[Federal Register Volume 85, Number 114 (Friday, June 12, 2020)]
[Proposed Rules]
[Pages 35835-35846]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-11530]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-117589-18]
RIN 1545-BP02


Statutory Limitations on Like-Kind Exchanges

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: These proposed regulations provide guidance under the Internal 
Revenue Code (Code) to implement recent changes enacted in the Tax Cuts 
and Jobs Act. The proposed regulations amend the existing regulations 
to add a definition of real property to reflect statutory changes 
limiting section 1031 to exchanges of real property. The proposed 
regulations also provide a rule addressing a taxpayer's receipt of 
personal property that is incidental to real property the taxpayer 
receives in the exchange. The proposed 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 for purposes of section 1031.

DATES: Written or electronic comments and requests for a public hearing 
must be received by August 11, 2020. Requests for a public hearing must 
be submitted as prescribed in the ``Comments and Requests for a Public 
Hearing'' section.

ADDRESSES: Commenters are strongly encouraged to submit public comments 
electronically. Submit electronic submissions via the Federal 
eRulemaking Portal at https://www.regulations.gov (indicate IRS and 
REG-117589-18) by following the online instructions for submitting 
comments. Once submitted to the Federal eRulemaking Portal, comments 
cannot be edited or withdrawn. The IRS expects to have limited 
personnel available to process public comments that are submitted on 
paper through mail. Until further notice, any comments submitted on 
paper will be considered to the extent practicable. The Department of 
the Treasury (Treasury Department) and the IRS will publish for public 
availability any comment submitted electronically, and to the extent 
practicable on paper, to its public docket. Send hard copy submissions 
to: CC:PA:LPD:PR (REG-117589-18), Room 5203, Internal Revenue Service, 
P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Edward C. Schwartz, (202) 317-4740; concerning submissions of comments 
and outlines of topics, or requests for a public hearing, Regina L. 
Johnson, (202) 317-5177 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

I. Overview

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1, as revised April 1, 2019) under section 
1031 of the Code (current regulations). The proposed amendments to the 
current regulations (proposed regulations) implement statutory 
amendments to section 1031 made by section 13303 of Public Law 115-97 
(131 Stat. 2054), 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 proposed regulations would limit 
the application of the like-kind exchange rules under section 1031 to 
exchanges 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). However, left unchanged by the TCJA, section 1031(b) 
provides that a taxpayer must recognize gain on the receipt of money 
and non-like-kind property in an exchange.

III. Current Regulations Regarding ``Like Kind''

    Although the TCJA removed personal and certain intangible property 
from eligibility for like-kind exchange treatment, the need to 
determine whether the relinquished real property

[[Page 35836]]

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. Real 
property of one kind or class may not, under section 1031, be exchanged 
for real property of a different kind or class. The fact that any real 
property involved is improved or unimproved is not material, for that 
fact relates only to the grade or quality of the real property and not 
to its kind or class. Under current Sec.  1.1031(a)-1(c), examples of 
exchanges of real property of a like kind include an exchange: By a 
non-dealer of city real estate for a farm or ranch; of improved real 
estate for unimproved real estate; and 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 like-kind property unless, 
within 45 days of the taxpayer's transfer of the relinquished real 
property, the real property is identified as replacement real property 
to be received in the exchange. Under current Sec.  1.1031(k)-1(c)(4), 
the maximum number of properties a taxpayer may identify as replacement 
real property is three properties, without regard to the fair market 
value of the properties, or any number of properties as long as the 
aggregate fair market value of the properties does not exceed 200 
percent of the aggregate fair market value of the relinquished real 
property. Current Sec.  1.1031(k)-1(c)(5) provides that, for purposes 
of the identification rules, property that is incidental to a larger 
item of property is not treated as property separate from the larger 
item 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), if a taxpayer actually or 
constructively receives money or property that is not of a like kind to 
the taxpayer's relinquished real property (other property) before the 
taxpayer receives like-kind replacement real property, gain or loss may 
be recognized. In addition, if the money or other property the taxpayer 
receives is in the full amount of the consideration for the 
relinquished real property, the transaction is a sale and not a 
deferred 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 result in a taxpayer not being considered in actual or 
constructive receipt of money or other 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 qualified 
intermediary is not considered the agent of the taxpayer for purposes 
of section 1031(a) and the determination of whether the taxpayer is in 
actual or constructive receipt of money or other 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, pursuant to the 
requirements of current Sec.  1.1031(k)-1(g)(6)(i), the agreement 
between the taxpayer and the qualified intermediary expressly limits 
the taxpayer's rights to receive, pledge, borrow, or otherwise obtain 
the benefits of money or other property held by the qualified 
intermediary.
    Under current Sec.  1.1031(k)-1(g)(7), in determining whether a 
taxpayer's rights to receive, pledge, borrow, or otherwise obtain the 
benefits of money or other property are expressly limited as provided 
in current Sec.  1.1031(k)-1(g)(6), the taxpayer's receipt of or right 
to receive items that a seller may receive as a consequence of the 
disposition of property and that are not included in the amount 
realized from the disposition of property (for example, prorated rents) 
are disregarded. Also disregarded are transactional items that relate 
to the disposition of the relinquished property or to the acquisition 
of the replacement property and appear under local standards in the 
typical closing statements as the responsibility of a buyer or seller, 
such as commissions, prorated taxes, recording or transfer taxes, and 
title company fees.

