Unsettled Questions

The aim here is to state precisely what is open, to set out the competing positions, and to identify what a practitioner can and cannot responsibly tell a client.

66.1 Holding period after partnership distribution

Many clocks, none for this question. The Code and regulations attach consequences to time around partnership transactions in several places. A partner's holding period for distributed property includes the partnership's, except for the rule that taxes gain on distributed inventory items as ordinary income if they are sold within five years.¹ Distributing contributed property to another partner, or distributing other property to the contributing partner, within seven years of a contribution can trigger precontribution gain (Chapter 50). Transfers of property to a partnership and of money to the partner within two years are presumed to be a disguised sale. A related party exchange is followed by a two-year watch period, and a revenue procedure gives dwelling units a 24-month safe harbor.² No statute, regulation, or published ruling says how long a partner who receives property in a distribution must hold it before exchanging it, or how long replacement property must be held before it is contributed to a partnership. Chapter 12.4 establishes that section 1031 has no holding period of its own, and Chapter 20 describes the drop and swap and swap and drop structures that depend on that silence.

Tacking is not intent. The holding period rules answer how long a taxpayer "has held" property, which matters for character and for the long-term holding period. Section 1031 asks something else: whether property is "held for productive use in a trade or business or for investment," which is a question of purpose.³ A distributee who takes the partnership's holding period under section 735(b) has not thereby shown that the distributee held the property for investment. No authority located for this chapter treats tacking as satisfying the purpose requirement, and the question has been litigated as one of intent.

The Ninth Circuit's answer and the Service's rulings. The two Ninth Circuit decisions that anchor these structures both rejected published rulings the Commissioner relied on. In Bolker, the Commissioner cited Revenue Ruling 77-337, in which a shareholder liquidated a corporation to acquire its shopping center under a prearranged plan to exchange the center immediately; the ruling held that the shareholder never held the center for investment. The court said revenue rulings are not controlling, found the ruling not precisely on point, and emphasized that the intent test applies to property received in an exchange, not to property given up.⁴ In Magneson, involving an exchange followed by a contribution of the replacement property to a partnership, the Commissioner relied on Revenue Ruling 75-292, which held that property transferred to a controlled corporation after an exchange was no longer held by the taxpayer; the court again treated the ruling as not binding and allowed the exchange.⁵ Those rulings addressed the corporate analogs, and the Ninth Circuit's decisions are the principal judicial authority for the partnership versions.

State tax appeals. California's Office of Tax Appeals addressed a drop and swap in 2018. A 10 percent partner's interest was redeemed for a tenancy in common interest in the partnership's sole property, and the former partner then exchanged that interest when the property was sold. Over a dissent, the panel held that she completed a section 1031 exchange, rejecting the Franchise Tax Board's step transaction argument and distinguishing Court Holding. The Office denied the Board's petition for rehearing in 2020. Both opinions are designated nonprecedential.⁶ The case shows that a State tax tribunal applying section 1031 as California incorporates it (Chapter 57) can reach the same result as the Ninth Circuit while leaving the question formally open even in that State.

What remains open. Four questions have no settled answer.

The first is whether any minimum interval between a distribution and an exchange is required. None is stated, and the risk assessment in 20.4 turns on time and formality for that reason.

The second is how much weight partnership-level negotiations carry. Where the partnership negotiated the sale before distributing the property, the substance-over-form and Court Holding arguments are strongest, and the California dissent would have treated the partnership as the seller on that ground.⁷

The third is how the other partnership clocks interact with the exchange. A drop of property contributed within the past seven years, or a swap and drop that pairs a contribution with a distribution of money within two years, raises questions under the precontribution gain and disguised sale rules that are independent of section 1031 and must be analyzed on their own terms (Chapter 50).⁸

The fourth is whether the Service will issue guidance. This chapter did not locate published guidance addressing the partnership structures directly, and the rulings on the corporate analogs date from 1975 and 1977.

