property for 
an interest in a DST in a transaction that qualifies for nonrecognition 
of gain under section 1031. The revenue ruling examines the grantor 
trust rules of sections 671 and 677 of the Code and the entity-
classification rules in section 7701 of the Code and the section 7701 
regulations. Rev. Rul. 2004-86 concludes that, under the facts of the 
ruling, including the DST agreement, the exchange qualifies for 
nonrecognition under section 1031.
    The Treasury Department and the IRS appreciate these helpful 
comments but have determined that they exceed the scope of the final 
regulations. That scope is limited to the definition of real property 
under section 1031 and to incidental property received in a section 
1031 exchange. Both Rev. Rul. 2003-56 and Rev. Rul. 2004-86 address 
other issues related to the application of section 1031.
    With regard to Rev. Rul. 2004-86, nothing in the proposed 
regulations or the TCJA is contrary to the view that a transfer of an 
interest in a DST, if a grantor trust, is treated as the transfer of 
the underlying property held by the DST. The Treasury Department and 
the IRS, however, will continue to review existing guidance concerning 
section 1031 like-kind exchanges to determine the effect of the TCJA on 
that guidance.

D. Computation Error in Examples Contained in Sec.  1.1031(k)-1(d)(2)

    A commenter highlighted that examples in Sec.  1.1031(k)-1(d)(2) 
include a computation error. For example, the sum of $187,500 and 
$87,500 is incorrectly provided as $250,000. Although, the proposed 
regulations do not address the rules in Sec.  1.1031(k)-1(d)(2), this 
Treasury decision corrects the scrivener's error identified by the 
commenter by replacing ``$87,500'' with ``$62,500'' each place it 
appears therein.

[[Page 77374]]

E. Interaction of Bonus Depreciation Rules With Section 1031

    One commenter discussed the interaction between the additional 
first year depreciation deduction rules in section 168 of the Code, 
commonly referred to as bonus depreciation, and the like-kind exchange 
rules in section 1031, as amended by the TCJA. The commenter pointed 
out that there may be an adverse timing difference between (i) when 
gain is recognized on the transfer of real property that includes the 
transfer of personal property, and (ii) when a taxpayer is allowed a 
bonus depreciation deduction for the acquisition of replacement real 
property and personal property subject to bonus depreciation. The 
commenter also asserted that when the 100-percent bonus depreciation 
rules expire after 2022, the gain associated with a section 1031 
exchange involving real estate including personal property will be 
larger than the gain intended by Congress.
    These comments, while helpful, exceed the scope of the final 
regulations. Accordingly, the final regulations do not include the 
guidance requested by the commenter. However, the Treasury Department 
and the IRS will consider the interaction between the bonus 
depreciation rules under section 168 and the like-kind exchange rules 
under section 1031.

V. Correction to Preamble of Proposed Regulations Regarding Kind or 
Class of Property

    One commenter noted that the background section of the preamble to 
the proposed regulations provides the following: ``Real property of one 
kind or class may not, under section 1031, be exchanged for real 
property of a different kind or class.'' Proposed regulations, 
Background, part III. The commenter correctly pointed out that this 
sentence is inaccurate because distinguishing between properties of a 
different class is relevant to personal property and whether, under 
section 1031 prior to enactment of the TCJA, personal properties were 
of like kind, not whether the properties were real property. 
Consequently, this sentence is deleted from part III of the Background 
of the preamble to the final regulations.

Statement of Availability of IRS Documents

    The IRS guidance cited in this preamble is published in the 
Internal Revenue Bulletin (or Cumulative Bulletin) and is available 
from the Superintendent of Documents, U.S. Government Publishing 
Office, Washington, DC 20402, or by visiting the IRS website at https://www.irs.gov.

Effective/Applicability Date

    These final regulations apply to exchanges beginning after December 
2, 2020. A taxpayer may rely on the proposed regulations (REG-117589-
18) published in the Federal Register on June 12, 2020 (85 FR 35835), 
if followed consistently and in their entirety, for exchanges of real 
property beginning after December 31, 2017, and before December 2, 
2020.

