The 2017 Restriction to Real Property

The legislative record explains the change in a single sentence, and the Joint Committee on Taxation scored it at $31.0 billion over ten years. This chapter examines the amendment, its transition rule, the personal property practice it ended, and the expanded expensing that Congress offered in its place. The definition of real property under the amended statute is examined in Chapters 8 and 14.

7.1 Repeal of personal property exchanges under the Tax Cuts and Jobs Act

The amendment. The Ways and Means Committee reported H.R. 1 on November 13, 2017, the conference report was filed on December 15, 2017, and the bill became Public Law 115-97 on December 22, 2017. Section 13303(a) replaced "property" with "real property" each place it appeared in section 1031(a)(1), so that the general rule now reads: "No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment."¹ The conforming amendments rewrote the exclusion in paragraph (2) to read, in full, "This subsection shall not apply to any exchange of real property held primarily for sale." They struck the rule that livestock of different sexes are not of like kind and the 2008 rule for shares in mutual ditch, reservoir, and irrigation companies, moved the rule for partnerships electing out of subchapter K to a new subsection (e), rewrote subsection (h) as a rule for foreign real property alone, and renamed the section "Exchange of real property held for productive use or investment."²

The legislative record. The Ways and Means Committee's reasons for the change fill one sentence, preceded by the observation that the definition of like-kind property "has been modified legislatively over the years to address issues relating to targeted types of property." The committee wrote: "With the provisions in the bill of increased and expanded expensing under sections 168(k) and 179 for tangible personal property and certain building improvements, the Committee believes that section 1031 should be limited to exchanges of real property not held primarily for sale."³ The Senate amendment followed the House bill, and the conference agreement followed the Senate amendment.⁴ Both reports summarized the like-class rules for personal property in their descriptions of present law. Neither discussed how much exchange activity the change would end or which kinds of property would be affected.

What Congress meant to preserve. The one substantive statement of intent concerns real property. In identical footnotes, the committee and conference reports stated: "It is intended that real property eligible for like-kind exchange treatment under present law will continue to be eligible for like-kind exchange treatment under the provision." The footnotes gave two examples. The first was shares in a mutual ditch, reservoir, or irrigation company that the highest court or a statute of the State of organization recognizes as real property, the subject of the statutory rule the same section struck. The second was improved and unimproved real estate, which remain of like kind.⁵ Treasury's 2020 regulations list qualifying shares in those companies among the intangible assets that are real property for section 1031 (Chapters 8 and 14).⁶

The antecedents. Congress had considered the question before in broader and narrower forms. Chairman Camp's 2014 bill would have repealed section 1031 outright, and the Administration's fiscal year 2016 budget proposed ending exchanges of art and collectibles along with a cap on deferral for real property (Chapters 62 and 64).⁷ The 2017 Act enacted something narrower than repeal and broader than the collectibles proposal: it ended exchanges of everything except real property.

7.2 Transition rules and the effective-date line

The rule. The amendments apply "to exchanges completed after December 31, 2017," but not to any exchange in which "the property disposed of by the taxpayer in the exchange is disposed of on or before December 31, 2017," or "the property received by the taxpayer in the exchange is received on or before December 31, 2017."⁸ The committee and conference reports restate the rule without elaboration.⁹ Because the line is drawn by exchange rather than by transfer, it mattered only for exchanges of personal property that straddled the end of 2017, which means deferred exchanges and reverse exchanges.

Deferred exchanges begun in 2017. A taxpayer who transferred relinquished personal property on or before December 31, 2017, could complete a deferred exchange by receiving replacement personal property in 2018. The statutory periods still applied. For a calendar-year taxpayer who transferred property late in 2017, the exchange period ended on the earlier of the 180th day or the due date of the 2017 return, so using the full 180 days could require extending that return (26.2).¹⁰

Exchange programs. The same exception governed continuous exchange programs for vehicles and equipment (7.3). Under Rev. Proc. 2003-39, replacement property received within 45 days was treated as identified even if it was matched with particular relinquished property later, so long as the match was made by the due date of the return.¹¹ By the statute's terms, property a program disposed of on or before December 31, 2017, remained eligible even if it was matched with replacement property received in 2018. Property disposed of in 2018 was not.