Explanation of Provisions

I. Definition of Real Property

A. Approach of the Proposed Regulations
    The determination of whether property is real property has taken on 
additional significance as a result of the TCJA amendments limiting 
like-kind exchange treatment under section 1031 to exchanges of real 
property. Prior to enactment of the TCJA, neither the Code nor the 
Income Tax Regulations provided a definition of the term ``real 
property'' for purposes of section 1031. The Treasury Department and 
the IRS have determined that regulations providing guidance on whether 
property is real property under section 1031 are needed because 
taxpayers need certainty regarding whether any part of the replacement 
property received in an exchange is non-like-kind property subject to 
the gain recognition rules of section 1031(b).
    The legislative history to the TCJA provides that real property 
eligible for like-kind exchange treatment under pre-TCJA law should 
continue to be eligible for like-kind exchange treatment after the 
enactment of the TCJA. The legislative history further provides that 
real property under section 1031 includes shares in a mutual ditch, 
reservoir, or irrigation company described in section 501(c)(12)(A) of 
the Code if the state in which the company is organized views the 
shares of the company as real property. Similarly, improved real estate 
and unimproved real estate are generally considered to be property of a 
like kind. H. Rept. 115-466, at 396, fn. 726 (2017) (Conference 
Report). These proposed regulations define the term ``real property'' 
for purposes of section 1031 in a manner consistent with the scope 
described by Congress in the Conference Report.
    Various Income Tax Regulations provide definitions of real property 
for purposes of applying Code sections other than section 1031. For 
example, Sec.  1.263(a)-3(b) generally defines real property for 
purposes of the requirement to capitalize amounts paid to acquire, 
produce, or improve tangible property under section 263(a) by reference 
to Sec. Sec.  1.48-1(c) and (d). Section 1.263A-8(c) provides a 
definition of real property for purposes of determining whether 
interest expense relating to the production of designated property must 
be capitalized under the rules in Sec.  1.263A-8. Section 1.1250-
1(e)(3) defines real property for purposes of determining depreciation 
or amortization recapture upon the disposition of certain property. 
Specifically, Sec.  1.1250-1(e)(3) uses section 48 principles for the 
definition of real property through its reference to the rules in Sec.  
1.1245-3(c). Section 1.856-10 provides a definition of real property 
for determining whether a corporation qualifies as a real estate 
investment trust (REIT) under sections 856 through 859 of the Code. 
Section 1.897-1(b) defines real property for purposes of section 897, 
which treats gain or loss from a foreign person's disposition of a U.S. 
real property