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 subject to review 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 (OIRA) has designated 
these final regulations as economically significant under section 1(c) 
of the MOA. Accordingly, the OMB has reviewed these final 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 13303 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. Final Regulations
    The final 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. Conference Report, at 396, fn. 726. On June 12, 2020, the 
Treasury Department and the IRS published a notice of proposed 
rulemaking (REG-117589-18) in the Federal Register (85 FR 35835) 
containing proposed regulations under section 1031 (proposed 
regulations). The final regulations retain the basic approach and 
structure of the proposed regulations, with certain revisions. In 
particular, the final regulations revise the definition of ``real 
property'' in the proposed regulations to provide that property is 
classified as real property for section 1031 purposes if, on the date 
it is transferred in an exchange, the property is real property under 
the law of the State or local jurisdiction in which that property is 
located. However, property ineligible for like-kind exchange treatment 
after enactment of the TCJA remains ineligible for like-kind exchange 
treatment after the enactment of the TCJA regardless of its 
classification under the laws of the State or local jurisdiction. The 
final regulations also revise the proposed definition of real property 
to eliminate, with regard to both tangible and intangible properties, 
any consideration of whether the particular property contributes to the 
production of income unrelated to the use or occupancy of space 
(referred to as the ``purpose or use test,'' as defined in part II.B.1 
of this Summary of Comments and Explanation of Revisions).
    The final regulations retain the rule relating to personal property 
in an exchange that is incidental to the real property exchange. 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

[[Page 77375]]

regulations is based on an existing rule in the regulations under 
section 1031, which provides that certain incidental property is 
ignored in determining whether a taxpayer has properly identified 
replacement property.
3. No-Action Baseline
    In this analysis, the Treasury Department and the IRS assess the 
benefits and costs of these final regulations relative to a no-action 
baseline reflecting anticipated Federal income tax-related behavior in 
the absence of these final regulations.
4. Economic Analysis of Final Regulations
    The statutory changes made by the TCJA to section 1031 limit like-
kind exchanges to real property. The final regulations provide that 
property is real property for purposes of section 1031 if, on the date 
it is transferred in an exchange, that property is classified as real 
property under the law of the State or local jurisdiction in which that 
property is located (local law test). Consequently, under the final 
regulations, property is classified as real property for purposes of 
section 1031 if the property is (i) so classified under the State and 
local law test, (ii) specifically listed as real property in the final 
regulations, or (iii) considered real property based on all the facts 
and circumstances under the various factors provided in the final 
regulations. The proposed regulations had extracted certain portions of 
the definition of real property from various existing regulations with 
the intention that they 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); 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'').
    The final regulations also eliminate the purpose or use test for 
tangible property to qualify as real property that was included in the 
proposed regulations. If tangible property is permanently affixed to 
real property and will ordinarily remain affixed for an indefinite 
period of time, the property is an inherently permanent structure and 
thus real property for section 1031 purposes, irrespective of the 
purpose or use of the property or whether it contributes to the 
production of income.
    As emphasized in comments received by the Treasury Department and 
the IRS, the proposed regulations may have caused certain real property 
that qualified for like-kind exchange treatment prior to the enactment 
of the TCJA to no longer qualify. The final regulations more closely 
follow the legislative history to the TCJA amendments to section 1031. 
See Conference Report, at 396, fn. 726 (providing that Congress 
``intended that real property eligible for like-kind exchange treatment 
under present law will continue to be eligible for like-kind exchange 
treatment under the [amended] provision''). The Treasury Department and 
the IRS have determined that using the local law test and eliminating 
the purpose or use test will reduce compliance costs relative to the 
proposed rules. As a result, taxpayers may rely on existing State and 
local law definitions of real property or may look to the specifically 
listed property or the various factors provided in the final 
regulations.
    The Treasury Department and the IRS have determined that there is 
not likely to be a material difference in the quantity of tangible 
property that qualifies as real property eligible for like-kind 
exchanges under the two standards. In making this determination, the 
Treasury Department and the IRS observed that, for an exchange to 
qualify for gain-deferral treatment under section 1031, the subject 
property (that is, the relinquished property) not only must constitute 
``real property,'' but also must be ``like kind'' with regard to the 
property exchanged therefore (that is, the replacement property). Like-
kind determinations are made pursuant to Federal, rather than State or 
local, tax law. See generally Sec.  1.1031(a)-1(b) through (d). 
Consequently, State and local law definitions of real property, on 
their own, affect only one prong of the section 1031 qualification for 
exchanges of property as a result of these final regulations. In the 
future, State and local governments could modify their tax laws to 
include additional assets within the definition of real property. 
However, the Treasury Department and the IRS cannot determine the 
extent to which State and local governments may take such actions. The 
Treasury Department and the IRS note that such actions likely would 
affect the tax revenue of those jurisdictions.
    Moreover, the final regulations provide that property ineligible 
for like-kind exchange treatment prior to enactment of the TCJA remains 
ineligible, including real property that was excluded from the 
application of section 1031. This approach is consistent with 
Congressional intent that ``real property eligible for like-kind 
exchange treatment'' under the law in effect prior to enactment of the 
TCJA will continue to be eligible for like-kind exchange treatment 
after enactment of the TCJA. See Conference Report at 396, fn. 726. 
Prior to amendment by the TCJA, former section 1031(a)(2) explicitly 
excluded certain assets from the application of section 1031. 
Accordingly, the final regulations exclude from the definition of real 
property the intangible assets listed in section 1031(a)(2) prior to 
its amendment by the TCJA, regardless of the classification of the 
property under State or local law, because such property never was 
``real property eligible for like-kind exchange treatment'' prior to 
enactment of the TCJA. Conference Report at 396, fn. 726. The final 
regulations may influence which intangible assets qualify as real 
property for like-kind exchanges relative the definition in the 
proposed regulations. To the extent an intangible asset derives its 
value from real property or an interest in real property, it is 
inseparable from that real property or interest in real property. 
Accordingly, the intangible asset does not produce or contribute to the 
production of income other than consideration for the use or occupancy 
of space, and therefore may be real property or an interest in real 
property under State or local law. Under the proposed regulations, the 
intangible asset, such as mineral extraction rights or timber cutting 
rights, that produces income other than for the use or occupancy of 
space and would not be considered real property. Under the final 
regulations, the mineral rights and timber cutting rights are real 
property if they are considered real property under State or local law.
    The modification of the definition of real property in the final 
regulations aligns the proposed definition to more closely track the 
intent of Congress as described in the Conference Report. The proposed 
rules could have had a significant impact on the amount of intangible 
property that previously qualified for like-kind exchanges. For 
example, oil and gas firms accounted for approximately $4 billion in 
deferred gains in 2012. This figure can be viewed as an upper limit on 
the size of the taxable income that the proposed rule could have 
excluded from qualifying for like-kind exchanges as it includes both 
developed fields that would have qualified under the proposed rule and

