Real Property Interests at the Margins

This chapter takes up the interests that do present something harder: rights carved out of land, rights above and below it, rights detached from it and made tradable, and rights that look like ownership without being it. The 2020 regulations enumerate many of these expressly, which has made the analysis considerably more tractable than it was before December 2020.

16.1 Fee, co-ownership, remainders, and life estates

Fee ownership and co-ownership are enumerated as intangible assets that are real property for section 1031 purposes.¹ Neither presents difficulty, and co-ownership is developed at length in Chapter 21 because the difficulty there is the taxpayer requirement rather than the property requirement.

Divided temporal interests are harder, and the regulation does not resolve them by enumeration. A life estate and a remainder are each interests in real property under the law of every American jurisdiction, so both routes to qualification are available: they are interests of the kind described in the general definition, and they are real property under State law within the meaning of the State-or-local-law paragraph.²

The live question is like kind rather than realness. Whether a life estate is of like kind to a fee, and whether a remainder is of like kind to a possessory interest, turns on the durational analysis that governs leaseholds at 16.2. A life estate measured by the life of a young measuring life may be expected to endure well beyond thirty years; one measured by the life of a person in extremis will not. Practitioners should be alert that the thirty-year convention has never been formally extended to life estates, and that the analogy, while natural, is an analogy.

16.2 Leaseholds and the thirty-year convention

A leasehold is enumerated as an intangible asset that is real property.³ That resolves realness. The like-kind question is resolved by a convention of long standing.

The regulation's example of an exchange solely in kind includes a taxpayer who "exchanges a leasehold of a fee with 30 years or more to run for real estate."⁴ A leasehold with thirty years or more remaining is therefore of like kind to a fee. The premise is that a term long enough approximates ownership in economic substance.

Four points of application matter and are regularly mishandled.

The measurement runs from the exchange, not from the inception of the lease. A fifty-year lease with twenty-two years remaining does not satisfy the convention. The relevant figure is the unexpired term at the moment of transfer.

Renewal options are generally counted toward the term. The reasoning is that an option exercisable at the holder's discretion extends the interest the holder actually possesses, and practitioners should confirm that the options are genuinely at the tenant's election rather than subject to landlord consent or renegotiated rent that makes exercise implausible.

A leasehold shorter than thirty years is not thereby disqualified from section 1031 altogether. It remains an interest in real property. It is simply not of like kind to a fee, and it may be exchanged for another leasehold interest of comparable character.

The convention runs in both directions. A fee may be exchanged for a qualifying long leasehold, and a taxpayer acquiring a ground lease position as replacement property should confirm the unexpired term at closing rather than at contract.

16.3 Easements and options

Both an easement and an option to acquire real property are enumerated as real property.⁵ The enumeration settles two questions that generated uncertainty before 2020.

Easements qualify. This reaches access easements, utility easements, and by extension conservation easements, which are servitudes restricting development in perpetuity. A taxpayer granting a perpetual conservation easement is disposing of an interest in real property, and the transaction can be structured as an exchange. Practitioners should note that the charitable deduction rules governing conservation easements are an entirely separate regime with their own substantiation requirements, and that a transaction structured as an exchange is not a contribution.

Options qualify as property, which is distinct from the role an option plays as a mechanism. An option to acquire real property is itself an interest in real property that may be exchanged. That is different from the use of options within an exchange structure, which is a question of receipt and control examined at Chapter 29.

The durational analysis of 16.2 has no clear analogue for easements. A perpetual easement is plainly a substantial interest; a term easement of short duration presents the same conceptual problem as a short leasehold, and the regulations do not supply a convention.

16.4 Natural products, mineral, water, and air rights

The general definition of real property includes unsevered natural products of land, and the regulation elaborates. Unsevered natural products, "including growing crops, plants, and timber; mines; wells; and other natural deposits," are generally treated as real property.⁶

The elaboration continues with the rule that governs timing in every extractive transaction. Natural products and deposits "such as crops, timber, water, ores, and minerals, cease to be real property when they are severed, extracted, or removed from the land."⁷

Severance is therefore the operative event, and it converts real property into personal property. The planning consequences are immediate. Standing timber is real property; cut logs are not. Minerals in place are real property; extracted ore is not. A transaction contemplating harvest or extraction before closing must be sequenced so that the transfer precedes the severance, and a taxpayer who has already severed is exchanging something outside section 1031.

