The Like-Kind Exchange of “Real Property” According to the Proposed Regulations

June 15, 2020

The Taxable Exchange

As a general rule, a taxpayer’s exchange of one property for another property is treated as a taxable event; the gain realized by the taxpayer – meaning the amount by which the fair market value of the property received by the taxpayer[i] exceeds the taxpayer’s adjusted basis (unrecovered investment) in the property they have given up – is treated as income.[ii]

For example, the gain realized by the taxpayer on the “conversion” of property into cash[iii] is included in the taxpayer’s gross income for purposes of determining their income tax liability.

Likewise, the gain realized on the taxpayer’s exchange of property for other property that differs materially in kind from the property relinquished by the taxpayer is treated as income.[iv]

The general principle reflected in the foregoing rules is that a taxpayer’s “readjustment” of what is essentially their continuing interest in a property should be excepted from the general gain recognition rule. This principle underlies many of the Code’s non-recognition provisions, including, for example, those dealing with corporate reorganizations,[v] certain contributions to business entities,[vi] certain modifications to debt instruments[vii] and, of course, like-kind exchanges.[viii]

The Like-Kind Exchange

Under Section 1031 of the Code, no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged for property of a “like-kind” which is to be held for productive use in a trade or business or for investment. The unrecognized gain inherent in the relinquished property is preserved in the hands of the taxpayer by requiring the taxpayer to take the replacement property with an adjusted basis equal to that of the relinquished property.[ix]

However, if a taxpayer’s exchange of property would meet the requirements of Section 1031 but for the fact that the taxpayer receives not only like-kind property that would be permitted to be exchanged on a tax-deferred basis, but also other non-qualifying property[x] or money (“boot”), then the gain realized by the taxpayer will have to be recognized and included in their gross income in an amount up to the fair market value of such boot.[xi]


With the enactment of the Tax Cuts and Jobs Act,[xii] the application of the like-kind exchange rules was limited – beginning with exchanges completed after December 31, 2017 – to the exchange of real property that is not held primarily for sale.[xiii] In other words, the TCJA removed personal property and certain intangible property from eligibility for like-kind exchange treatment.[xiv]

According to the Conference Committee Report,[xv] Congress intended that “real property” eligible for like-kind exchange treatment prior to the TCJA would continue to be eligible for like-kind exchange treatment under the TCJA. In light of the IRS and the courts historically having allowed such treatment for many kinds of real property, this statement of legislative intent boded well for taxpayers.

For example, improved real property and unimproved real property are generally considered to be property of a like-kind – the fact that the real property is improved or unimproved is not material, for that fact relates only to the grade or quality of the property and not to its kind.[xvi] Unproductive real property held by a taxpayer for future appreciation is treated as being held for investment and not primarily for sale. A taxpayer may exchange city real property for a ranch or farm, or they may exchange real property held for use in a trade or business for real property that the taxpayer will hold for investment, or vice versa.

Proposed Regulations

Seems straightforward enough, right? After all, what we commonly think of as real property is by definition easily identifiable as such; of course, I am referring to land and buildings.

However, such a simplistic approach to the identification of real property would be ill-conceived, and even unfounded. In fact, many well-established, pre-TCJA authorities have gone well beyond such a restrictive interpretation. For example, the IRS has treated a leasehold interest in a fee with 30 years or more to run as real property, stating that a taxpayer may exchange such a leasehold interest for a fee interest in real property as part of a like-kind exchange.[xvii]

Unfortunately, there is no accepted statutory or regulatory definition of real property for purposes of the like-kind exchange rules. Moreover, there are many properties, or interests in property, that may not intuitively be viewed as real property but which have, under certain circumstances, been treated as such by either the IRS or the courts.[xviii]

According to the preamble to the proposed regulations, their purpose is to give taxpayers some certainty regarding whether property is “real property” for purposes of the revised like-kind exchange rules; taxpayers, the preamble continues, need certainty regarding whether any part of the replacement property received in an exchange is non-like-kind property the receipt of which would require the recognition of gain.

Real Property

“Certainty,” it seems, comes at a price: a set of nesting doll[xix] rules, with one definition embedded within, or building upon, another.

