LIKE-KIND PROPERTY EXPLAINED

The phrase like-kind sounds like it should be narrow, but for real property it is one of the broadest tests anywhere in the tax code. Since the Tax Cuts and Jobs Act of 2018, Section 1031 applies only to real property held for productive use in a trade or business or for investment. Personal property exchanges, which used to allow deferral on equipment, vehicles, and similar assets, no longer qualify. Within the world of real property, however, the like-kind standard does not require the relinquished property and the replacement property to be the same type, grade, or quality of asset.

In practical terms, this means an investor selling a Boston, MA apartment building can exchange into raw land, a single tenant retail property, an industrial warehouse, a medical office building, or a hospitality asset, and the transaction can still qualify as like-kind, provided both properties are held for investment or business use rather than personal use. A property held primarily for personal use, such as a primary residence or a vacation home used predominantly by the owner, generally does not qualify as either relinquished or replacement property. Property held primarily for sale to customers, sometimes called dealer property, such as inventory held by a developer who builds and sells homes, is also excluded from Section 1031 treatment regardless of how it is titled.

What counts as real property under current law

The Treasury Regulations define real property broadly to include land and improvements to land, unsevered natural products of land, and certain intangible interests in real property such as leasehold interests of thirty years or more, easements, and some water and mineral rights. Machinery or equipment that is permanently affixed to real property and would be treated as a fixture under applicable state law, such as an elevator system or a building's core electrical and mechanical infrastructure, may also qualify as part of the real property. Personal property that is merely incidental to the real property, such as office furniture conveyed with a building sale, does not itself qualify but generally does not disqualify the exchange either, since incidental personal property up to certain thresholds is disregarded for identification and boot purposes.

Fractional and passive replacement options

Some investors, particularly those transitioning out of active property management, look at fractional ownership structures such as Delaware Statutory Trusts, sometimes shortened to DSTs, as a way to acquire like-kind replacement property without directly managing a building. A properly structured Delaware Statutory Trust interest, satisfying the requirements described in Revenue Ruling 2004-86, can qualify as like-kind real property for exchange purposes, giving an investor a beneficial interest in a professionally managed asset, such as a multifamily portfolio or a net lease retail portfolio, rather than direct title to a single property.

Delaware Statutory Trust interests are securities offerings, not conventional real estate purchases, and they carry different risk, liquidity, and disclosure characteristics than owning a property directly. We do not sell securities, and any discussion of Delaware Statutory Trust or tenant-in-common structures as part of an exchange strategy is limited to introductions to licensed securities providers who can offer these interests through proper regulatory channels. Investors considering a Delaware Statutory Trust as replacement property for a Boston, MA exchange should review the offering documents with a securities-licensed professional and a tax advisor before committing exchange proceeds, since these structures involve trust-level restrictions on borrowing, capital calls, and property management decisions that do not apply to directly owned real estate.

Tenancy-in-common structures, sometimes shortened to TIC arrangements, are a related but distinct concept worth understanding alongside Delaware Statutory Trusts. In a tenancy-in-common structure, each investor holds a direct, undivided fractional ownership interest in the real property itself, rather than a beneficial interest in a trust that owns the property, and the Internal Revenue Service outlined the conditions under which a tenancy-in-common interest will be respected as direct real property ownership, rather than as an interest in a business entity, in Revenue Procedure 2002-22. Because a tenancy-in-common interest is direct real property ownership rather than a security, it does not carry the same securities law considerations as a Delaware Statutory Trust interest, though it typically requires unanimous consent among the co-owners for major decisions, which can be more cumbersome than the more centralized management structure of a trust. Both structures can serve a similar purpose for an investor seeking passive, professionally managed replacement property, and the better fit generally depends on how much direct control and involvement the investor wants to retain.

Investors weighing a directly owned replacement property against a fractional structure often find it useful to first narrow down the asset class itself, whether that means a nationwide search using the site's Nationwide STNL Identification service for single tenant retail, or a Boston-focused search through the Boston Market Scan service for multifamily and mixed-use opportunities closer to home. Deciding on an asset class and ownership structure together, rather than sequentially, generally produces a shorter and more realistic identification list once the forty-five-day clock starts running, since the investor is not simultaneously reconsidering the ownership structure while also trying to evaluate specific properties against a tight deadline.