IRC § 1031 provides:

“No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment”, IRC § 1031(a)(1).

The following requirements must be met:

1) Real Property.
2) Property held for a qualified purpose.
3) Real Property relinquished must be like-kind with replacement real property.
4) An exchange is required.

Property Requirement

As used in IRC § 1031(a), the words “like-kind real property” refer to the nature or character of the property and not to its grade or quality. Whether real estate is improved or unimproved is immaterial, Reg § 1.1031(a)-1(b). Improved real estate may be exchanged for unimproved real estate; an apartment building may be exchanged for a ranch or farm; and a leasehold with 30 years or more to run may be exchanged for a fee interest in real estate. Reg § 1.103(a)(-1(c)(2). Option renewal periods are included in determining the leasehold’s remaining duration. Rev Rul 78-72, 1978-1 CB 258.

Section 1031 does not apply to any exchange of:

• stock in trade or other real property held primarily for sale,
• interests in a partnership.
(1) Stock in Trade – or Dealer Property.

Stock in trade is property that would be included in the inventory of a dealer of that type of goods, See IRC § 1221(1). Stock in trade is property held for sale to customers in the ordinary course of the taxpayer’s trade or business, See Land Dynamics v. Comm., TC Memo 1978-259. Real property may be considered dealer property, and the gain on the sale of it is taxed as ordinary income, Margolis v. Comm., 337 F.2d 1001 (CA9 1964).

The distinction between dealer property and property held for productive use in trade or business or for investment is one of fact and there are no safe harbor provisions, Comm v. Tri-S Corp., 400 F.2d 862 (CA10-1968). Among factors that should be considered in determining whether a taxpayer holds property primarily for sale to customers I the ordinary course of his or her trade or business are:

(a) The purpose for which the property was initially acquired;
(b) The purpose for which the property was subsequently held;
(c) The extent to which improvements, if any, were made to the property by the taxpayer;
(d) The frequency, number and continuity of sales by the taxpayer;
(e) The extent and nature of the transactions involved;
(f) The ordinary business of the taxpayer;
(g) The extent of advertising, promotion or other active efforts used in soliciting buyers for the sale of the property;
(h) The listing of the property with brokers;
(i) The purpose for which the property was held at the time of sale, Klarkowski v. Comm. TC Memo 1965-328, affd 385 F.2d 398, (CA7 1962).

The fact that one is a dealer in property will not disqualify a taxpayer under IRC § 1031. Land Dynamics v. Comm., TC Memo 1978-259. See also Rev Rul 75-538, 1975-2 CB 34. A dealer may segregate dealer assets from assets to be held for productive use in trade or business or for investment. Ideally, the dealer should segregate the non-dealer assets in a separate entity and keep the two groups separate on the books and records, See Hicks v. Comm. TC Memo 1978-373; Harbour Properties, Inc. v. Comm. TC Memo 1973-134; Paullus v. Comm. TC Memo 1996-419; Neal T. Baker Enterprises, Inc., TC Memo 1998-302. One court found the relinquished property was held primarily for sale and ineligible for exchange treatment because the property was shown on the taxpayer’s books as “work in progress.” Neal T. Baker Enterprises, Inc. v. Comm, TC Memo 998-259.

Qualified Purpose Requirement

Property must be held by the taxpayer for either productive use in a trade or business or for investment. Personal residences, by implication, are ineligible for non-recognition treatment under IRC § 1031(a)(1), Ltr Rul 8915012.
The taxpayer’s purpose for holding the relinquished property and the replacement property is determined when the exchange takes place. Rev Rul 57-244, 1957-1 CB 247; Klarkowski v. Comm., TC Memo 1965-328, affd 385 F.2d 398 (CA 7 1967). Whether property is held for a proper purpose is a question of fact, Gulf Stream Land & Development Corp., 71 TC 587 (1979); Everett V. Comm, TC Memo 1978-53; Bernard v. Comm., TC Memo 1967-176. The taxpayer has the burden of proof on this issue, Land Dynamics v. Comm., TC Memo 1978-259.