Water and air space superjacent to land are within the general definition.⁸ Air rights and development rights above a parcel are real property, as are water rights that take the form of an interest in the land rather than a contractual entitlement to a quantity.

The regulation supplies a specific rule for a category that had long been litigated. Shares in a mutual ditch, reservoir, or irrigation company described in section 501(c)(12)(A) are real property if, at the time of the exchange, the shares "have been recognized by the highest court of the State in which the company was organized, or by a State statute, as constituting or representing real property or an interest in real property."⁹ The condition is exacting: judicial recognition by the State's highest court, or a statute. A practitioner relying on this provision should locate the decision or the statute rather than assume local practice suffices.

16.5 Ground rent and reserved interests

Maryland practice encounters an interest that most jurisdictions do not, and it shows why the regulation's enumerated list comes before the State-or-local-law route.

Under a Maryland ground lease, the occupant holds a leasehold for a term, usually ninety-nine years, renewable forever, and the ground lease holder retains the reversion and fee simple title to the land, subject to the lease and to the occupant's right to redeem. Maryland treats the occupant's leasehold estate as personal property rather than real property. The arrangement has no close analogue in most States.

Both sides of the arrangement are enumerated in the regulation's list of intangible assets that are real property, which includes fee ownership and a leasehold.¹⁰ That enumeration controls. The State-or-local-law paragraph applies only except as otherwise provided in the enumerated list, so Maryland's label on the occupant's leasehold does not take it outside section 1031. A Maryland ground lease leasehold is real property for section 1031 purposes even though Maryland law calls it personal property, and whether it is of like kind to a fee is then governed by the unexpired term analysis of 16.2.

The holder's side needs one further check. Its legal form is fee ownership subject to the lease, which is enumerated, but its economic substance is a right to a stream of rent that the occupant may redeem for a lump sum, and the excluded intangibles of paragraph (a)(5), the ceiling described at 14.6, apply regardless of State classification.¹¹ A holder proposing to exchange ground rents should confirm that what it holds is the reversion in the land and not only a right to payment.

Chapter 61.4 develops the Maryland treatment, including the registration, redemption, and remedy statutes and the two Court of Appeals decisions that limited them.

16.6 Development rights and transferable credits

Land development rights are enumerated as real property.¹² The enumeration is significant because these interests are, by design, detached from any particular parcel and made tradable.

Transferable development rights present the recurring difficulty. A jurisdiction permitting an owner in a preservation district to sever unused density and sell it for use elsewhere has created something that trades like a commodity while originating in land. The enumeration of land development rights supports treating them as real property, and the State-or-local-law route supplies an alternative where the local statute characterizes them as interests in real property.

The limiting principle is supplied by the catch-all governing similar intangible interests, which requires that the asset derive its value from real property or an interest in real property and be inseparable from it.¹³ An instrument that has become fully fungible, detached from any identified parcel, and freely tradable in a market of its own is in tension with the inseparability requirement. The further an instrument travels from its originating land, the weaker the case.

Practitioners should also test any such instrument against the licenses-and-permits rule at 14.5. A credit that functions as permission to conduct an activity rather than as an interest in land is outside section 1031 regardless of State characterization.

16.7 Cooperative and condominium interests

A condominium unit is ordinary real property. Title is held in fee, the interest is recorded, and no special analysis applies.

A cooperative is different in form and required a special rule. The occupant of a cooperative apartment owns shares in a corporation and holds a proprietary lease rather than title to the unit. Absent a rule, the shares would be stock and therefore excluded.

The regulation supplies the rule by enumerating stock in a cooperative housing corporation as an intangible asset that is real property.¹⁴ The exclusion of stock in the same paragraph is drafted to accommodate this, reaching only stock "not described in" the inclusion list.¹⁵

Two cautions follow. The corporation must be a cooperative housing corporation, a defined term, and shares in an entity that merely resembles one are outside the rule and fall back into the stock exclusion. And a cooperative interest in a personal residence faces the holding requirement of Chapter 12 independently, which is where most cooperative exchanges actually fail.