The Regulatory Scheme

This chapter maps them: what each section does, when it was written, and which still govern exchanges today. It then examines the deferred exchange regulation, which governs the typical modern transaction, the 2020 definition of real property, and the applicability dates that decide which version of a rule governs a particular exchange.

10.1 Structural map of the regulations under §1031

The sections. The regulations open with a table of contents listing the captions of the regulations under section 1031.¹ By origin and subject the sections fall into four groups. The oldest were first issued in 1960 and revised in 1967: the regulation on property held for productive use or investment, which also defines like kind, and the regulations on the receipt of other property or money, on losses, and on basis.² The second group came with the deferred exchange rulemaking and its companion like-class project in 1991: the like-class regulation for personal property, the qualified intermediary safe harbor for simultaneous exchanges, the multiple property regulation, and the deferred exchange regulation itself.³ The third group consists of special rules: a temporary regulation, in place since 1988, coordinating section 1031 with the asset allocation rules of section 1060; a regulation on the assumption of liabilities; and a 1971 regulation restating the former statutory rule that livestock of different sexes are not of like kind.⁴ The fourth is the 2020 definition of real property, issued with amendments to the older regulations.⁵

What still applies. The 2020 regulations added a sorting rule. For exchanges beginning after December 31, 2017, section 1031 and the regulations on held-for-use property, simultaneous exchanges through intermediaries, section 1060 coordination, liabilities, multiple properties, and deferred exchanges, together with the references to section 1031 in the regulations on other property, losses, and basis, "apply only to qualifying exchanges of real property."⁶ Two sections are missing from that list: the like-class regulation and the livestock regulation. Both concern personal property and remain in the Code of Federal Regulations, although the rules they implement no longer reach exchanges after 2017 (7.3). The sorting rule itself applies to exchanges beginning after December 2, 2020. The statute's effective date, by contrast, turns on exchanges completed after December 31, 2017, with transition exceptions keyed to when property was disposed of or received (7.2).⁷

Related regulations outside the series. Several regulations elsewhere in Part 1 govern exchanges. The rule that exceptions to recognition are strictly construed, and the description of an exchange as a reciprocal transfer of property, appear in the general regulation on sales and exchanges (Chapters 2 and 23).⁸ Depreciation of property acquired in an exchange, and bonus depreciation of such property, are governed by regulations under section 168 (Chapter 36 and 7.4).⁹ The taxation of income earned on exchange funds held by escrow holders and intermediaries is governed by regulations under section 468B, issued in 2008.¹⁰

10.2 §1.1031(k)-1 as the operative code of the modern exchange

Scope. A deferred exchange is one in which, under an agreement, the taxpayer transfers relinquished property and later receives replacement property.¹¹ The typical modern exchange, in which a qualified intermediary transfers the relinquished property to a buyer and later acquires the replacement property for the taxpayer, fits that definition, so this regulation governs most of what practitioners do. Simultaneous exchanges through an intermediary are covered by a separate one-paragraph safe harbor, and reverse exchanges fall outside the regulation and are governed by Rev. Proc. 2000-37 (5.5 and 6.3).¹²

Its architecture. The regulation's paragraphs follow the life of a transaction.¹³ Paragraph (a) defines a deferred exchange and states that a sale followed by a purchase of like-kind property does not qualify, whether or not the identification and receipt requirements are met. Paragraphs (b) through (e) implement the statutory identification and exchange periods: how property is identified, how many properties may be identified and at what values, what counts as receipt of identified property, and how property still to be produced is identified and received (Chapters 25 and 26). Paragraph (f) addresses actual and constructive receipt of money or other property (Chapter 29). Paragraph (g) contains the four safe harbors (security arrangements, qualified escrow accounts and trusts, qualified intermediaries, and interest and growth factors), the restrictions on the taxpayer's access to funds, the items disregarded in applying the safe harbors, including the 2020 incidental property rule, and examples (Chapter 27 and 8.4). Paragraph (h) treats interest and growth factors as interest. Paragraph (j) determines gain and basis and coordinates the safe harbors with installment reporting. Paragraph (k) defines disqualified persons (Chapter 28). Paragraphs (m) through (o) define fair market value, disclaim any inference about constructive receipt for other purposes, and state the effective date.

Amendment history. Since 1991 the regulation has been amended four times: in 1994 to coordinate the safe harbors with installment reporting, in 2002 to narrow the definition of disqualified person after changes in federal banking law, in 2008 in connection with the regulations on exchange funds, and in 2020 to add the incidental property rule.¹⁴ Its core has not changed. The identification limits, the safe harbors, and the definition of a qualified intermediary stand substantially as written in 1991, so authorities interpreting the 1991 text generally remain relevant.