66.2 Non-safe-harbor parking after the Service's non-acquiescence

Where matters stand. The reverse exchange safe harbor is not exclusive, and its revenue procedure disclaims any inference about parking arrangements outside it.⁹ In Estate of Bartell, the Tax Court upheld an arrangement in which a facilitator held title to replacement property for seventeen months while the taxpayer built a drugstore on it, holding that the facilitator did not need the benefits and burdens of ownership to be treated as the owner.¹⁰ The Service responded with an Action on Decision announcing that, outside the safe harbor, it will treat the benefits and burdens of ownership as dispositive, while acknowledging that inside the safe harbor a taxpayer may hold those benefits and burdens for up to 180 days before the exchange (Chapter 30).¹¹ The resulting position is a published Tax Court decision on one side and a stated litigating position on the other.

Five open questions.

Does Bartell reach later transactions? The parking in Bartell began before the safe harbor existed. Whether a court would apply the same facilitator doctrine to an arrangement entered into after the safe harbor became available, by a taxpayer who simply chose not to use it, has not been decided. The revenue procedure's disclaimer of any inference cuts both ways: it does not condemn such arrangements, and it does not endorse them.

What will an appellate court do? The principal authority is a Tax Court decision. This chapter did not locate a later reported decision applying Bartell to a transaction after the safe harbor took effect, and no court of appeals has addressed the question the Action on Decision frames.

Is there an outer limit on duration? Bartell involved seventeen months. Nothing in the decision states a maximum, but the longer property is parked, and the more the taxpayer controls and finances it, the more the arrangement resembles a purchase by the taxpayer followed by a later sale.

How far does the improvement exception extend? A later revenue procedure removed from the safe harbor property that the taxpayer owned within 180 days before the titleholder acquires it.¹² Improvements to property the taxpayer already owns therefore must be structured outside the safe harbor, where the Service's benefits and burdens position applies with full force (Chapter 31).

Does the change in deference matter? It matters less here than for regulations. A revenue procedure never commanded the deference once given to regulations, and an Action on Decision is a statement of litigating position, not authority. A court deciding whether an arrangement is an "exchange" decides the statute's best reading for itself, giving the Service's views whatever persuasive weight their reasoning earns.¹³

Advice. The advice in 30.6 stands. A non-safe-harbor parking arrangement is a litigating position, and the client should be told in writing that the Service has announced it will challenge it.

66.3 The boundary of the State-law definitional test

The rule and how it arrived. Except as otherwise provided in the rules for intangible assets, property is real property for section 1031 purposes if, on the date it is transferred in an exchange, it is real property under the law of the State or local jurisdiction in which it is located.¹⁴ The proposed regulations had confined State law to shares in mutual ditch, reservoir, and irrigation companies. Commenters objected, and the final regulations adopted a general State and local law test, applicable to both tangible and intangible property. They excluded the intangibles listed in former section 1031(a)(2) regardless of State law, provided that a State's classification of property as personal does not prevent qualification under the federal definitions, and rejected the reasoning of a 2012 Chief Counsel Advice to the extent it suggested that State law is disregarded. They also declined to treat property as real property because it is essentially the same as property classified as real property elsewhere, and declined to freeze State classifications as of a fixed date.¹⁵

Which body of State law. The regulation refers to property that is real property under the law of the State or local jurisdiction, without saying which body of that law. States classify the same asset differently for different purposes: property tax assessment, recording and conveyancing, fixtures under the Uniform Commercial Code, condemnation compensation, and succession. Maryland classifies the leasehold in a ground rent as personal property while the federal regulation lists a leasehold as real property (16.5). No authority states whether a real property classification for any purpose suffices, whether the classification must be the State's general one, or how a conflict among a State's own classifications is resolved.

State or local. The regulation says "State or local jurisdiction." It does not say what happens when a county's classification, for assessment for example, differs from the State's classification in statute or case law.