“Distinct Asset”

The predicate definition in the series of definitions developed by the proposed regulations is the term “distinct asset.”[xx] An item cannot be an improvement to land – i.e., it cannot be an “inherently permanent structure” or a “structural component” of an inherently permanent structure – and, therefore, cannot be treated as real property, unless it is a distinct asset.[xxi]

According to the proposed regulations, 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. The assets and systems listed below as a structural component are also treated as distinct assets.

The determination of whether a particular separately identifiable item of property is a distinct asset is based on all the facts and circumstances, including whether: (A) the item is customarily sold or acquired as a single unit rather than as a component part of a larger asset; (B) the item can be separated from a larger asset, and if so, the cost of separating the item from the larger asset; (C) the item is commonly viewed as serving a useful function  dependent of a larger asset of which it is a part; and (D) separating the item from a larger asset of which it is a part impairs the functionality of the larger asset.

“Real Property”

The proposed regulations start out easily enough, stating that real property includes land and improvements to land, unsevered natural products of land, and water and air space superjacent to land.[xxii]

Example. Taxpayer 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. Taxpayer 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.


Improvements to land, in turn, include “inherently permanent structures” and the “structural components” of inherently permanent structures.[xxiii]

“Inherently Permanent Structure”

An inherently permanent structure means any building or other structure that is a “distinct asset” that is permanently affixed to real property, and that will ordinarily remain affixed for an indefinite period of time.[xxiv]


For this purpose, the proposed regulations define a “building” as any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. Thus, “buildings” include the following distinct assets if permanently affixed: houses, apartments, hotels, motels, enclosed stadiums and arenas, enclosed shopping malls, factory and office buildings, warehouses, barns, enclosed garages, enclosed transportation stations and terminals, and stores.[xxv]

“Other Structures”

The following assets are also treated as inherently permanent structures, 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; certain inherently permanent advertising displays; inherently permanent outdoor lighting facilities; railroad tracks and signals; telephone poles; power generation and transmission facilities; permanently installed telecommunications cables; microwave transmission, cell, broadcasting, and electric transmission towers; oil and gas pipelines; offshore drilling platforms, derricks, oil and gas storage tanks; grain storage bins and silos; and enclosed transportation stations and terminals.[xxvi]

If property is not included in the list of inherently permanent structures, the proposed regulations provide that the following factors that must be used to determine whether the property is an inherently permanent structure: (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.[xxvii]

Example. Taxpayer owns an office building with a sculpture in its atrium. The sculpture is very large and very heavy. The building was 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.

A sculpture is not identified as one of the inherently permanent structures enumerated in the regulations; thus, Taxpayer must use the above factors to determine whether the sculpture is an inherently permanent structure.

The sculpture: (A) is permanently affixed to the building; (B) is not designed to be removed but, rather, is designed to remain in place indefinitely; (C) would be damaged if removed, and would damage the building to which it is affixed; and (D) is expected to remain in the building indefinitely; and (E) would require significant time and expense to move. These factors support the conclusion that the sculpture is an inherently permanent structure and, thus, real property.

Example. Taxpayer owns bus shelters, each of which consists of four posts, a roof, and panels enclosing two or three sides. Taxpayer enters into a long-term lease with a local transit authority for use of the bus shelters. Each shelter is prefabricated from steel and is bolted to the sidewalk. Disassembling and 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. The bus shelters are not permanently affixed enclosed transportation stations or terminals, they are not buildings, nor are they listed as inherently permanent structures. Therefore, the bus shelters must be analyzed to determine whether they are inherently permanent structures using the above factors 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. These factors support the conclusion that the bus shelters are not inherently permanent structures and, thus, are not real property.

“Structural Components”

The term “structural component” means any distinct asset that is a constituent part of, and integrated into, an inherently permanent structure. If interconnected assets work together to serve an inherently permanent structure (for example, systems that provide a building with electricity, heat, or water), the assets are analyzed together as one distinct asset that may 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.[xxviii]

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.[xxix]

Example. Taxpayer owns an office building that it leases to tenants. The building includes partitions owned by Taxpayer that are used to delineate space within the building. The office building has an interior, non-load-bearing, conventional drywall partition system. The system was installed during construction of the office building. The conventional system is comprised of fully integrated gypsum board partitions, studs, joint tape, and covering joint compound. It reaches from the floor to the ceiling. In addition, the system is a distinct asset within the meaning of the regulations.

