What is a Like-Kind 1031 Exchange?

The sale of less than a fee interest may also qualify for tax deferral under §1031 if certain criteria are met. For example, leasehold interests exceeding 30 years and certain oil and gas interests can be considered like-kind to other real estate. Additionally, the IRS has issued several private letter rulings finding that certain types of conservation and agricultural easements are like-kind to real estate. A conservation easement is a voluntary agreement entered into by landowners conveying certain rights and generally limiting the type or amount of development on their property while still retaining ownership of the land. Generally, for 1031 exchange purposes, the easement needs to be perpetual in nature and considered an interest in real estate under state law in order to be considered like-kind to real estate.

Conservation easements are generally conveyed to nonprofit or government entities, and the landowner may receive cash or a charitable deduction in return for granting the easement. When cash is received, a 1031 exchange may be a good option to defer the capital gains taxes that may be owed on those proceeds.

There have also been instances where the landowner received compensation other than cash in exchange for the easement. In Private Letter Ruling No. 200649028 the IRS approved an exchange where the taxpayer received stewardship credits as compensation. Using a Qualified Intermediary, the taxpayer conveyed to the county a perpetual restrictive stewardship easement over ranch land in return for stewardship credits equal to the value of the property rights that the taxpayer permanently relinquished. During the exchange period, the taxpayer converted the credits to cash by selling them to third-party buyers. The cash was then used to purchase the replacement property. The taxpayer was never in receipt of the credits or the relinquished property proceeds during the exchange period. The stewardship easement was held to be like kind to a fee interest in real estate.

The IRS based its decision on the fact that the stewardship easement was considered an interest in real property under state law and that the easement was perpetual. The ruling also discussed how the sale of the easement significantly and permanently restricted the future use of the taxpayer’s property such that the fair market value of the property, if sold, would be impaired.

In summary, remember that a §1031 exchange opens many investment opportunities for property owners. You are not limited to only exchanging fee interests for other fee interests. There are many other possibilities, including conservation easements, leasehold interests, and water rights. Please feel free to contact me to discuss your options.

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