[[Page 35837]]

interest as income effectively connected with a U.S. trade or business.
    Although there are many similarities in the way various sections of 
the Code, and the regulations under those sections, define ``real 
property,'' there are also differences in those definitions that 
reflect the different purposes underlying those provisions. Certain 
sections of the Code and Income Tax Regulations apply broad definitions 
and sets of rules for the definition of real property, while others 
apply narrower definitions. For example, Sec.  1.1250-1(e)(3) uses a 
narrow definition of real property, which is relied upon for purposes 
of applying section 168 and former section 38. Under section 168, a 
tangible asset that is personal property, as opposed to real property, 
generally is depreciated at a faster rate than real property is 
depreciated. See section 168(c) and (g)(2)(C). Under former section 38, 
the investment tax credit applied to qualified investment in 
depreciable property (section 38 property) described in former section 
48(a), which primarily included tangible personal property and excluded 
real property. See Sec. Sec.  1.48-1(c) and (d). In contrast, section 
897 uses a broad definition of real property that includes items of 
personal property that are associated with the use of real property. 
See section 897(c)(6)(B) (real property includes movable walls, 
furnishings, and other personal property associated with the use of the 
real property). Under section 897, an item of property may be treated 
as a U.S. real property interest under the Foreign Investment in Real 
Property Act provisions, notwithstanding that it is characterized as 
personal property for other purposes of the Code. In the context of 
REITs under sections 856 through 859, the regulations defining real 
property set forth a broader definition for purposes of satisfying the 
REIT quarterly asset test. The regulations under section 856 were based 
in part on the particular policies underlying the REIT provisions, and 
apply only for purposes of the REIT provisions.
    The Treasury Department and the IRS have concluded that it would 
not be appropriate to adopt wholesale as the definition of real 
property for purposes of section 1031 an existing definition of real 
property from another section of the Code or regulations due to the 
varying purposes of each of the provisions of the Code, and the intent 
of Congress that real property eligible for like-kind exchange 
treatment under pre-TCJA law should continue to be eligible for like-
kind exchange treatment in years beginning after 2017. Using the 
definition of real property in Sec.  1.263(a)-3(b), Sec.  1.263A-8(c), 
Sec.  1.1250-1(e), or other regulations discussed in this Explanation 
of Provisions, would be inappropriate because, for example, certain 
shares in a mutual ditch, reservoir, or irrigation company are real 
property eligible for like-kind exchange treatment under pre-TCJA law, 
but would not be real property under some of the other regulations. 
Similarly, Sec.  1.856-10 provides that property having an active 
function such as producing, manufacturing, or creating a product is not 
real property under section 856, but nothing in pre-TCJA section 1031 
law suggests that real property held for productive use in a trade or 
business or for investment should necessarily be excluded from the 
definition of real property because of an active rather than passive 
function.
    Thus, instead of a wholesale adoption of an existing real property 
definition used in another Code or regulations section, these proposed 
regulations incorporate certain aspects from existing regulatory 
definitions of real property that are consistent with the legislative 
history underlying the TCJA amendment to section 1031 indicating that 
real property eligible for like-kind exchange treatment under pre-TCJA 
law should continue to be eligible for like-kind exchange treatment 
after the enactment of the TCJA. 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, and providing 
that local law is not controlling for purposes of determining whether 
property is real property under that section; 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.
B. Proposed Definition of Real Property
    Under the proposed regulations, real property includes land and 
improvements to land, unsevered crops and other natural products of 
land, and water and air space superjacent to land. Improvements to land 
include inherently permanent structures and the structural components 
of inherently permanent structures. The proposed regulations also 
provide that local law definitions generally are not controlling in 
determining the meaning of the term ``real property'' for purposes of 
section 1031. This real property definition language is very similar to 
the language in most of the other regulatory provisions previously 
mentioned, including the regulations under section 48, section 263(a), 
and section 263A. The definition under the proposed regulations, 
however, includes differences necessary for the proper application of 
section 1031.
    These proposed regulations provide that each distinct asset must be 
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. Items that are specifically listed in these 
proposed regulations as buildings and other inherently permanent 
structures are distinct assets. Assets and systems specifically listed 
in these proposed regulations as types of structural components also 
are treated as distinct assets. Other distinct assets are identified 
using factors provided by these proposed regulations. All listed 
factors must be considered, and no one factor is determinative. These 
rules are based on similar rules concerning distinct assets in Sec.  
1.856-10(e).
    The proposed regulations provide that inherently permanent 
structures include any building or other structure that is permanently 
affixed to real property and that will ordinarily remain affixed for an 
indefinite period of time. 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. ``Buildings'' also 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. The definition of building and the examples of buildings in the 
proposed regulations are derived from Sec.  1.48-1(e)(1) and Sec.  
1.856-10(d)(2)(ii)(B).
    The proposed regulations also provide a list of structures that 
qualify as inherently permanent structures. If property is not included 
in the list of inherently permanent structures, the proposed 
regulations provide factors that must be used to determine whether the 
property is an inherently permanent structure for purposes of section 
1031. These factors are similar to the factors in Sec.  1.856-
10(d)(2)(iv).
    Under the proposed regulations, property that is in the nature of

