What Qualifies as "Real Property" After the 2020 Final Regulations?
The Tax Cuts and Jobs Act of 2017 eliminated like-kind exchanges for personal property, limiting Section 1031 to real property only. This raised a critical question: what exactly is "real property"?
The 2020 Final Regulations (Statutory Limitations on Like-Kind Exchanges, T.D. 9935) provide welcome clarity – and the definition is broader than many investors realize.
The Core Categories
Land – Land itself is, of course, the quintessential real property. Fee simple ownership of land – whether vacant, improved, agricultural, or commercial – clearly qualifies for Section 1031 treatment. This includes all natural characteristics of the land such as topography, soil, and location.
Inherently Permanent Structures – Buildings, parking facilities, bridges, tunnels, and other permanently affixed improvements. The regulations establish a facts-and-circumstances test considering factors like the manner of affixation, whether the structure is designed to be moved, and the time and expense required for removal.
Structural Components – Items that are part of the structure itself, including walls, floors, ceilings, HVAC systems, plumbing, electrical systems, and even some fixtures.
Unsevered Natural Products – Growing crops, timber, and minerals still in the ground qualify as real property.
Intangible Interests in Real Property – This is where it gets interesting for sophisticated investors.
Intangible Real Property Interests: Often Overlooked Opportunities
The regulations confirm that the following intangible interests qualify as real property for Section 1031 purposes:
Fee Ownership and Co-Ownership Interests – Standard ownership, tenancy in common, and similar arrangements.
Leasehold Interests (30+ Years Remaining) – A lease with 30 or more years remaining (including renewal options) is treated as real property. This opens significant planning opportunities.
Options to Acquire Real Property – The right to purchase land or improvements qualifies.
Easements – Both appurtenant and in gross easements are real property interests.
Cell Tower Leaseholds: A Growing Opportunity
With the expansion of 5G networks, cell tower ground leases have become valuable assets. Under the 2020 regulations, these interests can qualify for 1031 treatment:
Lessee's Leasehold Interest – If you hold a leasehold interest in a cell tower site (as the lessee) and your lease has 30+ years remaining (including renewal options), you can exchange out of that leasehold position. The 30-year rule from the regulations treats long-term leaseholds as real property for Section 1031 purposes. This applies whether you're the original lessee or an investor who purchased the lease rights.
Landowner's Fee Interest – If you own the underlying land (as lessor) and sell it subject to an existing cell tower lease, you're selling fee simple real property – which unquestionably qualifies for 1031 treatment regardless of the lease term.
Selling a Perpetual Easement – Many tower companies now purchase perpetual easements rather than lease. These easements clearly qualify as real property under the regulations.
The "License" Trap – Be careful: if your agreement is structured as a revocable license rather than a lease or easement, it may not qualify. Review the document's legal characterization, not just its title.
Practical Application: A lessee holding a cell tower ground lease with 30+ years remaining sells that leasehold interest for $500,000. Because the leasehold qualifies as real property under the regulations, they can exchange into other real property – an apartment building, farmland, or even another cell tower lease – and defer the entire gain.
Development Rights and Air Rights
Development rights represent a particularly valuable form of real property, especially in urban areas and regulated markets:
Transferable Development Rights (TDRs) – Many jurisdictions allow the transfer of development rights from one parcel to another. Under the 2020 regulations, these rights qualify as real property because they derive their value from real property and are inseparable from an interest in real property.
Air Rights – The right to develop or use the space above a property is a real property interest. This is common in urban development where air rights above rail yards, parking structures, or existing buildings are sold separately.
Conservation and Agricultural Easements – When you sell a conservation easement or agricultural preservation easement, you're selling a real property interest. The proceeds can be exchanged into other real property.
Density Bonuses and Zoning Entitlements – Depending on how they're structured, these may qualify if they're tied to specific real property interests rather than mere governmental permissions.
Practical Application: A developer who sells TDRs for $2 million can exchange into income-producing property, deferring gain that would otherwise be taxed at federal rates up to 23.8% (plus state taxes).
