Like-Kind Real Estate



In order to have a successful 1031 tax deferred exchange, an investor must trade relinquished property for “like-kind” replacement property.  The like-kind requirement for real property is very broad.  For example, improved property and unimproved property are considered like-kind for purposes of an exchange.  Similarly, commercial property can be exchanged for residential property; a 30-year lease can be exchanged for a fee interest; or a single-family home can be exchanged for multiple retail centers. Generally, any real estate can be exchanged for any other real estate, as long as it is held for investment purposes or used in connection with the owner’s business.

In several recent Private Letter Rulings (“PLR”), the IRS has held that certain intangible rights relating to a real property interest are like-kind to real property.  Additionally, Congress recently passed the Food, Conservation, and, Energy Act of 2008, otherwise known as the “Farm Bill,” which expands the scope of like-kind property to include stock in certain types of companies.  The rulings and the Farm Bill are discussed in greater detail below.




In PLR 2006-49028, the IRS held that a stewardship easement was like-kind to a fee interest in real estate.  The IRS based its decision on the fact that the stewardship easement was considered an interest in real property under state law and that the easement was perpetual.  The ruling also discussed that the sale of the easement significantly and permanently restricted the future use of the taxpayer’s property such that the fair market value of the property, if sold, would be impaired.   


The transaction discussed in this PLR was somewhat unique in its structure.  First, the taxpayer conveyed the relinquished property by granting the county a perpetual restrictive stewardship easement over his ranch in return for a certain amount of stewardship credits.  The value of the credits was equal to the value of the property rights that the taxpayer permanently relinquished to the county.  During the exchange period, the taxpayer converted the credits to cash by selling them to a third party buyer.  The cash was then used to purchase the replacement fee interest.  The taxpayer structured the transaction by entering into an exchange agreement with a qualified intermediary prior to his disposal of the relinquished property and assigning the qualified intermediary its rights under all of the applicable contracts with the county, the third party buyer and the seller of the replacement property.  The taxpayer never had actual or constructive receipt of the credits or the relinquished property proceeds during the exchange period. The IRS held that this structure did not disqualify the transaction from 1031 tax deferral treatment.




More recently, in PLR 2008-05012 and PLR 2009-01020, the IRS determined that certain development rights were like-kind to a fee interest. The first ruling involved transferable development rights (“TDRs”).  TDRs are a development tool that allows a landowner who cannot or does not want to develop further improvements on their property to sell the development rights associated with that property to other land owners who need those development rights in order to expand the development capacity on their property. In this PLR, the taxpayer sold a piece of property and used the exchange proceeds to purchase TDRs. The development rights were then used to construct improvements on land already owned by the taxpayer.  In its decision, the IRS reasoned that the development rights were considered real property under state law and the rights were perpetual in nature; meaning that the rights would never expire.  Interestingly, the IRS did not seem concerned that the development rights would be transferred to a property already owned by the taxpayer.


PLR 2009-01020 involved a taxpayer who was in contract to sell land that included certain residential density development rights.  The taxpayer also had certain development rights on other land that it owned. The taxpayer wanted to sell its development rights (those attached to the sale property and the others attached to other property) to the buyer and complete an exchange by trading into real estate, a 30 year ground lease, and other development rights that would be transferred from the buyer.  The IRS ruled that the development rights owned by the taxpayer were like-kind to real estate and that the transaction would be a valid exchange. 




Generally speaking, shares of stock are not eligible for tax deferred treatment in a 1031 exchange.  However, the most recent Farm Bill passed by Congress included a provision that adds a new section to IRC Section 1031.  The new section, 1031(i), provides that stock in mutual ditch, reservoir and irrigation companies is eligible property for exchanges. The mutual ditch, reservoir or irrigation company must be an organization described under IRC Section 501(c)(12)(A), and the shares of such company must have been recognized by the highest court of the state in which such company is organized as constituting or representing real property or an interest in real property.  If these criteria are met, the stock will be considered like-kind to real estate.


The Farm Bill, coupled with the PLRs discussed above, add new types of property to the growing list of property rights (including long term ground leases, easements, right of ways, mineral rights and water rights) that the IRS may view as like-kind to real estate.


References: Internal Revenue Code 1031; Food, Conservation, and Energy Act of 2008; PLR 2006-49028; PLR 2008-05012; PLR 2009-01020.