Section 1031: What is Real Property? Four Things You Should Know From the New Final Regulations

Effective December 2, 2020, the IRS issued its Final Regulations (the “Final Regs”) clarifying what is real property under Section 1031 of the Internal Revenue Code. The IRS issued these regulations to provide guidance in response to statutory changes in the Tax Cuts and Jobs Act, which provided that personal property is no longer eligible for Section 1031 treatment. Here are some highlights from the Final Regs, including a couple of major changes from the June 2020 proposed regulations (the “Proposed Regs”).

  1. Improvements are real property. No surprises here. Basically, inherently permanent structures (like buildings) and the structural components in them (like electrical wiring) are real property. The Final Regs ditched the Proposed Regs’ purpose or use test, so that means that taxpayers don’t have to labor over whether gas lines that a restaurant tenant installed exclusively to heat its fryers are real property or not—under the Final Regs, the gas lines are real property.
  2. If it’s real property under state or local law, it’s probably real property for 1031 purposes. The Final Regs departed from the Proposed Regs on this point too. The Final Regs more broadly defer to state and local law in determining what constitutes real property. The state and local law test applies to both tangible and intangible property and controls unless: (a) Federal law specifically classifies the type of property as personal property; (b) the Final Regs specifically classify the type of property as real property; or (c) after analyzing the various applicable factors provided by the Final Regs, it’s considered real property.
  3. Intangible property is real property if it derives value from real property or an interest in real property and is inseparable from the real property or interest in real property. Think: co-ownership interests in real property, leaseholds, options to buy real property, easements, and land development rights. The IRS’s commentary to the Final Regs did note that leaseholds and easements may need to be long term to be like kind, but the Final Regs only address what qualifies as real property. The Final Regs expressly exclude certain securities, including interests in partnerships, from being classified as real property. The Proposed Regs and Final Regs are generally consistent on classifying intangible property.


  1. Incidental personal property will not disqualify your 1031 exchange if it’s worth 15% or less of the deal. It must be the type of personal property that’s typically transferred together with real property (like the laundry machines that come with the apartment building you bought). You’ll still recognize any gain on this personal property, but you won’t lose your 1031 tax treatment on the rest of the transaction. The Proposed Regs and Final Regs are consistent on this rule too.

Thankfully, the Final Regs clarify what’s real property for 1031 purposes and do so in a taxpayer friendly manner. Hopefully, 1031’s stick around long enough to make reading this blog post worth it!