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Exchange Basics


Fee vs. Leasehold Land

  1. Under Section 1031(a), the word "like-kind" refers to the nature or character of the property and not to its grade or quality. One kind or class of property may not be exchanged under Section 1031 for property of a different kind or class.
  2. For example, the receipt of fee ownership in property in consideration for the execution of a long-term lease is not an exchange of property, but is instead the execution of a lease accompanied by the receipt of advance rental income.
  3. Similarly, the transfer of property and cash for the construction of a new plant on a taxpayer's land was held to represent the payment of consideration for the purchase of new property and not an exchange of like-kind property.
  4. In Revenue Ruling 72-601, the father and son were both farm owners. The son conveyed a life estate in his farm to his father, while reserving a remainder interest for himself. The father conveyed a remainder interest in his farm to his son, reserving a life estate for himself. The IRS ruled that the son merely transferred the right to use his farm for a period of years and received in return the equivalent of rental income and not property qualifying under Section 1031. The father transferred a remainder interest in return for a leasehold of less than 30 years' duration, when measured against his life expectancy. The leasehold was thus not like-kind property, and the transaction was taxable. If the father's life expectancy had equaled or exceeded 30 years, the father's transfer might have qualified, but not the son's.
  5. Similar results should be expected in exchanges involving what is essentially a right to receive income represented by contracts, patents, copyrights, etc.
  6. A transaction structured to be a sale of the taxpayer's property followed by a leaseback of the same property may be construed as an exchange of a fee absolute estate for a leasehold estate. The IRS has argued for exchange treatment in this context to prevent a taxpayer from recognizing a loss on the "sale" transaction.
  7. An exchange of real property for personal property does not qualify because the nature or character of the property is not of like-kind. The fact that property is improved or unimproved relates only to its grade or quality and not to its kind or class. A leasehold of a fee with 30 years or more to run and real estate in fee are of "like-kind."

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