Depending on the needs of a new tenant, the conventional system may remain in place when a tenant vacates the premises. The system is integrated into the office building and is designed and constructed to remain in areas not subject to reconfiguration or expansion. The conventional system can be removed only by demolition, and, once removed, neither the system nor its components can be reused. Removal of the system causes substantial damage to the system itself, but does not cause substantial damage to the building.

The conventional partition system is comprised of walls that are integrated into an inherently permanent structure and are listed as structural components in the regulations. Thus, the conventional partition system is real property.

If a component of a building or inherently permanent structure is a distinct asset and is not listed in the proposed regulations as a structural component, the determination of whether the component is a structural component will be 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.

Intangible Assets?

Having addressed the more conventional meaning of “real property,” the proposed regulations next consider instances in which intangible property may properly be treated as real property for purposes of the like-kind exchange rules.

An intangible asset may be treated as real property, or as an interest in real property, to the extent it derives its value from real property or an interest in real property, is inseparable from that real property or interest in real property, and does not produce or contribute to the production of income other than consideration for the use or occupancy of space.

For instance, a license, permit, or other similar right that is solely for the use, enjoyment, or occupation of land or an inherently permanent structure, and that is in the nature of a leasehold or easement, generally is an interest in real property.[xxx]

Example. Taxpayer receives a special use permit from the government to place a cell tower on Federal 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 Taxpayer if the site is needed for a higher public purpose. The permit is in the nature of a leasehold that allows Taxpayer to place a cell tower in a specific location on government land. Therefore, the permit is an interest in real property.

However, the proposed regulations also provide that a license or permit to engage in or operate a business on real property is not real property or an interest in real property if the license or permit produces or contributes to the production of income other than consideration for the use and occupancy of space.[xxxi]

Personal Property

I know, “personal property?” you say. “What about the TCJA? Aren’t like-kind exchanges now limited to real properties?” Indeed, they are.

The proposed regulations, however, take a practical approach, recognizing there are times when a taxpayer’s acquisition of replacement real property as part of a like-kind exchange may necessarily include the acquisition of some personal property.

According to the proposed regulations, if such personal property is acquired incidentally to the acquisition of replacement real property in a deferred like-kind exchange,[xxxii] its acquisition will be disregarded for purposes of determining whether the taxpayer is in constructive receipt of the funds from the sale of the relinquished property, thereby causing the entire exchange to be taxable. In the absence of such a rule, it may be possible to argue that the use of the sale proceeds to acquire non-qualifying property violates the existing regulatory safe harbors by which a taxpayer in a deferred exchange may avoid claims of constructive receipt of money for purposes of the like-kind exchange rules.[xxxiii]

Under the proposed rules, personal property will be “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 such incidental personal property does not exceed 15 percent of the aggregate fair market value of the replacement real property.

For example, this may include the acquisition of office furniture where an office building is acquired as replacement property as part of a deferred like-kind exchange.[xxxiv]

First Impressions

These proposed regulations will apply to exchanges beginning on or after the date they are published as final regulations. Pending the issuance of final regulations, a taxpayer may rely on these proposed regulations – provided they are followed “consistently and in their entirety” – for exchanges of real property beginning after December 31, 2017, and before the final regulations are published.

Taxpayers and their advisers should welcome the guidance provided by the proposed regulations, as well as the opportunity for relying upon them immediately.

Most of the material presented in the proposed regulations would not be characterized as ground-breaking; nevertheless the regulations confirm the fact-intensive nature of the analysis that has to be undertaken in determining whether a particular property constitutes real property for purposes of the like-kind exchange rules.

In furtherance of this process, the proposed rules remove the uncertainty that may have surrounded the treatment of any of the inherently permanent structures and structural components specifically identified therein; equally important, they also provide a helpful set of general principles and factors for determining the treatment of any items not so described.

Of course, the IRS has requested comments on various parts of the proposed rules. It will behoove the taxpayer to stay attuned to these as they are released, and to review the final rules for any changes.


The “amount realized” by the taxpayer.

[ii] In other words, the amount that remains after the taxpayer’s remaining investment has been returned to them constitutes the realized gain. If the amount realized by the taxpayer is insufficient to restore to the taxpayer their adjusted basis for the property, the taxpayer has sustained a loss.