[[Page 35838]]

machinery or is essentially an item of machinery or equipment is 
generally not an inherently permanent structure and not real property 
under section 1031. In the case, however, of a building or inherently 
permanent structure that includes property in the nature of machinery 
as a structural component, the machinery is real property if it serves 
the inherently permanent structure and does not produce or contribute 
to the production of income other than for the use or occupancy of 
space. These rules regarding machinery are very similar to the rules in 
Sec.  1.263A-8(c)(4) and Sec.  1.856-10(d)(3).
    Under the proposed regulations, structural components of inherently 
permanent structures are improvements to land and thus real property 
for purposes of section 1031. A structural component is 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 qualify as a structural 
component. For example, a gas line that provides fuel to a building's 
heating system comprises a part of the structural component that is the 
heating system, and therefore qualifies as real property for section 
1031 purposes. However, if the purpose of a gas line is to provide fuel 
to business equipment in a building, such as fryers and ovens in a 
building utilized as a restaurant, the gas line is not a constituent 
part of an inherently permanent structure and therefore not real 
property for section 1031 purposes. Comments are requested on whether 
the function of a distinct asset that is not machinery is appropriate 
to use as the basis for determining whether the asset qualifies as real 
property for section 1031 purposes.
    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 within the physical space of the inherently 
permanent structure served by the structural component. If a distinct 
asset is customized in connection with the rental of space in or on an 
inherently permanent structure to which the asset relates, the 
customization does not affect whether the distinct asset is a 
structural component.
    The proposed regulations also contain a list of properties that are 
structural components for purposes of section 1031. For components not 
included in the list, the proposed regulations provide factors for 
determining whether the component is a structural component of a 
building or inherently permanent structure and thus real property for 
section 1031 purposes. The proposed regulations also address tenant 
improvements to a building that are inherently permanent or otherwise 
classified as real property and property produced for sale that is not 
real property in the hands of the producing taxpayer or a related 
person. The rules in the proposed regulations relating to structural 
components are similar to the rules in many of the other regulations 
discussed in this preamble.
    The proposed regulations provide that unsevered natural products of 
land generally are treated as real property under section 1031. This 
includes growing crops, plants, and timber; mines; wells; and other 
natural deposits. 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.
    The proposed regulations also address instances in which intangible 
property is considered real property under section 1031. An intangible 
asset is real property or an interest in real property for purposes of 
section 1031 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, easement, or fee ownership, generally is an interest in real 
property for purposes of section 1031.
    Under the proposed regulations, a license or permit to engage in or 
operate a business on real property is not real property or an interest 
in real property for purposes of section 1031 if the license or permit 
produces or contributes to the production of income other than 
consideration for the use and occupancy of space. The rules in the 
proposed regulations relating to intangible assets are similar to the 
rules in Sec.  1.856-10(f) and are consistent with pre-TCJA law 
concerning whether an intangible asset is real property for section 
1031 purposes. See Commissioner v. Crichton, 122 F.2d 181 (5th Cir. 
1941), concluding that an interest in mineral rights is real property 
for section 1031 purposes, Peabody Natural Resources Co. v. 
Commissioner, 126 T.C. 261 (2006), holding that coal supply contracts 
were real property for section 1031 purposes, and Rev. Rul. 68-331, 
1968-1 C.B. 352, holding that the interest of a lessee in a producing 
oil lease is an interest in real property for section 1031 purposes.
    These proposed regulations define real property only for purposes 
of section 1031. Consequently, the proposed regulations provide that no 
inference should be drawn from the section 1031 definition of real 
property for any purpose outside of section 1031, including for the 
classification of property for depreciation, whether depreciation 
recapture applies, or defining an asset for disposition purposes under 
section 168 and the regulations under section 168.
    The Treasury Department and the IRS request comments regarding the 
definition of real property set forth in these proposed regulations. In 
particular, the Treasury Department and the IRS request comments 
regarding the proposed relevant factors and analysis for determining 
the qualification of an item as real property.

