In December of 2020, the US Inner Income Service (the “IRS”) issued ultimate rules (T.D. 9935) (the “Ultimate Rules”) on like-kind exchanges underneath Part 1031 of the Inner Income Code of 1986, as amended. The Ultimate Rules, which usually apply to exchanges starting after December 2, 2020, present much-needed readability for pure resource-related belongings. Along with numerous types of financial pursuits in minerals in place (i.e., working or working pursuits, royalty pursuits, and overriding royalty pursuits), oil and gasoline pipelines (whether or not above- or below-ground), offshore platforms (whether or not for drilling or manufacturing), derricks, and oil and gasoline storage tanks usually must be handled actual property for Part 1031 functions.
Moreover, the Ultimate Rules (a) revise the definition of “actual property” for Part 1031 functions, (b) get rid of the “Function or Use Check” (as described beneath) for each tangible and intangible belongings, and (c) present for sure different clarifications, together with adapting an current incidental property exception. The Ultimate Rules additionally expressly state that the foundations of the Ultimate Rules apply just for functions of Part 1031.
Part 1031 usually
Part 1031 usually offers that no acquire or loss is acknowledged in reference to an alternate of actual property held for productive use in a commerce or enterprise or for funding if such actual property is exchanged solely for actual property of like form which can be to be held both for productive use in a commerce or enterprise or for funding.1 Part 1031 was amended by Part 13303 of the Tax Cuts and Jobs Act to restrict its utility to exchanges of actual property for these exchanges accomplished after December 31, 2017 (topic to a restricted transition rule for sure belongings). Previous to such modification, Part 1031 could possibly be effected on a broader array of belongings (broader than merely “actual property”).
On June 12, 2020, the Division of the Treasury (“Treasury”) and the IRS revealed proposed rules within the Federal Register containing proposed Part 1031 rules. After consideration of public feedback, the Ultimate Rules undertake sure parts of the proposed rules, with modifications.
a. Impression of state or native regulation definitions on the dedication of what’s “actual property”
Below the Ultimate Rules, property is taken into account actual property for Part 1031 functions if, on the date of the alternate, such property is assessed as actual property underneath the regulation of the State or native jurisdiction during which that property is positioned (the “State or Native Regulation Check”). The State or Native Regulation Check is relevant to each tangible and intangible property classifications.
Below the Ultimate Rules, a three-pronged strategy applies to the dedication of whether or not property is actual property for Part 1031 functions. Property is assessed as actual property for Part 1031 functions if the property is:
(1) Labeled as actual property underneath the State or Native Regulation Check (topic to sure exceptions);
(2) Particularly listed as actual property within the Ultimate Rules; or
(3) Thought of actual property based mostly on a information and circumstances evaluation utilizing the components supplied for within the Ultimate Rules.
Thus, even when property just isn’t labeled as actual property underneath the State or Native Regulation Check, such dedication doesn’t preclude the property from being thought of actual property for Part 1031 functions.
b. Function or Use Check eradicated
Below the proposed rules, the operate of property was thought of in figuring out whether or not such property is actual property for Part 1031 functions (the “Function or Use Check”). For example, underneath the proposed rules, equipment couldn’t usually be labeled as actual property if the equipment contributes to the manufacturing of earnings unrelated to the use or occupancy of house.
Based mostly on enter from commentators, Treasury and the IRS eradicated the Function or Use Check for tangible property within the Ultimate Rules. Thus, if tangible property is completely affixed to actual property and can ordinarily stay affixed, such property is usually thought of an inherently everlasting construction and thus actual property for Part 1031, regardless of whether or not the property contributes to the manufacturing of earnings. Below the Ultimate Rules, gadgets of equipment and gear are labeled as actual property in the event that they comprise an inherently everlasting construction, a structural part, or are actual property underneath the State or Native Regulation Check.
c. Sure intangible belongings included as actual property
Below the Ultimate Rules, intangible belongings which can be actual property for Part 1031 functions embody, partly, (i) payment possession, (ii) co-ownership, (iii) a leasehold curiosity, (iv) an choice to accumulate actual property, (v) an easement, and (vi) sure different pursuits.
d. Inherently everlasting construction definition revised
Below the proposed rules, an inherently everlasting construction (which might thus usually be handled as actual property for Part 1031 functions) consists of, partly, an asset that’s completely affixed to actual property and that can stay affixed for an indefinite time frame. Nonetheless, the proposed rules didn’t outline the phrase “completely affixed.” In an try to supply further readability, the Ultimate Rules include further language relating to the that means of “completely affixed,” by noting that “[a]ffixation is taken into account everlasting whether it is fairly anticipated to final indefinitely based mostly on all of the information and circumstances.”2
e. Offshore platforms and pipelines (and sure different pure resource-related belongings)
The proposed rules particularly listed offshore drilling platforms and oil and gasoline pipelines as inherently everlasting constructions, and subsequently such property was outlined as actual property for Part 1031 functions. One commentator aptly famous that the adjective “drilling” must be faraway from “offshore drilling platform,” as an offshore platform used for manufacturing is structurally just like an offshore drilling platform. Taking the feedback under consideration, the Ultimate Rules make clear that “offshore platforms” are thought of inherently everlasting constructions for Part 1031 functions,3 versus merely “offshore drilling platforms.” Additional, the preamble to the Ultimate Rules notes that an oil and gasoline pipeline is listed as inherently everlasting and subsequently actual property for Part 1031 functions, no matter whether or not above or beneath floor.
As well as, underneath the Ultimate Rules, the time period actual property continues to incorporate unsevered pure merchandise of the land.4 Unsevered pure merchandise of the land consists of, partly, timber, mines, wells, and different pure deposits. Pure merchandise and deposits (akin to ores and minerals) stop to be actual property, nonetheless, as soon as they’re severed, extracted (e.g., produced), or faraway from the land. Additional, inherently everlasting constructions (that are thought of qualifying enhancements to land, and thus actual property for Part 1031 functions) embody, along with the oil and gasoline pipelines and the offshore platforms described above, derricks and oil and gasoline storage tanks.
For pure resource-related belongings which can be neither labeled as actual property underneath the State or Native Regulation Check or particularly listed within the Ultimate Rules, such property should be handled as actual property based mostly on the components described in Treas. Reg. § 1.1031(a)-3(a)(2)(ii)(C). Whether or not specific meters or compressors affixed or related to pipelines or different pure useful resource property is taken into account actual property for Part 1031 functions have to be decided by their distinctive information and circumstances.
In any alternate associated to pure resource-related properties, taxpayers must proceed to investigate the affect of Sections 1245 and 1254 (for example), which have separate and distinct gain-recognition guidelines that will apply relying on the information of the switch or alternate.
1 Below Part 1031(b), nonetheless, a taxpayer should acknowledge acquire on an alternate to the extent of cash and non-like-kind property (i.e., private property) acquired within the alternate.
2 Treas. Reg. § 1.1031(a)-3(a)(2)(ii)(A).
3 Treas. Reg. § 1.1031(a)-3(a)(2)(ii)(C).
4 Treas. Reg. § 1.1031(a)-3(a)(1).