[[Page 77376]]

mineral rights that may have been excluded. The proposed rule may have 
also affected other intangible real property such as mineral rights not 
associated with oil and gas properties or timber cutting rights, but 
these are likely small when compared to the deferred gains in the oil 
and gas industry.
    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 final 
regulations disregard certain incidental personal property. 
Specifically, the final 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 not 
like-kind to real property. The 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 on the value of incidental personal 
property in excess of 15 percent, the Treasury Department and the IRS 
have 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 and the 
IRS have determined that the burden of accurately measuring the 
separate costs of comingled personal and real property would increase.
    In addition, the final 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 placed in service after 
September 27, 2017, and 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.
    As part of the economic analysis of the proposed regulations, the 
Treasury Department and the IRS requested comments and information that 
would help further inform the analysis underlying the proposed 15-
percent limitation for incidental personal property. See part I.A.4 of 
the Special Analyses of the proposed regulations (85 FR 35840). No 
comments were received by the Treasury Department or the IRS.
    The Treasury Department and the IRS have determined that these 
final regulations will not have meaningful effects regarding the 
section 1031 qualification of real property exchanges. Finally, these 
final 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 final 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 final 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 
final 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 
final 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 final 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 final regulations. Those estimates would 
capture both changes made by the TCJA and those that arise out of 
discretionary authority exercised in the final regulations.
    The current status of the Paperwork Reduction Act submissions 
related to section 1031 is provided in the following table. The section 
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 section 1031 requirements. 
These numbers are therefore unrelated to the future calculations needed 
to assess the burden imposed by the final 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 TCJA. The Treasury Department and the 
IRS request comments on all aspects of

[[Page 77377]]

information collection burdens related to the final 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 10/30/20 (85
                                                FR 68956). Public
                                                Comment period closes on
                                                12/29/20.
------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2020/10/30/2020-24139/proposed-extension-of-information-collection-request-submitted-for-public-comment-comment-request.
------------------------------------------------------------------------

