On this More More Monday, we are discussing recent IRS memorandum (ILM 201238027) which tackled the issue of whether the federal definition of real property trumped a state's definition of real property for 1031 purposes. The memorandum was in response to a request for guidance on how state law characterizations of property as real or personal affect whether the property is of like-kind for purposes of section 1031. The following scenarios were outlined:
Case 1: A natural gas pipeline in State A (constructed along a right of way on real property) that is classified as personal property in State A is exchanged for a State B natural gas pipeline that is constructed along a right of way on real property and that is classified as real property in State B. (The right of ways associated with the exchanged pipelines in State A and State B are also exchanged.)
Case 2: A steam turbine attached as a fixture in a State A land improvement (a building) as a component of a system for the commercial production of electricity that is treated as real property in State A is exchanged for a steam turbine attached as a fixture in a State B land improvement as a component of a system for the commercial production of electricity that is treated as personal property in State B. (The land and buildings associated with the steam turbines in both State A and State B are also exchanged.)
Case 3: A steam turbine that is attached as a fixture in a State A land improvement (a building) as a component of a system for the commercial production of electricity and that is treated as real property in State A is exchanged for raw land in State B. (The land and building associated with the steam turbine were also exchanged as part of the transaction.)
Case 4: A steam turbine that is attached as a fixture in a State A land improvement (a building) as a component of a system for the commercial production of electricity and a State A natural gas pipeline (constructed along a right of way on real property), both treated as real property in State A, are exchanged for a State B natural gas pipeline (constructed along a right of way on real property and that is identical in all material physical respects to the State A natural gas pipeline) that is treated as personal property in State B. (The land, buildings and right of ways associated with the steam turbine and pipelines were also exchanged as part of this transaction.)
IRS concluded that federal income tax law rather than state law controls whether exchanged properties are of like-kind for purposes of § 1031. Under the Income Tax Regulations of § 1031, properties are generally of like-kind if they are of the same nature and character. State law property classifications, while relevant for determining if property is real or personal property, are not determinative of whether properties are of the same nature and character. Rather, all facts and circumstances should be considered in determining whether properties are of the same nature and character and thus are of like-kind.
While this ILM cannot be cited as precedent, its applicability will likely be much more far reaching that just pipelines and turbines.
The 1031 CORP. Exchange Team is always happy to discuss this in greater detail. Contact us any time.