Holding Period

There is no specific holding period requirement for either the relinquished property or the replacement property. The Internal Revenue Service’s position is that if the taxpayer’s property was acquired immediately before the exchange, the taxpayer acquired the property primarily to dispose of it, rather than hold it for productive use in trade or business or for investment, Rev Rul 84-121, 1984-1 CB 168; Rev Rul 77-337, 1972 CB 305; Rev Rul 57-244, 1957-1 CB 247. The courts have been much more liberal in determining that a taxpayer has held property long enough to qualify, 124 Front St., Inv. v. Comm. 65 TC (1975), 1976-2 CB 3 (property held six months before exchange); Rutherford v. Comm. TC Memo 1978-505 (transfer immediately upon acquisition); Allegheny County Auto Mart, Inc. v. Comm. TC Memo Op Dkt 38166 (1953), affd per curiam 208 F.2d 653 (CA 3 1953) (property held five days before exchanges). The IRS also takes the position that if replacement property is disposed of immediately after the exchange, it was not held for qualified purposes, See Rev Rul 75-292, 1975-2 CB 333. A number of cases have taken the same position. Regals Realty Co. v. Comm.,127 F.2d 931 (CCA2 1942)(replacement property listed for sale on month after exchange); Griffin v. Comm. 49 TC 253 (1967) (replacement property sold under a contract executed before the exchange); Bernard v. Comm., TC Memo 1967-176 (replacement property sold two weeks after the exchange); Black v. Comm. 35 TC 90 (1960)(replacement property sold eight months after exchange). But see Boise Cascade Corp. v. Comm., TC Memo 1974-315 (replacement property sold within a year after the exchange, but exchange upheld).

Like-Kind Requirement

Real Property.

Examples of real property exchanges held to be like-kind are:

(1) Unimproved real property for unimproved real property, Reg § 1.103(a)-1(b), (c); Rev Rul 72-515, 1972-2 CB 466; Barker v. Comm., 74 TC 55 (1980);
(2) Commercial building for lots, Burkhard Inv. Co. v. U.S. 102 F.2d 642 (CCA9 1938);
(3) City real estate for a ranch or farm, Reg § 1.1031(a)-1(c); Braley v. Comm. 14 BTA 1153 (1929); Rutland v. Comm., TC Memo 1977-8;
(4) One property for more than one property and vice versa, Coupe v. Comm. 52 TC 394 (1969), acqd. in result only 1970-1 CB xv;
(5) A tenancy-in-common interest for a fee interest and vice versa, Rev Rul 79-44, 1979-1 CB 265, Rev Rul 73-476, 1973-2 CB 300; Rev Rul 68-186, 1968-1 CB 354;
(6) An easement for a fee interest, Rev Rul 72-549, 1972-2 CB 472;
(7) Water rights for a fee interest where water rights are real property under state law, Rev Rul 55-749, 1955-2 CB 295;
(8) Real property held for investment, which includes a personal residence for other investment real property including a residence (the residences are treated separately under IRC § 121 and former IRC § 1034), Rev Rul 59-229, 1959-2 CB 180;
(9) A fee for a fee, subject to a 99-year lease, Koch v. Comm. 71 TC 54 (1978), acqd. 1979-1 CB 1;
(10) A fee for a leasehold with 30 years or more to run, Reg § 1.1031(a)-1(c); Rev Rul 78-72, 1978-1 CB 258; Rev Rul 68-394, 1968-2 CB 338, (all unexercised option periods are included in meeting the 30-year requirement), Century Elec. Co. v. Comm. 912 F.2d 155 (CA8 1952):

Improvements To Be Constructed

The transfer of property in exchange for property with improvements constructed according to the taxpayer’s specifications will qualify for non-recognition under IRC § 1031, provided the party constructing the improvements did not act as the taxpayer’s agent, Coastal Terminals, Inc. v. U.S., 320 F.2d 333 (CA4 1963); J.H. Baird Pub. Co. . Comm. 39 TC 609 (1962), acqd. 1963-2 CB 4, or the party constructing the improvements is the intermediary or exchange accommodation titleholder and the improvements are constructed prior to the taxpayer’s acquisition of the replacement property. Reg § 1.103(k)-1(e)(4). The party making the improvements may acquire the land and complete the improvements “solely for the purpose of making the exchange.” Rev Rul 75-291, 1975-2CB 333. If the improvements are constructed on land the taxpayer owns, the transaction will not qualify under IRC § 1031. The improvements are not like-kind to the real estate. The transaction in effect is the purchase of a new facility and not an exchange. Bloomington Coca Cola Bottling Co. v. Comm. 189 F.2d 14 (CA 7 1951), Land is not the same nature or character as a building, See Rev Rul 76-391, 1976-2 CB 243, to the same effect in an IRC § 1033 context.