IRS Issued Final Regulations on Sec. 1031 Like-Kind Exchanges, Provides Definition of Real Property, Addresses Taxpayer’s Receipt of Personal Property Incidental to Real Property

IRS Issued Final Regulations on Sec. 1031 Like-Kind Exchanges, Provides Definition of Real Property, Addresses Taxpayer’s Receipt of Personal Property Incidental to Real Property

by:

Alex Bagne, JD, CPA, MBA, CCSP – President of ICS Tax, LLC

Kevin Johnson, CCSP, LEED AP – Midwest Practice Leader

John Walgrave, CCSP, LEED Green Associate – Central Practice Leader

The IRS released final regulations providing guidance under IRC Sec. 1031 that define real property to implement recent changes for like-kind exchanges. Sec. 1031 allows for the deferral of gain recognition on the sale of business property if the relinquished property is replaced with “like-kind” property. Prior to the Tax Cuts and Jobs Act (TCJA), both personal property and real property qualified for like-kind exchange treatment, but now only real property qualifies.

Confusion arose for real estate investors who sought to accelerate the timing of tax deductions through cost segregation. The primary purpose of a cost segregation study is to identify components of real property that may be reclassified and depreciated under Sec. 168 rules generally applicable to personal property, which permit rapid depreciation and accelerated deductions. The concern was whether the elements of real property segregated from basic land and buildings were also eligible for deferral of gain under Sec. 1031 by remaining classified as real property under that tax provision.

The final regulations make clear that classification as Sec. 168 property does not preclude treatment of property as real property for Section 1031 purposes, providing that different principles apply to classification under the two sections.  Thus, cost segregation studies are not inconsistent with Sec. 1031 exchanges, although certain recapture rules under Sec 1245 and 1250 must still be taken into account.   The final rules also discard an element of the earlier proposed rules which would have denied real property classification to certain assets used to produce goods or services, such as gas lines serving restaurant equipment.  This change will allow such assets to be the subject of cost segregation without creating adverse effects under Sec. 1031.

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