Real property is not like kind. The State-law test decides whether an asset is real property. It does not decide whether two real properties are of like kind, and the preamble says so expressly.¹⁶ The Chief Counsel Advice the preamble discussed had concluded that a steam turbine was not of like kind to undeveloped land because it did not share land's nature or character, and commenters argued that the turbine's classification as real property under State law should make the two like kind. The preamble rejected the Advice's treatment of State law only as to the real property question. Whether an asset that is real property solely by virtue of State law is of like kind to land is open. The general rule that it is immaterial whether real estate is improved or unimproved has not been tested against an asset that is real property only under State law.¹⁷

Intangibles and the similar interests sentence. The intangible asset rule lists qualifying interests, adds that similar interests qualify if they derive their value from real property and are inseparable from it, and then excludes stock, securities, partnership interests, beneficial interests, and choses in action regardless of State law; a separate rule excludes licenses and permits to operate a business.¹⁸ The State-law test applies "except as otherwise provided" in that rule. The exclusions plainly cap the State-law route. Whether the similar interests sentence also limits it, so that an intangible classified as real property by a State must also be inseparable from real property, is less clear. On the text, the sentence reads as an additional route to qualification, not a limit, and the preamble's statement that the State-law test applies to intangible property supports that reading. No authority has decided it.

Timing. Classification is fixed on the date of transfer. A State that reclassifies an asset by statute during an exchange period changes the answer for property transferred after the change, and the preamble's refusal to fix classifications as of a date accepts that consequence.

No inference elsewhere. The regulations disclaim any inference outside section 1031, so property that is real property for section 1031 through State law may still be section 1245 property for depreciation and recapture.¹⁹ The recapture consequences of an exchange that qualifies only through State law are analyzed in Chapter 37 and deserve particular attention in exactly these cases.

66.4 Regulatory validity in a post-deference environment

The change in doctrine. In 2024 the Supreme Court overruled Chevron. Courts must exercise independent judgment in deciding whether an agency has acted within its statutory authority, and they may not defer to an agency's interpretation simply because a statute is ambiguous. Courts may still seek aid from the views of those who administer a statute, giving them weight according to their persuasiveness. Where the best reading of a statute is that it delegates discretionary authority, a court recognizes the delegation, fixes its boundaries, and ensures reasoned decisionmaking within them. The Court added that prior decisions upholding specific agency actions under Chevron remain subject to statutory stare decisis.²⁰ The tax case that had applied Chevron to Treasury regulations generally, Mayo Foundation, therefore no longer supplies the framework, although its holding about the particular regulation it reviewed retains that protection.²¹ Two other decisions change the practical setting. A challenge under the Administrative Procedure Act accrues when the plaintiff is injured by final agency action, not when the rule is issued, so a newly injured party may challenge a decades-old regulation.²² And the Anti-Injunction Act does not bar a suit to set aside an IRS reporting requirement merely because noncompliance is backed by a tax penalty.²³

The footing of the section 1031 regulations. The identification and exchange periods appear in section 1031(a)(3), which contains no grant of rulemaking authority. The deferred exchange regulations were issued in 1991, and the 2020 real property regulations cite the Secretary's general authority under section 7805.²⁴ After Loper Bright, the question for any contested regulation is whether it reflects the best reading of the statute, not whether it is a permissible one.

Where a challenge could arise. Safe harbors that favor taxpayers are unlikely to be challenged by the taxpayers they protect, and the Service is bound by its own regulations. The pressure points are rules that narrow what the statute arguably allows.

Identification limits. The statute requires that replacement property be identified within 45 days. The regulations limit the number or value of properties that may be identified, through the three-property, 200 percent, and 95 percent rules (Chapter 25).²⁵ A taxpayer who timely identified more property than the regulations allow, and then acquired some of it, could argue that the best reading of "identified" imposes no numerical limit. The regulation's defenders would point to more than thirty years of reliance on it and would argue that the statute's purpose is to prevent open-ended identification. The argument has not been tested since Loper Bright.

Real property definitions. The 2020 regulations exclude certain intangibles regardless of State law and exclude licenses and permits to operate a business. The preamble grounds the first exclusion in the text of former section 1031(a)(2) and the conference report to the 2017 Act.²⁶ A taxpayer holding an interest that State law classifies as real property but the regulation excludes could argue that "real property" in the statute should be read to include it. The historical grounding the preamble supplies is the kind of reasoning a court applying independent judgment would weigh.