[iii] What we typically refer to as a “sale.”

[iv] Treas. Reg. Sec. 1.1001-1(a).

[v] IRC Sec. 368.

[vi] IRC Sec. 351 and Sec. 721.

[vii] Reg. Sec. 1.1001-3 (the “Cottage Savings” rules).

[viii] IRC Sec. 1031.

[ix] IRC Sec. 1031(d). Of course, this presumes a value-for-value exchange.

[x] Thus, the proper treatment of such “additional” replacement property as like-kind or not can make a huge difference in the amount of gain recognized by the exchanging taxpayer.

[xi] IRC Sec. 1031(b). The taxpayer’s basis for the replacement property would be increased by the amount of gain so recognized, and reduced by the amount of money received. IRC Sec. 1031(d).

[xii] P.L. 115-97. The “TCJA.”

[xiii] However, an exception is provided for any exchange if the property disposed of by the taxpayer in the exchange was disposed of on or before December 31, 2017, or the property received by the taxpayer in the exchange was received on or before such date.

[xiv] Many other classes of property were already excluded; for example, stocks, bonds, or notes; other securities or evidences of indebtedness; interests in a partnership; certificates of trust or beneficial interests; and choses in action.

[xv] Report 115-466, Sec. 13303. The Joint Committee report doesn’t add much. JCS-1-18.

[xvi] Reg. Sec. 1.1031(a)-1(b).

[xvii] Reg. Sec. 1.1031(a)-1(c).

[xviii] For example, shares in a mutual ditch, reservoir, or irrigation company (described in section 501(c)(12)(A)) 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. The proposed regulations clarify that, with the exception of the foregoing items, local law definitions generally are not controlling in determining the meaning of the term “real property” for purposes of IRC Sec. 1031. Prop. Reg. Sec. 1.1031(a)-3(a)(1). The goal, of course, is to provide uniformity across state lines.

[xix] I prefer saying “Matryoshka” dolls, though there is nothing maternal or familial about these definitions.

[xx] Prop. Reg. Sec. 1.1031(a)-3(a)(4).

[xxi] See Prop. Reg. Sec. 1.1031(a)-3(a)(2)(ii)(A) and Sec. 1.1031(a)-3(a)(2)(iii)(A).

[xxii] Prop. Reg. Sec. 1.1031(a)-3(a)(1).

Yes, the context generally informs you of the meaning, but I looked up “superjacent” anyway. “Lying immediately above or upon something else.” Works for air rights; but water rights? Close enough, I suppose.

[xxiii] Prop. Reg. Sec. 1.1031(a)-3(a)(2)(i).

[xxiv] Prop. Reg. Sec. 1.1031(a)-3(a)(2)(ii)(A).

[xxv] Prop. Reg. Sec. 1.1031(a)-3(a)(2)(ii)(B).

[xxvi] Prop. Reg. 1.1031(a)-3(a)(2)(ii)(C).

The proposed regulations do not explain what it means for a structure to be “affixed,” but they do explain that affixation to real property may be accomplished by weight alone, meaning that something may be too heavy to move. For example, “Lou is affixed to his desk.”

This example is also helpful: Taxpayer 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. The pipelines are permanently affixed and are listed as other inherently permanent structures in the regulations. Thus, the pipelines are real property.

[xxvii] Prop. Reg. Sec. 1.1031(a)-3(a)(2)(ii)(C).

[xxviii] Prop. Reg. Sec. 1.1031(a)-3(a)(2)(iii)(A).

[xxix] Prop. Reg. Sec. 1.1031(a)-3(a)(2)(iii)(B).

[xxx] Prop. Reg. Sec. 1.1031(a)-3(a)(5).

[xxxi] Prop. Reg. Sec. 1.1031(a)-3(a)(5)(ii).

[xxxii] IRC Sec. 1031(a)(3); Reg. Sec. 1.1031(k)-1.

[xxxiii] Prop. Reg. Sec. 1.1031(k)-1(g)(7)(iii). See Reg. Sec. 1.1031(k)-1(g)(6).

[xxxiv] We’ll assume for this purpose that the acquisition of the furniture is industry practice in this type of transaction.