Reverse exchanges. For reverse exchanges the result depended on the structure (30.4). In one form, an accommodation party holds the replacement property until the taxpayer arranges the sale of the relinquished property, and the taxpayer then transfers the relinquished property to the accommodation party in exchange for the replacement property. In the other, the accommodation party acquires the replacement property and exchanges it with the taxpayer at once, then holds the relinquished property until it can be sold.¹² In the first form, the taxpayer disposes of the relinquished property and receives the replacement property when the exchange occurs, so an arrangement in which replacement personal property was parked in 2017 but the exchange occurred in 2018 met neither exception. The safe harbor points the same way, because it treats the exchange accommodation titleholder, not the taxpayer, as the beneficial owner of parked property. In the second form, a taxpayer who completed the exchange with the accommodation party in 2017 had both disposed of and received property on or before December 31, 2017, and so was within the exception by its terms, even if the accommodation party did not sell the relinquished property until 2018.

What the line did not change. Exchanges of real property were unaffected on either side of the date. Personal property received in an exchange of real property had always been boot, because real property and personal property were never of like kind, and it remains boot (Chapters 17 and 33).¹³

7.3 What was lost: the vanished personal-property exchange practice

The like-class rules. Since 1991 the regulations had defined like kind for personal property in two tiers. In their final form, depreciable tangible personal properties were of a like class, and therefore of like kind, if they fell within the same General Asset Class or the same Product Class. The thirteen General Asset Classes, drawn from Rev. Proc. 87-56, included office furniture and equipment, computers, automobiles and taxis, light and heavy general purpose trucks, and airplanes other than those used to carry passengers or freight commercially. Product Classes were six-digit manufacturing categories of the North American Industry Classification System.¹⁴ A computer could be exchanged for a printer and a grader for a scraper, but an airplane could not be exchanged for a heavy truck.¹⁵ Intangible and nondepreciable personal property had no like classes. Whether such properties were of like kind depended on the nature of the rights and of the underlying property: the copyright on one novel was of like kind to the copyright on another but not to the copyright on a song, and the goodwill of one business was never of like kind to the goodwill of another.¹⁶ The conference report's summary of present law also noted a 2009 Chief Counsel Advice concluding that trademarks, trade names, mastheads, and customer-based intangibles that can be described and valued apart from goodwill qualified.¹⁷

Where the deferral was. The practice these rules supported was concentrated in vehicles and equipment. In 2012, C corporations classified in vehicles and transportation accounted for 69.7 percent of corporate deferred gain from like-kind exchanges.¹⁸ Businesses that bought and sold vehicles in volume, Hertz's U.S. car rental operation among them, ran continuous exchange programs. Rev. Proc. 2003-39 gave those programs safe harbors. It required a single unrelated intermediary, a master exchange agreement restricting the taxpayer's access to proceeds, assignment of the purchase and sale contracts with written notice to the other parties, intermediary control of the sale proceeds, and matching of relinquished property with replacement property. In return, it treated each matched group as a separate exchange, allowed replacement property received within 45 days to be matched later, and addressed joint accounts and the netting of amounts owed to buyers.¹⁹ A program qualified only if it involved exchanges of 100 or more properties.²⁰ Outside those programs, the ordinary trade-in of a business vehicle or machine for a new one was itself a like-kind exchange. Section 1031 applied whether or not the taxpayer wanted it to. In Redwing Carriers, Inc. v. Tomlinson, the government treated a trucking company's replacement of its trucks as an exchange in order to disallow the loss the company sought to deduct, despite the company's effort to route the transactions around the statute (9.6). Recapture income under section 1245 was deferred along with the gain, except to the extent of boot.²¹

Other categories. Several narrower practices ended with the program and trade-in exchanges. Exchanges of intangible business assets lost nonrecognition. So did exchanges of livestock, whose special rule that animals of different sexes are not of like kind was struck, and exchanges of art and collectibles held for investment, which the Administration had proposed in 2015 to end (7.1).²² Losses on trade-ins, which section 1031(c) had disallowed, became recognizable under the general rules.²³

