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Final regulations revise Section 1031 real property definition

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November 2020

Overview

Section 1031 provides nonrecognition treatment for certain exchanges of like-kind property.  The 2017 tax reform act (the Act) amended Section 1031, for exchanges completed after December 31, 2017, to limit nonrecognition treatment to exchanges of real property. 

The IRS and Treasury have released final regulations defining ‘real property.’  The final regulations largely adopt the definitions in proposed regulations published in June 2020, with several significant changes.  The proposed regulations are discussed in the Insight Proposed regulations define real property under Section 1031

The final regulations apply to exchanges beginning after the date the regulations are published in the Federal Register.  The preamble to the final regulations provides that taxpayers may apply the proposed regulations for exchanges beginning after December 31, 2017, and before the date the final regulations are published if they apply all the proposed rules consistently. 

The takeaway

The final regulations largely adopt the proposed regulations with minor clarifications and two significant changes, the adoption of the state law definition of real property and the deletion of the purpose or use test.  The adoption of the state law definition of real property may be helpful as state and local law classifications often have been informative in characterizing property as real or personal. The elimination of the purpose or use test is likely to enhance the administrability of the definition of real property. 

President-elect Biden’s campaign tax proposals include a call to eliminate certain 'tax preferences for real estate,' which could include Section 1031 exchanges. The outlook for action on these plans will remain uncertain at least until control of the Senate is settled by the January run-offs in two undecided contests.

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Julanne Allen

Partner, M&A Tax, PwC US

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