II. Incidental Personal Property

    The Treasury Department and the IRS are aware that taxpayers have 
questioned the effect of the receipt of personal property that is 
incidental to the taxpayer's replacement real property in an intended 
section 1031 exchange. For example, taxpayers have asked whether an 
exchange fails to meet the requirements of Sec.  1.1031(k)-1(g)(6)(i) 
if funds from the transfer of relinquished property held by the 
qualified intermediary are used to acquire an office building, 
including the personal property in the office building. Taxpayers and 
qualified intermediaries are concerned 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. Under 
Sec.  1.1031(k)-1(a), if a taxpayer actually or constructively receives 
the funds held by a qualified intermediary before receiving the 
replacement property, the transaction is a sale and not a section 1031 
like-kind exchange.
    In response to these inquiries, the proposed regulations add to the 
items in Sec.  1.1031-1(g)(7) that are disregarded in determining 
whether the agreement between the taxpayer and the qualified 
intermediary expressly limits the taxpayer's rights to receive, pledge, 
borrow, or otherwise obtain the benefits of money or other property 
held by the qualified intermediary. The proposed

[[Page 35839]]

regulations provide that personal property that is incidental to 
replacement real property is disregarded in determining whether a 
taxpayer's rights to receive, pledge, borrow, or otherwise obtain the 
benefits of money or other property held by a qualified intermediary 
are expressly limited as provided in Sec.  1.1031(k)-1(g)(6). 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 regulations 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).
    The Treasury Department and the IRS request comments regarding the 
proposed treatment of a taxpayer's receipt of personal property that is 
incidental to the taxpayer's replacement real property in an intended 
section 1031 exchange. In addition, the Treasury Department and the IRS 
request comments regarding the two-factor analysis for determining 
whether personal property is incidental to real property acquired in 
such an exchange. In particular, comments are requested with regard to 
the appropriateness of the proposed 15-percent fair market value limit 
set forth in that test for personal property transferred with real 
property.

III. Outdated Regulations

    The Treasury Department and the IRS request comments regarding 
whether existing regulations under section 1031 that apply to tax years 
before the TCJA amendments to section 1031 limiting its application to 
exchanges of real property should be removed.

Proposed Applicability Date

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

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 significant 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 has designated these 
regulations as significant under section 1(b) of the MOA. Accordingly, 
the OMB has reviewed these 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 13301 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. Proposed Regulations
    The proposed 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. H. Rept. 115-466, at 396, fn. 726 (2017). Therefore, the 
Treasury Department and the IRS propose to extract certain portions of 
the definition of real property from various existing regulations that 
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, and providing 
that local law is not controlling for purposes of determining whether 
property is real property; 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.'' Consistent with 
these existing regulations, the proposed regulations define real 
property to include land and improvements to land, unsevered crops and 
other natural products of land, and water and air space superjacent to 
land. Improvements to land include inherently permanent structures, and 
the structural components of inherently permanent structures.
    The proposed regulations also include a separate rule relating to 
personal property in an exchange that is incidental to the real 
property exchanged. 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 regulations is based on an existing rule in the regulations 
under 1031, which provides that certain incidental property is ignored 
in determining whether a taxpayer has properly identified replacement 
property.
3. No-Action Baseline
    The Treasury Department and the IRS have assessed the benefits and 
costs of these proposed regulations relative to a no-action baseline 
reflecting anticipated Federal income tax-related behavior in the 
absence of these proposed regulations.
4. Economic Analysis of Regulation
    In general, the proposed regulations use existing definitions of 
real property