A code rather than a statement of principles. The regulation's method is what makes it the operative code. It does not state principles and leave their application to litigation. It specifies deadlines, counts, percentages, and contract terms, and it attaches consequences to documents: identification must follow prescribed procedures (25.1), and a safe harbor applies only if the agreement expressly contains the paragraph (g)(6) restrictions on the taxpayer's rights to the funds.¹⁵ The result is predictability purchased with rigidity. A deferred exchange that departs from the safe harbors is tested under the regulation's general rules on actual and constructive receipt and under ordinary agency principles, where results are less certain (Chapter 29).¹⁶

10.3 §1.1031(a)-3 and the definitional turn

From kind to category. For sixty years the central regulatory question under section 1031 was whether properties were of like kind, and the regulation answering it was brief: "like kind" refers to "the nature or character of the property and not to its grade or quality," and whether real estate is improved or unimproved is not material.¹⁷ That generosity survives. What changed in 2020 is where the difficult questions sit. Among real properties the like-kind test does little work, so the decisive question for most assets is now whether they are real property at all, and the regulation that answers it is far longer than the paragraph that defines like kind (Chapters 14 and 15).

Method. The definitional regulation works in layers.¹⁸ It begins with a general definition: land and improvements to land, unsevered natural products of land, and water and air space superjacent to land. Improvements are inherently permanent structures and their structural components, each defined generally, illustrated by lists, and supplemented by factors for items the lists do not resolve. Intangible assets are treated separately. The regulation lists interests that are real property, such as fee ownership, co-ownership, leaseholds, options to acquire real property, easements, and land development rights; extends that treatment to similar interests that derive their value from real property and are inseparable from it; and lists interests that are never real property, which substantially reproduce the categories struck from the statute in 2017 (8.3). A license or permit is real property if it is solely for the use, enjoyment, or occupation of land or an inherently permanent structure and is in the nature of a leasehold or easement, but a license or permit to operate a business on real property is not.¹⁹ Over all of this sits the State or local law route, subject to the listed exclusions, and a closing rule confining the definition to section 1031.²⁰ Examples follow.

Why the turn matters. The regulation's structure has three consequences for interpretation. First, because the definition is expressly confined to section 1031, an item's treatment for depreciation or recapture does not decide its treatment for exchange purposes: a structure may be section 1245 property for depreciation and real property for section 1031.²¹ Second, the State law route and the regulation's own lists and factors are cumulative. Property that qualifies under either is real property unless it falls within the listed exclusions (8.3). Third, the definition is recent. Unlike the deferred exchange regulation, it has not accumulated decades of interpretation, and several of its boundaries remain open (66.3).

10.4 Applicability dates and taxpayer reliance

The statutory limit. Section 7805(b) limits retroactive regulations. As it now reads, a regulation generally may not apply to a taxable period ending before the earliest of the date the regulation is filed with the Federal Register, the date a related proposed or temporary regulation was filed, or the date a notice substantially describing its expected contents was issued to the public. The limit does not apply to regulations filed or issued within 18 months after enactment of the statute they relate to, and the Secretary may provide for retroactive application to prevent abuse or to correct procedural defects.²²

How the section 1031 regulations have used it. The regulations have generally applied prospectively, with an election or a reliance rule covering the period between proposal and final rule.²³ The deferred exchange regulation applies to transfers on or after June 10, 1991, and a transfer made on or after May 16, 1990, the date of the proposal, is treated as complying if it satisfies either the final regulation or the proposed one. The installment reporting rules added in 1994 apply to transfers on or after April 20, 1994, and taxpayers may apply them to transfers back to June 10, 1991.²⁴ The 2020 definition of real property and the incidental property rule apply to exchanges beginning after December 2, 2020, and taxpayers may rely on the proposed regulations, if followed consistently and in their entirety, for exchanges of real property beginning after December 31, 2017, and before that date.²⁵ The 2020 rules came more than 18 months after the 2017 Act, so the exception for promptly issued regulations was not available. Treasury instead made the final rules prospective and offered reliance on the proposal for the intervening period.

The verbs matter. The dates are keyed to different events. The 2017 statutory amendments apply to exchanges "completed" after December 31, 2017, with exceptions keyed to when property was disposed of or received. The deferred exchange regulation and the simultaneous exchange safe harbor are keyed to "transfers" made on or after their dates. The like-class regulation applies to exchanges "occurring" on or after April 11, 1991, and the 2020 rules to exchanges "beginning" after December 2, 2020.²⁶ For an exchange that straddles one of those dates, the first question is which event the relevant provision measures.

Revenue procedures. The administrative safe harbors carry their own dates. Rev. Proc. 2000-37 applies to arrangements in which the titleholder acquires its indicia of ownership on or after September 15, 2000, and its 2004 modification applies to transfers to titleholders on or after July 20, 2004 (6.3).²⁷ Revenue procedures are not regulations, and their weight is a separate question (11.2).