Water Rights: Critical for Agricultural Investors
In the arid West, water rights are often more valuable than the land itself. The 2020 regulations provide important guidance:
Appurtenant Water Rights – Water rights that attach to and run with specific land clearly qualify as real property. When you sell irrigated farmland, the appurtenant water rights are part of the real property being exchanged.
Water Rights Sold Separately – This is where careful analysis is required. Under Treasury Regulation § 1.1031(a)-3(a)(5), an intangible asset qualifies as real property if: - State or local law characterizes it as real property, OR - It derives its value from real property or an inherent permanent structure and is inseparable from that real property
Many states (including Washington, California, Oregon, and Idaho) treat water rights as real property under state law, which satisfies the first test.
Types of Water Rights That May Qualify: - Riparian rights (rights to use water from adjacent streams) - Appropriative rights (rights based on beneficial use, common in Western states) - Groundwater rights (rights to pump from aquifers) - Irrigation district shares (depending on structure)
Practical Application: A farmer selling 100 acres of irrigated farmland with senior water rights worth $1.5 million can exchange into other agricultural property, a commercial building, or even water rights appurtenant to different land – deferring the entire gain.
Rights of Interest to Apple Farmers and Agricultural Operations
For orchardists, row crop farmers, and other agricultural operators in Washington's apple-growing regions (Wenatchee, Yakima Valley) and beyond, several real property interests deserve attention:
Orchard Land with Established Trees – Growing crops that are "unsevered natural products" are real property. Apple trees, grape vines, cherry trees, and other permanent plantings attached to the land qualify. This means the entire value of an established orchard – land plus trees – can be exchanged.
Agricultural Water Rights – As discussed above, the irrigation water rights critical to apple production are exchangeable real property interests in Washington.
Cold Storage and Packing Facilities – These inherently permanent structures qualify as real property. An apple grower selling a packing facility can exchange into other real property.
Agricultural Conservation Easements – If you've been approached about selling a conservation or agricultural preservation easement on your orchard land, understand that the proceeds can be exchanged into other real property – perhaps additional orchard acreage in another area.
Leasehold Interests in Farmland – A long-term farm lease (30+ years with renewals) is real property. If you hold a valuable lease on productive apple ground and sell that leasehold interest, you can exchange the proceeds.
Processing Plant Interests – Ownership interests in juice processing facilities, dehydration plants, or other agricultural processing facilities attached to land qualify as real property.
Practical Application: An apple farmer approaching retirement sells their 200-acre orchard (land, trees, water rights, and packing facility) for $8 million. Rather than recognizing millions in gain, they exchange into: - A smaller orchard they'll manage actively - NNN retail properties for passive income - Apartment buildings in Wenatchee - Or any combination of qualifying real property
The entire gain is deferred, and if held until death, the step-up in basis eliminates it permanently.
The "Incidental Personal Property" Identification Safe Harbor
The regulations provide a helpful safe harbor for the 45-day identification period: if personal property is typically transferred together with real property and its fair market value does not exceed 15% of the real property's value, it does not need to be separately identified and does not count as a separate property for purposes of the Three-Property Rule or 200% Rule.
What This Means in Practice: If you're identifying an apartment complex worth $1,000,000 that includes $150,000 or less of furniture, appliances, and other personal property, you can simply identify "the apartment complex" without separately listing all the personal property. It counts as one property for identification purposes.
Important Limitation: This is an identification safe harbor only. The personal property is still taxable – its fair market value is treated as "boot" and will be recognized as gain. The 15% rule doesn't make the personal property tax-free; it simply prevents the identification from being defective.
This rule is particularly relevant for:
- Furnished vacation rentals
- Agricultural properties with equipment
- Hotels and restaurants with FF&E
- Cell tower leases that include equipment shelters
Key Takeaway
The 2020 regulations significantly expanded what many practitioners understood as "real property" for Section 1031 purposes. Cell tower interests, development rights, water rights, and agricultural assets all present exchange opportunities that were less certain before the regulations provided clarity.
At Olympic Exchange Accommodators, we've facilitated exchanges involving these diverse property types since 1990. If you're considering an exchange involving non-traditional real property interests, contact us early in your planning process.
Jeff Helsdon, CES® Certified Exchange Specialist since 2003