Safe harbor conditions. Many of the regulatory restrictions, including the limits on a taxpayer's rights to money held by a qualified intermediary, are conditions of safe harbors rather than rules of disqualification. A taxpayer outside a safe harbor is governed by general principles of receipt and agency (Chapters 27 and 29), and invalidating a condition would not by itself convert a failed exchange into a good one.

Forum and timing. Deficiency proceedings in the Tax Court and refund suits remain the ordinary routes for testing a regulation. The accrual rule and the Anti-Injunction Act decision make a pre-enforcement challenge to a reporting requirement more feasible than before, but a suit for the purpose of restraining the assessment or collection of tax remains barred.²⁷

What has not changed. Loper Bright does not invalidate any regulation. It changes the question a court asks. Long-standing regulations on which taxpayers and the Service have relied for decades will be measured against the statute's best reading, and their thoroughness and consistency will count in their favor. Because much section 1031 litigation has turned on facts rather than on the validity of a regulation, few prior holdings would carry statutory stare decisis, and the independent judgment standard would operate largely on a clean slate.

66.5 Deferral and the taxation of unrealized appreciation

What Moore decided and what it reserved. In Moore v. United States, the Court upheld the mandatory repatriation tax. It described its holding as narrow: limited to taxing the shareholders of an entity on the entity's undistributed realized income, attributed to the shareholders, where the entity itself has not been taxed on that income. It cautioned that nothing in the opinion authorizes taxing both an entity and its owners on the same undistributed income, and it stated that the decision does not resolve whether realization is a constitutional requirement for an income tax.²⁸ The separate writings divided on that reserved question. Justice Jackson's concurrence found no constitutional realization requirement, reading later decisions as confining Eisner v. Macomber and relying on Cottage Savings' description of realization as a rule founded on administrative convenience. Justice Barrett, joined by Justice Alito, concurred only in the judgment, observing that the Government had asserted a power to tax all economic gains, including appreciation in property value, and that the Court did not address that assertion. Justice Thomas, joined by Justice Gorsuch, dissented (Chapter 1).²⁹

Why the reserved question matters less to section 1031 than it first appears. An exchange of one property for another with different legal entitlements is a realization event.³⁰ Section 1031 postpones the recognition of gain that has already been realized. Repeal, a cap, an interest charge, or a deferral recapture amount collected on a later transfer would all tax realized gain. None of those reforms, described in Chapter 64, depends on the question Moore reserved.

Where it matters. Three kinds of proposal would test it.

The first is annual taxation of property that has not been sold. The Billionaires Income Tax Act would treat holding a tradable covered asset at the close of a taxable year as a taxable event, and the minimum tax in the fiscal year 2023 through 2025 budgets would have reached unrealized gains generally.³¹ Those rules would sit squarely within the reserved question.

The second is realization at gift or death. A gift or a death is a transfer but not a sale or exchange, and the Supreme Court has not decided whether Congress may treat either as the occasion for taxing accrued gain. Moore's attribution analysis does not address it.

The third is taxing appreciation that accrues in replacement property after an exchange, before any later disposition. That is the first category applied to exchange property, and it raises the same question.

How the answer would change section 1031. If realization is not constitutionally required, section 1031 is purely a legislative choice about timing, and Congress could reach the gain in an exchange chain annually if it wished. If realization is required for an income tax, reform is confined to realization-based designs, and the basis rule for property acquired from a decedent becomes the decisive policy lever, because deferred gain disappears only at death.³²

What a practitioner can say. Under current law, gain deferred through section 1031 is taxed on a later taxable disposition and eliminated by a basis step-up at death. Among existing rules, the clearest example of a tax on an individual's unrealized appreciation in real property without a sale is the expatriation regime for covered expatriates.³³ Whether Congress may go further is an open constitutional question, and any proposal that taxes appreciation without a transfer should be expected to produce litigation over the question the Court reserved in 2024.