Section 1031(a)(1) provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment. Exchanged properties must of of the same kind or class to qualify.
Generally, real property must be exchanged for other real property, to be of the same kind or class. In a recent private letter ruling, the issue was raised whether real property could be exchanged for development rights in real property (which development rights were to be applied to property already owned by the taxpayer). The IRS found that the development rights were the equivalent of real property and thus a Section 1031 exchange was allowed.
In determining that the development rights were real property, the IRS noted:
- the fact that the development rights would be applied to other property owned by the taxpayer was not a problem;
- it was enough that development rights were treated as real property for some purposes under state and local law, even though they were not treated as real property for all such purposes;
- the fact that the rights are "as-of-right" and not discretionary meant they existed permanently, which was an important factor in finding them to be real property;
- it was also helpful that the transfer of development rights was subject to local transfer taxes like a deed transfer; and
- it was also helpful the development rights were perpetual and not temporary.