[[Page 35840]]

in the Income Tax Regulations to define real property under section 
1031 so that like-kind exchanges of real property that took place prior 
to the TCJA would qualify for like-kind exchange treatment after the 
passage of the TCJA, which is consistent with the legislative history 
of the TCJA. In addition, taxpayers are familiar with the approach in 
the proposed regulations concerning incidental personal property, which 
is consistent with rules regarding identification of replacement 
property under existing section 1031 regulations.
    The statutory changes made by the TCJA to section 1031 limit like-
kind exchanges to real property. 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 proposed regulations disregard certain 
incidental personal property. Specifically, the proposed 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 non-like-kind property. The proposed 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 in excess of 15 percent, the Treasury 
Department 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 has 
determined that the burden of accurately measuring the separate costs 
of comingled personal and real property would increase.
    In addition, the proposed 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 acquired after September 27, 
2017, and placed in service after September 27, 2017, and generally 
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. The Treasury Department requests comments and 
information that would help further inform the analysis underlying the 
proposed 15-percent limitation for incidental personal property.
    The Treasury Department and the IRS have determined that these 
rules will not have a significant effect on the market for like-kind 
exchanges of real property. Finally, these proposed 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 proposed 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 proposed 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 
proposed 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 
proposed 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 proposed 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 proposed regulations. Those estimates would 
capture both changes made by the TCJA and those that arise out of 
discretionary authority exercised in the proposed regulations.
    The current status of the Paperwork Reduction Act submissions 
related to 1031 is provided in the following table. The 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 1031 requirements. These numbers are 
therefore unrelated to the future calculations needed to assess the 
burden imposed by the proposed 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 Act. The Treasury Department and the

[[Page 35841]]

IRS request comments on all aspects of information collection burdens 
related to the proposed 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
                                                    9/30/19 (84 FR
                                                    51712). Public
                                                    Comment period
                                                    closed on 11/29/19.
                                                    Thirty-day notice
                                                    published in the
                                                    Federal Register on
                                                    12/18/19 (84 FR
                                                    69458). Comment
                                                    period closed on 1/
                                                    17/20. Approved by
                                                    OMB through 1/31/
                                                    2021.
------------------------------------------------------------------------
 Link: https://www.federalregister.gov/documents/2019/12/18/2019-27285/agency-information-collection-activities-submission-for-omb-review-comment-request-us-individual.
------------------------------------------------------------------------

    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 proposed 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 proposed 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 proposed 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 other 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 proposed 
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 proposed 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 proposed regulations use 
certain aspects from existing regulatory definitions of real property 
that are 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 proposed 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 proposed 
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 proposed 
regulations is unknown but likely substantial because like-kind 
exchange are entered into by entities of all sizes. Although a 
substantial number of small entities is potentially affected by these 
proposed regulations, the Treasury Department and the IRS have 
concluded that the proposed regulations will not have a significant 
economic impact on a substantial number of small entities because the 
costs to comply with these proposed 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 proposed regulations. Thus, taxpayers 
that engage in like-kind exchanges of real property in 2018 and later 
years won't have any additional burden as compared to taxpayers 
engaging in like-kind exchanges in years before 2018. Accordingly, it 
is hereby certified that these proposed regulations will not have a 
significant economic impact on a substantial number of small entities.
    Notwithstanding this certification, the Treasury Department and the 
IRS invite comments from the public about the impact of this proposed 
rule on small entities.
    Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

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 2019, that threshold is approximately $164 million. This 
proposed 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

[[Page 35842]]

law, unless the agency meets the consultation and funding requirements 
of section 6 of the Executive Order. This proposed 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.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ADDRESSES heading. 
The Treasury Department and the IRS request comments on all aspects of 
the proposed rules. Any electronic comments submitted, and to the 
extent practicable any paper comments submitted, will be made available 
at http://www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person who timely submits electronic or written comments. Requests for 
a public hearing are also encouraged to be submitted electronically. If 
a public hearing is scheduled, notice of the date and time for the 
public hearing will be published in the Federal Register. Announcement 
2020-4, 2020-17 IRB 1, provides that until further notice, public 
hearings conducted by the IRS will be held telephonically. Any 
telephonic hearing will be made accessible to people with disabilities.

