By Tom Ochsenschlager, JD, CPA
Last month, the IRS issued final regulations (TD 9935) explaining the limitations on like-kind exchanges that were imposed in the Tax Cuts and Jobs Act (TCJA). The TCJA limited the ability to qualify for a tax-free exchange under Section 1031 to exchanges of real property. Accordingly, exchanges of personal or intangible property that qualified for tax-free exchange prior to the TCJA no longer do.
In addressing the TCJA limitation, the proposed regulations limited the definition of real property to land, buildings and their permanent structural components and provided a “purpose or use test” that excluded incidental property located within the real property that was unrelated to the use or occupancy of the property such as machinery and equipment.
The final regulations revoke the purpose or use test, thereby expanding the definition of real property to include property held for the productive use in a trade or business. Additionally, the proposed regulations provide that even property not considered real property under state law may qualify based on the facts and circumstances. However, it is clear in the regulations that regardless of state law definition of real property, intangibles such as artwork, patents, intellectual property, stock in a corporation and a partnership interest do not qualify as assets eligible for tax-free exchange.
The final regulations are generally effective for exchanges of real property completed after Dec. 31, 2017. An amended return may be necessary to take advantage of the expanded definition of property now eligible for exchanges that occurred in 2018 and 2019 that did not qualify under the proposed regulations.