    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 final 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 final 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 final 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 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 final 
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 final 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 final regulations use a State or local law test 
and certain aspects from existing regulatory definitions of real 
property in a manner 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 final 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 final 
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 final 
regulations is unknown but likely substantial because like-kind 
exchanges are entered into by entities of all sizes. Although a 
substantial number of small entities is potentially affected by these 
final regulations, the Treasury Department and the IRS have concluded 
that the final regulations will not have a significant economic impact 
on a substantial number of small entities because the costs to comply 
with these final 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 final regulations other than the time to read and 
understand these regulations. Thus, taxpayers that engage in like-kind 
exchanges of real property in 2018 and later years will not have any 
additional burden as compared to taxpayers engaging in like-kind 
exchanges in years before 2018. Accordingly, the Secretary certifies 
that these final regulations will not have a significant economic 
impact on a substantial number of small entities.
    Pursuant to section 7805(f), the notice of proposed rulemaking 
preceding this final regulation was submitted to the Chief Counsel for 
the Office of Advocacy of the Small Business Administration for comment 
on its impact on small business (85 FR 35835). No comments on the 
notice were received from the Chief Counsel for the Office of Advocacy 
of the Small Business Administration.

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 2020, that threshold is approximately $156 million. This 
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 law, 
unless the agency meets the

[[Page 77378]]

consultation and funding requirements of section 6 of the Executive 
Order. This 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.

VI. Congressional Review Act

    The Administrator of OIRA has determined that this Treasury 
decision is a major rule for purposes of the Congressional Review Act 
(5 U.S.C. 801 et seq.) (CRA). Under section 801(3) of the CRA, a major 
rule takes effect 60 days after the rule is published in the Federal 
Register.
    Notwithstanding this requirement, section 808(2) of the CRA allows 
agencies to dispense with the requirements of section 801 when the 
agency for good cause finds that such procedure would be impracticable, 
unnecessary, or contrary to the public interest and the rule shall take 
effect at such time as the agency promulgating the rule determines. 
Pursuant to section 808(2) of the CRA, the Treasury Department and the 
IRS find, for good cause, that a 60-day delay in the effective date is 
unnecessary and contrary to the public interest.
    Following the amendments to section 1031 by the TCJA, the Treasury 
Department and the IRS published the proposed regulations to provide 
certainty to taxpayers. In particular, and as emphasized by the wide 
variety of public comments received in response to the proposed 
regulations, taxpayers lacked certainty regarding the longstanding role 
of State and local law in real property determinations for purposes of 
qualification under section 1031. Consistent with Executive Order 13924 
(May 19, 2020), the Treasury Department and the IRS have determined 
that an expedited effective date of the final regulations would ``give 
businesses, especially small businesses, the confidence they need to 
re-open by providing guidance on what the law requires.'' 85 FR 31353-
4. Accordingly, the Treasury Department and the IRS have determined 
that the rules in this Treasury decision shall take effect on the date 
of publication in the Federal Register.

Drafting Information

    The principal authors of these regulations are Edward C. Schwartz 
and Suzanne R. Sinno 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.

Amendments to the Regulations

    Accordingly, 26 CFR part 1 is 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 December 2, 2020. Paragraph (e)(2)(viii)(A) 
of this section as contained in 26 CFR part 1 edition revised as of 
April 1, 2020, applies before December 2, 2020.

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 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 December 2, 2020. Paragraph (c)(4)(i) of this 
section as contained in 26 CFR part 1 edition revised as of April 1, 
2020, applies before December 2, 2020.

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 after December 2, 2020.

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

[[Page 77379]]

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 intangible interest in real property of a 
type described in this paragraph (a)(1) is real property for purposes 
of section 1031 and this section. Property that is real property under 
State or local law as provided in paragraph (a)(6) of this section is 
real property for purposes of section 1031 and 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 structure 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. Affixation 
is considered permanent if it is reasonably expected to last 
indefinitely based on all the facts and circumstances.
    (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 paragraph (a)(2)(ii) of this section 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 platforms, derricks, oil and gas storage 
tanks; and grain storage bins and silos. Affixation to real property 
may be accomplished by weight alone. If property is not listed as an 
inherently permanent structure in paragraph (a)(2)(ii)(B) or (C) of 
this section, the determination of whether the property is an 
inherently permanent structure under paragraph (a)(2)(ii) of this 
section 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.
    (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. For this section, 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;
    (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