Drafting Information

    The principal author of these proposed regulations is Edward C. 
Schwartz 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.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be 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 [EFFECTIVE DATE OF THE FINAL RULE]. 
Paragraph (e)(2)(viii)(A) of this section as contained in 26 CFR part I 
edition revised as of April 1, 2019, applies before the effective date 
of the final rule.
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 the sentence in 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 [EFFECTIVE DATE OF THE FINAL RULE]. Paragraph 
(c)(4)(i) of this section as contained in 26 CFR part I edition revised 
as of April 1, 2019, applies before the effective date of the final 
rule.
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 on or after [EFFECTIVE DATE 
OF THE FINAL RULE].
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 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 interest in real property of a type described in this 
paragraph (a)(1), 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 and this section. Except 
for a state's characterization of shares in a

[[Page 35843]]

mutual ditch, reservoir, or irrigation company described in paragraph 
(a)(5)(i) of this section, local law definitions are not controlling 
for purposes of determining the meaning of the term real property under 
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 structures 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.
    (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 this paragraph (a)(2)(ii) 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 
drilling platforms, derricks, oil and gas storage tanks; grain storage 
bins and silos; and enclosed transportation stations and terminals. 
Affixation to real property may be accomplished by weight alone. If 
property is not listed as an inherently permanent structure in this 
paragraph (a)(2)(ii)(C), the determination of whether the property is 
an inherently permanent structure under this paragraph (a)(2)(ii) 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.
    (D) Machinery. Property that is in the nature of machinery or is 
essentially an item of machinery or equipment is generally not an 
inherently permanent structure and not real property for purposes of 
this section. In the case, however, of a building or inherently 
permanent structure that includes property in the nature of machinery 
as a structural component, the machinery is real property provided it 
serves the inherently permanent structure and does not produce or 
contribute to the production of income other than for the use or 
occupancy of space.
    (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. 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;

[[Page 35844]]

    (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 impairs the functionality of the larger asset.
    (5) Intangible assets--(i) In general. To the extent an intangible 
asset 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, the 
intangible asset is real property or an interest in real property. Real 
property includes shares in a mutual ditch, reservoir, or irrigation 
company described in section 501(c)(12)(A) if, at the time of the 
exchange, the 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.
    (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 or easement 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 if the license or permit produces or contributes to the 
production of income other than consideration for the use and occupancy 
of space.
    (6) 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.
    (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; and
    (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 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. (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 
in a backup capacity. The 3D printer weighs 12 tons and is designed 
to remain in place indefinitely once installed in 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.
    (ii) The 3D printer is machinery and, thus, generally not an 
inherently permanent structure and not real property under paragraph 
(a)(2)(ii)(D) of this section. In addition, although permanently 
affixed by virtue of its weight and installed during construction of 
E's building, the 3D printer produces income other than for the use 
or occupancy of space. Thus, the 3D printer is not property in the 
nature of machinery as a structural component within the meaning of 
paragraph (a)(2)(ii)(D) of this section and, therefore, is not real 
property.
    (iii) The electrical generator serves the entire building and 
does not generate income

[[Page 35845]]

other than for the use or occupancy of the building. Thus, the 
electrical generator is property in the nature of machinery as a 
structural component within the meaning of paragraph (a)(2)(ii)(D) 
of this section and, therefore, is real property.
    (6) Example 6: Generator for Industrial 3D Printer. The facts 
are the same as in paragraph (b)(5), Example 5, except that E 
installed the electrical generator for the purpose of keeping the 
industrial 3D printer operating in the event of a power outage. The 
generator, itself machinery, was installed to serve the operation of 
machinery and not the building. Thus, the electrical generator is 
not a structural component within the meaning of paragraphs 
(a)(2)(ii)(D) and (a)(2)(iii)(A) of this section and, therefore, is 
not real property.
    (7) Example 7: 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) The raised flooring 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 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 under this section.
    (8) Example 8: 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.
    (ii) The steam turbine is machinery and, therefore, generally is 
not an inherently permanent structure and not real property under 
paragraph (a)(2)(ii)(D) of this section. Although the steam turbine 
has characteristics of a structural component because it is 
permanently affixed, installed during construction of F's building, 
and serves F's building, the steam turbine is machinery that 
produces income other than for the use or occupancy of space. Thus, 
the steam turbine is not an inherently permanent structure within 
the meaning of paragraph (a)(2)(ii)(D) of this section and, 
therefore, is not real property.
    (9) Example 9: 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 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 building 
within the meaning of paragraph (a)(2)(iii) of this section. 
Therefore, the Modular Partition System is not real property.
    (10) Example 10: 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) 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.

