Recent Case: Leasehold Interests Not Like-Kind to Fee Interest

In order to qualify for tax deferral under Internal Revenue Code §1031, both the property sold as relinquished property and the property acquired as replacement property must be like-kind. §1.1031(a)-1(b) of the Treasury Regulations clarifies that the term “like-kind” refers to the nature or character of the property interests involved, but not the grade or quality of the specific property. Under this test, the courts have generally concluded that a fee simple interest in real property is like-kind to a wide range of real property interests. Thus, developed land is like-kind to undeveloped land and a fee interest is like-kind to certain mineral interests, water rights and certain long term leasehold estates. Along those lines, Treasury Regulation §1.1031(a)-1(c) provides that a tenant’s interest in a leasehold estate with 30 years or more remaining to run, including option extensions, is like-kind to a fee simple interest in real property. Given the specificity of the regulation, most tax advisors believe that a taxpayer attempting to exchange a leasehold interest with less than 30 years remaining at the time of the exchange would not be like-kind to a fee simple interest in other property.

In VIP Industries Inc. & Subsidiaries v. Commissioner, T.C. Memo 2013-357, the taxpayer exchanged a leasehold interest with a remaining term of 21 years for fee simple interests in two Oregon replacement properties. There were no option extensions. After citing regulation §1.1031(a)-1(c) and reviewing precedent cases, the court concluded that leasehold interests with remaining terms similar to the one at issue are not like-kind to fee interests in real property. Precedent cases included May Department Stores Co. v. Commissioner, 16 T.C at 556, (holding that a 20-year leasehold was not like-kind to a fee interest); Standard Envelope Mfg. Co. v. Commissioner, 15 T.C. at 48 (holding that leasehold interest with a terms of 1 year and an option to renew for a term of 24 years was not like-kind to a fee interest). Thus, in the VIP Industries case, the court found that the taxpayer’s leasehold interest in VIP Industries with a term of 21 years and 4 months remaining is closer in nature to the leasehold interests and not like-kind to a fee interest. As such, the exchanger was not entitled to deferral of tax under Section 1031.

In light of the VIP Industries case, taxpayers who wish to exchange a leasehold interest for a fee interest should only proceed if the leasehold interest has more than 30 years remaining, including options to renew that would extend the leasehold interest over the 30 year threshold. As always, consult with your tax and legal advisors about your specific situation well in advance of a contemplated 1031 exchange.

Vacation Homes and Other Ownership Tax Issues

Vacation Homes Handbook
» Click here to download

According to the National Association of Realtors, the
vacation home market is heating up again and many real estate professionals are reporting strong sales in many vacation home hot spots.

In response to increased activity in many vacation markets, Asset Preservation has created a brand-new Vacation Home Handbook that covers many tax issues related to the ownership and sale of a vacation or second home. This brochure is very comprehensive, contains hyperlinks to key tax code sections and provides useful guidance to property owners, real estate professionals, closers, attorneys and CPAs in resort communities and vacation home marketplaces throughout the United States. This is a “must have” resource for anyone involved with real estate in a vacation area or resort market!!

API’s Vacation Homes Handbook contains the following information:

    This section discusses the “safe harbor” for exchanges of vacation homes and also what will not qualify for an exchange of a vacation home property.
    1. Second Home/Vacation Home with No Rental Activity
      1. Tax Consequences during Ownership
      2. Tax Consequences at Disposition
      3. How to determine if a vacation property could be considered a principal residence and qualify for Section 121 tax exclusion
    2. Second Home/Vacation Home Rented Less than 15 Days a Year
      1. Tax Consequences during Ownership
      2. Tax Consequences at Disposition
    3. Vacation Home Rented for More than 15 Days a Year
      1. Tax Consequences during Ownership
      2. Tax Consequences at Disposition
    4. Property Held Primarily for Investment in a Vacation Area
      1. Tax Consequences during Ownership
      2. Tax Consequences at Disposition

U.S. Median House Price Climbs the Most in 7 1/2 Years

The median selling price of an existing single-family home reached $203,500 in the second quarter, a 12.2% increase compared with Q2 of 2012 and the sharpest year-on-year gain since Q4 of 2005, according to the National Association of Realtors. Tightening inventory is a major factor, Chief Economist Lawrence Yun says. Read More…

New Reporting Requirement For Certain California 1031 Exchanges

California has enacted a new reporting for taxpayers who exchange out of a relinquished property located in California and into replacement property located outside of California. For tax years beginning on and after January 1, 2014, taxpayers that exchange out of California must file a report with the Franchise Tax Board for the year of the exchange and for subsequent tax years. The statue creates a new procedure for tracking deferred gain and Section 18032 has been added to the California Revenue and Taxation Code. California has always maintained that the deferred gain was taxable in California and this new procedure will make it easier to enforce these rules. Read More…

National Council of Real Estate Investment Fiduciaries Property Index

Privately owned real estate produced a return of 2.87% in this year’s second quarter, according to the property index managed by the National Council of Real Estate Investment Fiduciaries. That was the highest return indicated by the NCREIF index since the fourth quarter of 2011. Read More…

Top 10 Places in the U.S. to Buy a Vacation Home

According to a National Association of Realtors study, approximately one-in-four vacation home market buyers purchased with the intention to rent out their vacation area property., reported their list of the most popular June destinations, and compiled a Top-10 listTo see the top-10 June destinations reported by, Read More…

Webinar: Exchanges & Tax Planning in an Environment of Increasing Taxation

This 1.5 hour CPE course provides a concise and thorough overview of IRC Section 1031 tax deferred exchanges for accountants, CPAs and financial advisors. In addition to covering critical IRS time deadlines, “like-kind” requirements and other exchange related issues, the class will provide a summary of current developments including applicable Revenue Rulings, PLR’s and other IRS guidance on current issues related to exchanges. Register Now…

Dates: September 23rd
Time: 12:00 p.m. – 1:00 p.m.
Cost: Free
Credit: 1.5 Hours (CPE)

1031 Exchange Resources

Open a 1031 ExchangeOpen an Exchange

1031 Exchange Materials1031 Materials

1031 Exchange NewsPast eNewsletters

1031 Exchange Webinar and PodacatWebinar/Podcast