[[Page 77380]]

impairs the functionality of the larger asset.
    (5) Intangible assets--(i) In general. Intangible assets that are 
real property for purposes of section 1031 and this section include the 
following items: Fee ownership; co-ownership; a leasehold; an option to 
acquire real property; an easement; stock in a cooperative housing 
corporation; shares in a mutual ditch, reservoir, or irrigation company 
described in section 501(c)(12)(A) of the Code if, at the time of the 
exchange, such 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; and land development rights. Similar interests are real 
property for purposes of section 1031 and this section if the 
intangible asset derives its value from real property or an interest in 
real property and is inseparable from that real property or interest in 
real property. The following intangible assets are not real property 
for purposes of section 1031 and this section, regardless of the 
classification of such property under State or local law--
    (A) Stock not described in paragraph (a)(5)(i) of this section, 
bonds, or notes;
    (B) Other securities or evidences of indebtedness or interest;
    (C) Interests in a partnership (other than an interest in a 
partnership that has in effect a valid election under section 761(a) to 
be excluded from the application of all of subchapter K);
    (D) Certificates of trust or beneficial interests; and
    (E) Choses in action.
    (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, easement, or other similar right, 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, regardless of its classification under 
State or local law.
    (6) State or local law. Except as otherwise provided in paragraph 
(a)(5) of this section, property is real property within the meaning of 
paragraph (a)(1) of this section under State or local law if, on the 
date it is transferred in an exchange, the property is real property 
under the law of the State or local jurisdiction in which that property 
is located.
    (7) 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. In each example, unless otherwise provided, the State or 
local law of the applicable jurisdiction in which the property at issue 
is located does not address whether the property is real property.
    (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;
    (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

[[Page 77381]]

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 and generator. (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 and the 3D printer in a backup capacity. The 3D printer weighs 
12 tons, is designed to remain in place indefinitely once installed in 
the building, and its removal would be time-consuming and very costly, 
and would cause significant damage to 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. Although costly and time-consuming to 
remove, removal of the generator will not result in substantial damage 
to the generator or the building.
    (ii) The 3D printer is not listed as an example of a structural 
component under paragraph (a)(2)(iii)(B) of this section. Therefore, 
the 3D printer 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 3D printer--
    (A) Is time-consuming and costly to move;
    (B) Is not designed to be moved;
    (C) If removed, would cause significant damage to the building in 
which it is located; 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 support the conclusion that the 3D printer is a 
structural component of E's building and real property under this 
section. Thus, the 3D printer is real property.
    (iv) The electrical generator also is not listed as an example of a 
structural component under paragraph (a)(2)(iii)(B) of this section and 
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 generator--
    (A) Is time-consuming and costly to move;
    (B) Is not designed to be moved;
    (C) If removed, would not result in significant damage to the 
generator or the building in which it is located; and
    (D) Was installed during construction of the building.
    (v) The factors described in paragraphs (a)(2)(iii)(B)(1) through 
(4) of this section, considered in the aggregate, support the 
conclusion that the generator is a structural component of E's 
building. Although the generator's removal would not result in 
significant damage to the generator or to E's building, that factor 
does not outweigh the factors supporting the conclusion that it is a 
structural component. Consequently, the generator is a structural 
component of E's building and real property under this section.
    (6) Example 6: 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) Although floors are listed as an example of a structural 
component under paragraph (a)(2)(iii)(B) of this section, the raised 
flooring system installed to facilitate the operation of E's 3D printer 
is not a constituent part of, and integrated into, an inherently 
permanent structure as required by paragraph (a)(2)(iii)(A) of this 
section and, therefore, is not flooring as 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.
    (7) Example 7: 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 and its removal would be costly and 
cause damage to the building.
    (ii) The steam turbine is not listed as an example of a structural 
component under paragraph (a)(2)(iii)(B) of this section and 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 steam turbine--
    (A) Is costly to remove from the building in which it is located;
    (B) Is not designed to be moved;
    (C) If removed, would cause damage to the building; 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 support the conclusion that the steam turbine is a 
structural component of F's building and real property under this 
section. Thus, the steam turbine is real property.
    (8) Example 8: 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

[[Page 77382]]

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 office building within the 
meaning of paragraph (a)(2)(iii) of this section. Therefore, the 
Modular Partition System is not real property.
    (9) Example 9: 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)(B) 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.
    (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. H installed meters and compressors during 
the construction of the pipelines. However, unlike other types of such 
meters and compressors, these particular meters and compressors 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. Therefore, the meters and compressors 
installed by H are not structural components within the meaning of 
paragraph (a)(2)(iii) of this section and, therefore, are not real 
property.
    (10) Example 10: State or local law determination of property. (i) 
J owns water pipeline in State X that it wants to exchange for cell 
phone towers located in State Y. On the date that J transfers the water 
pipeline in an exchange for the cell phone towers, the water pipeline 
is classified as real property under the law of State X, the 
jurisdiction in which the water pipeline is located.
    (ii) The water pipeline is real property under paragraphs (a)(1) 
and (a)(6) of this section, regardless of whether the water pipeline is 
listed as an inherently permanent structure or a structural component 
of an inherently permanent structure, or is real property under the 
factors listed in paragraph (a)(2)(ii)(C) or (a)(2)(iii)(B) of this 
section.
    (iii) Cell phone towers are listed as an inherently permanent 
structure under

