The IRS issued its Final Regulations, or Final Regs, to clarify what ‘real property’ is under Section 1031 of the Internal Revenue Code. This defines what properties qualify for tax-deferred 1031 exchanges when exchanging like-kind properties. Statutory changes took place in the Tax Cuts and Jobs Act, so the IRS issued these clarifications. They made proposed regulations in June 2020, but the Final Regs look a bit different. Our team at Diversified Investment Strategies is here to fill you in on the final changes!
Most notably, the Tax Cuts and Jobs Act states that personal property is no longer eligible for Section 1031 treatment. However, incidental personal property will not disqualify you for a 1031 exchange if it’s worth 15 percent or less of the deal. This includes personal property that is typically transferred together with real property, such as laundry machines that come with an apartment building. You still must recognize any gain you receive from this personal property, but you won’t lose your 1031 exchange tax benefits on the transaction as a whole.
Improvements are considered real property. This means that permanent structures/buildings are real property, and the structural components inside them are also real property, such as electrical wiring. The Proposed Regs consisted of a purpose or use test, but the Final Regs dismissed that. This is good news. Real estate investors don’t have to deal with figuring out whether updates in their investment property count as real property or not, such as gas lines installed in a restaurant.
The Final Regs defer to state and local law in determining what constitutes as real property. This departs from the Proposed Regs as well. The state and local law test applies to tangible and intangible property in most cases. There are a few cases when it doesn’t. For example, if Federal law classifies the type of property as personal property, if the Final Regs classify the type of property as real property, or if it’s considered real property after analyzing numerous factors provided by the Final Regs.
Intangible property is considered real property if it derives value from real property or an interest in real property, and is inseparable from real property. This includes co-ownership interests in real property, leaseholds, easements and land development rights. The Final Regs exclude certain securities, such as interests in partnerships.
If you have any questions about these changes, about 1031 exchanges, or about anything related to real estate investments, give our team at DIS a call! We are here to help answer your questions and to guide you through the best real estate decisions for you and your investments in 2021.
There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general
market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental
rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties,
financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the
entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not
guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular
situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically
have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and
accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and
Diversified 1031 does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance.
Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Diversified 1031 is independent of CIS.