[[Page 35846]]

    (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. Although the meters 
and compressors were installed during the construction of the 
pipelines, they 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. 
Thus, the meters and compressors are not structural components 
within the meaning of paragraph (a)(2)(iii) of this section and, 
therefore, are not real property.
    (11) Example 11: Land use permit. J 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 J if the site 
is needed for a higher public purpose. The permit is in the nature 
of a leasehold that allows J 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. K 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. K's building is an inherently 
permanent structure under paragraph (a)(2)(ii)(A) of this section 
and, therefore, is real property. However, K's license to operate a 
casino is not a right for the use, enjoyment, or occupation of K's 
building, but is rather a license to engage in the business of 
operating a casino in the building for the production of income. 
Therefore, the casino license is not real property under paragraph 
(a)(5) of this section.

    (c) Applicability date. This section applies to exchanges of real 
property beginning on or after [EFFECTIVE DATE OF THE FINAL RULE].
0
Par. 7. Section 1.1031(k)-1 is amended by:
0
1. Removing ``, and'' at the end of paragraph (g)(7)(i) and adding a 
semicolon in its place;
0
2. Removing the period at the end of paragraph (g)(7)(ii) and adding 
``; and'' in its place;
0
3. Adding paragraph (g)(7)(iii);
0
4. In paragraph (g)(8), designating Examples 1 through 5 as paragraphs 
(g)(8)(i) through (v), respectively;
0
5. Further redesignating newly redesignated paragraphs (g)(8)(i)(i) and 
(ii) as paragraphs (g)(8)(i)(A) and (B);
0
 6. Further redesignating newly redesignated paragraphs (g)(8)(i)(A)(A) 
and (B) as paragraphs (g)(8)(i)(A)(1) and (2), respectively;
0
7. Designating the undesignated paragraph immediately following newly 
redesignated paragraph (g)(8)(i)(A)(2) as paragraph (g)(8)(i)(A)(3);
0
8. Further redesignating newly redesignated paragraphs (g)(8)(ii)(i) 
through (iii) as paragraphs (g)(8)(ii)(A) through (C);
0
 9. Further redesignating newly redesignated paragraphs 
(g)(8)(ii)(A)(A) through (C) as paragraphs (g)(8)(ii)(A)(1) through 
(3);
0
 10. Further redesignating newly redesignated paragraphs 
(g)(8)(ii)(A)(1)(1) and (2) as paragraphs (g)(8)(ii)(A)(1)(i) and (ii), 
respectively;
0
11. In newly redesignated paragraph (g)(8)(ii)(A)(1)(i), removing ``, 
or'' at the end of the paragraph and adding ``; or'' in its place;
0
12. Designating the undesignated paragraph immediately following newly 
redesignated paragraph (g)(8)(ii)(A)(3) as paragraph (g)(8)(ii)(A)(4); 
and
0
13. Further redesignating newly redesignated paragraphs (g)(8)(iii)(i) 
through (v) as paragraphs (g)(8)(iii)(A) through (E), respectively;
0
 14. Further redesignating newly redesignated paragraphs (g)(8)(iv)(i) 
through (iii) as paragraphs (g)(8)(iv)(A) through (C), respectively;
0
15. Further redesignating newly redesiganted paragraphs (g)(8)(v)(i) 
through (iii) as paragraphs (g)(8)(v)(A) through (C), respectively;
0
 16. In newly redesiganted paragraph (g)(8)(v)(B), removing 
``(g)(4))(i)'' and adding ``(g)(4)(i)'' in its place; and
0
 17. Adding paragraphs (g)(8)(vi) and (g)(9).
    The additions read as follows:


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

* * * * *
    (g) * * *
    (7) * * *
    (iii) Personal property 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 incidental personal 
property transferred with the real property does not exceed 15 percent 
of the aggregate fair market value of the replacement real property.
* * * * *
    (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 other 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 on or after [EFFECTIVE DATE 
OF THE FINAL RULE].
* * * * *

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2020-11530 Filed 6-11-20; 8:45 am]
BILLING CODE 4830-01-P