[[Page 77383]]

paragraph (a)(2)(ii)(C) of this section. Thus, the cell phone towers 
that J acquires in the exchange for the water pipeline are real 
property under this section, regardless of the State or local 
characterization of the cell phone towers or whether the cell phone 
towers are real property under the factors in paragraph (a)(2)(ii)(C) 
or (a)(2)(iii)(B) of this section.
    (11) Example 11: Land use permit. K 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 K if the site is needed for a higher 
public purpose. The permit is in the nature of a leasehold that allows 
K 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. L 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. L's building is an inherently 
permanent structure under paragraph (a)(2)(ii)(A) of this section and, 
therefore, is real property. However, L's license to operate a casino 
is not a right for the use, enjoyment, or occupation of L's building, 
but is rather a license to engage in or operate the casino business in 
the building. Therefore, the casino license is not real property or an 
interest in real property under paragraph (a)(5)(ii) of this section.
    (c) Applicability date. This section applies to exchanges beginning 
after December 2, 2020.

0
Par. 7. Section 1.1031(k)-1 is amended by:
0
1. In paragraph (d)(2), removing ``$87,500'' and adding in its place 
``$62,500'' each place it appears;
0
2. Removing ``, and'' at the end of paragraph (g)(7)(i) and adding a 
semicolon in its place;
0
3. Removing the period at the end of paragraph (g)(7)(ii) and adding 
``; and'' in its place;
0
4. Adding paragraph (g)(7)(iii);
0
5. In paragraph (g)(8), designating Examples 1 through 5 as paragraphs 
(g)(8)(i) through (v), respectively;
0
6. In newly designated paragraph (g)(8)(i):
0
a. Redesignating paragraph (g)(8)(i)(i) as paragraph (g)(8)(i)(A);
0
b. In newly designated paragraph (g)(8)(i)(A), redesignating paragraphs 
(g)(8)(i)(A)(A) and (B) as paragraphs (g)(8)(i)(A)(1) and (2), 
respectively;
0
c. Designating the undesignated paragraph immediately following newly 
redesignated paragraph (g)(8)(i)(A)(2) as paragraph (g)(8)(i)(A)(3); 
and
0
d. In newly designated paragraph (g)(8)(i) redesignating paragraph 
(g)(8)(i)(ii) as paragraph (g)(8)(i)(B);
0
7. In newly designated paragraph (g)(8)(ii):
0
a. Redesignate old paragraph (i) as paragraph (A);
0
b. Redesignate old paragraph (A) as paragraph (1);
0
c. Redesignate old paragraphs (1) and (2) as paragraphs (i) and (ii), 
respectively;
0
d. Redesignate old paragraphs (B) and (C) as paragraphs (2) and (3), 
respectively;
0
e. Designating the undesignated paragraph immediately following newly 
redesignated paragraph (g)(8)(ii)(A)(3) as paragraph (g)(8)(ii)(A)(4); 
and
0
f. Redesignate old paragraphs (ii) and (iii) as paragraphs (B) and (C), 
respectively;
0
8. In newly designated paragraph (g)(8)(iii), redesignating old 
paragraphs (i) through (v) as paragraphs (A) through (E), respectively;
0
9. In newly designated paragraph (g)(8)(iv), redesignating old 
paragraphs (i) through (iii) as paragraphs (A) through (C), 
respectively;
0
10. In newly designated paragraph (g)(8)(v), redesignating old 
paragraphs (i) through (iii) as paragraphs (A) through (C), 
respectively;
0
11. Adding paragraph (g)(8)(vi); and
0
12. Adding paragraph (g)(9).
    The additions read as follows:


Sec.  1.1031(k)-1   Treatment of deferred exchanges.

* * * * *
    (g) * * *
    (7) * * *
    (iii) Personal property generally resulting in gain recognition 
under section 1031(b) 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 property described in 
paragraph (g)(7)(iii)(A) of this section transferred with the real 
property does not exceed 15 percent of the aggregate fair market value 
of the replacement real property or properties received in the 
exchange.
* * * * *
    (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 non-like-kind 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 after December 2, 2020.
* * * * *

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
    Approved: November 18, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-26313 Filed 11-30-20; 4:15 pm]
BILLING CODE 4830-01-P