What survives. California continued to allow deferral on exchanges of personal property by individuals below its income thresholds until taxable years beginning in 2025 (57.3).²⁴ Federally, the like-class regulation was never withdrawn, and the multiple property exchange regulation still refers to General Asset Classes and Product Classes, which makes both documents of mostly historical interest (Chapter 32).²⁵

7.4 Interaction with expanded bonus depreciation as a substitute

The stated trade. The Ways and Means Committee tied the restriction expressly to expensing, citing the bill's provisions on increased expensing and on section 179 (7.1).²⁶ As enacted, the 2017 Act allowed an additional first-year depreciation deduction of 100 percent for qualified property acquired after September 27, 2017, and placed in service after that date, with the percentage scheduled to step down by 20 percentage points a year after 2022.²⁷ The allowance extends to used property if the taxpayer had not used the property before acquiring it.²⁸ The 2025 reconciliation act repealed the step-down and restored the 100 percent allowance for property acquired after January 19, 2025.²⁹ Section 179, the other expensing provision the committee cited, now allows up to $2,500,000 a year, reduced dollar for dollar once section 179 property placed in service exceeds $4,000,000, and the deduction cannot exceed taxable income from the active conduct of a trade or business.³⁰

The arithmetic of substitution. With full expensing, recognizing gain on a trade-in and deducting the full cost of the replacement produces the same first-year result as deferral. Suppose a business trades in equipment with an adjusted basis of $10,000 and a value of $25,000 and pays $15,000 more for new equipment costing $40,000. Before 2018 the trade-in was an exchange: the $15,000 gain was deferred, and the new equipment took a basis of $25,000, the old basis plus the cash paid. After 2017 the trade-in is a sale. The business recognizes $15,000 of gain, much or all of it ordinary income under section 1245, and takes a $40,000 cost basis. If the new equipment is fully expensed, the first year shows a $40,000 deduction against $15,000 of income, a net deduction of $25,000, which is what expensing the $25,000 exchanged basis would have produced.³¹ At a lower percentage the equivalence fails. At 60 percent, the sale produces $24,000 of expensing against $15,000 of gain, a net first-year deduction of $9,000, while an exchange would have produced $15,000 of expensing on the $25,000 basis. Regular depreciation on the remaining basis follows in both cases, so the difference is one of timing, but it is a difference.

Evidence from before the Act. The substitution was visible before 2017. Treasury economists reported that Hertz suspended its U.S. car rental exchange program from August 2010 until October 2012 because 100 percent bonus depreciation on newly acquired vehicles more than offset the gains recognized on vehicle dispositions.³² The revenue estimate for the 2017 restriction is consistent with the same interaction. It was scored at $0.5 billion for fiscal year 2018, rising each year to $7.2 billion for fiscal year 2027, while the expensing percentage was scheduled to fall. The estimate does not state its reasons (62.3).³³

Where the substitute falls short. Expensing is not a complete replacement for deferral. Bonus depreciation reaches qualified property, defined principally as property with a recovery period of 20 years or less, together with certain software and production costs, so it does nothing for land, collectibles, or goodwill, which is amortized over fifteen years. A deduction that exceeds income produces a net operating loss, and for losses arising in taxable years beginning after 2017 the net operating loss deduction is limited to 80 percent of taxable income. State results depend on whether a state follows federal bonus depreciation (Chapter 57).³⁴ For exchanges of real property after 2017, the regulations allow the additional first-year deduction on replacement property acquired in an exchange, but the basis carried over from the relinquished property qualifies only if the replacement property meets the original use requirement; for used property, only the excess basis qualifies (Chapter 36).³⁵

Assessment. For a business that turns over vehicles and equipment and buys new property each year, full expensing largely replaced what exchanges had provided, at least for federal tax and while the percentage stood at 100. The practical effect of the 2017 restriction therefore depended on a separate provision that Congress allowed to phase down and then, in 2025, restored. Bonus depreciation reaches real estate only in part, through components with short recovery periods, so section 1031 remained the principal way to defer gain when real estate proceeds are reinvested, alongside the narrower alternatives compared in Chapters 45 and 47.