Transferable development rights count as "like kind" to real estate, so they can be replacement property in a § 1031 exchange

Plain-English summary

A real estate partnership wanted to sell one property and, in a like-kind exchange under section 1031, use the proceeds to buy "transferable development rights" (TDRs). TDRs are zoning credits: they let the owner build more floor area on a receiving site than local zoning would normally allow. The partnership planned to apply the TDRs to a second property it already owned, to enlarge an office-building project there. Under section 1031, gain is deferred only when real property is swapped for real property of "like kind," so the question was whether these development rights count as like-kind real property. The IRS ruled that they do. It relied on the section 1031 regulations, which say that land development rights and intangible interests that are real property under state or local law qualify as real property for section 1031 purposes, and the taxpayer represented that TDRs are treated as real property under its state's law. The IRS also confirmed, citing Rev. Rul. 68-394, that using the acquired rights on land the taxpayer already owned does not disqualify them as like-kind replacement property. The ruling is narrow: it only decides the "like kind" question and expresses no opinion on whether the rest of the exchange qualifies for deferral. It matters to developers who buy and sell zoning-based development rights and want to fold them into tax-deferred exchanges.

Ruling snapshot

• Question: Are transferable development rights of "like kind," within the meaning of § 1031, to the real property the taxpayer is giving up?
• Outcome: approved
• Key authorities: IRC § 1031; Treas. Reg. §§ 1.1031(a)-1(b), 1.1031(a)-3(a)(1), (a)(5)(i), (a)(6); Rev. Rul. 68-394; Rev. Rul. 67-255

Full text (IRS public release)

 Internal Revenue Service                                   Department of the Treasury
                                                            Washington, DC 20224

 Number: 202335002                                          Third Party Communication: None
 Release Date: 9/1/2023                                     Date of Communication: Not Applicable
 Index Number: 1031.00-00
                                                            Person To Contact:
 ----------------------------------------                   ------------------------, ID No. ------------------
 -------------------------                                  ----------------------------------------------------
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 -----------------------------------                        Telephone Number:
                                                            -------------------
                                                            Refer Reply To:
                                                            CC:ITA:B4
                                                            PLR-102826-23
                                                            Date:
                                                            June 05, 2023



Legend
 Taxpayer        =   -------------------------
 Property 1      =   ---------------------------
 Property 2      =   -------------------------
 DE 1            =   --------------
 DE 2            =   --------------
 State Z         =   -------------
 City A          =   -------------
 City B          =   --------------------
 County          =   ------------------------------
 District        =   --------------------------------
 Date 1          =   -----------------------
 Date 2          =   -----------------
 Date 3          =   -------------------
 Date 4          =   -----------------------
 Date 5          =   -----------------------
 X               =   ---------
 $Y              =   -----------------




Dear ---------------:

This is in response to your request for a private letter ruling dated February 3, 2023.
Specifically, you have asked us to rule that transferable development rights (“TDRs”)

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are of “like kind”, within the meaning of § 1031 of the Internal Revenue Code (“Code”),
to the Relinquished Property transferred by Taxpayer.


                                          FACTS

Taxpayer is a State Z limited partnership. Taxpayer holds real property directly in its
own name and through a series of single-member limited liability companies that are
disregarded entities for federal income tax purposes. Taxpayer uses the accrual method
of accounting and a calendar taxable year.

Taxpayer owns Property 1 located in City A, State Z, through one of its disregarded
entities, DE 1. Taxpayer is the sole member of DE 1. Property 1 has been held for
productive use in a trade or business or for investment within the meaning of § 1031 of
the Code. Taxpayer intends to sell Property 1 and acquire TDRs as part of a like-kind
exchange structured as a reverse exchange. Taxpayer owns Property 2 located in City
B, State Z, through one of its disregarded entities, DE 2. Taxpayer is the sole member
of DE 2.

As part of its intended reverse exchange, DE 2 loaned funds to an exchange
accommodation titleholder (EAT) to purchase the TDRs. The initial closing for the TDR
acquisition occurred on Date 1, with the EAT currently holding title to the purchased
TDRs. To complete the reverse exchange, DE 1 will sell Property 1 through a qualified
intermediary (QI), and the QI will transfer the sale proceeds to the EAT. The TDRs will
be transferred directly from the EAT to DE 2. The EAT will use the proceeds it receives
to pay back the loan from DE 2. Taxpayer plans to use the TDRs to enhance
Taxpayer’s development project at Property 2 by increasing the floor area to an amount
greater than would otherwise be permitted by zoning regulations.

The TDRs originate from an MOU between City B and District, dated Date 4. (“TDR
MOU”). District recorded a Covenant Restricting Use of Land and Notice of
Development Restrictions dated Date 2 with the County on Date 3. The TDR MOU
establishes a mechanism to accommodate the District’s acquisition of three properties
located in City B for development of a facility, public park, and related uses. The District
will fund the acquisition and development of the property in part by the sale of
transferable unutilized development rights related to the property to third party
purchasers (“TDR Participants”). The TDR Participants will seek approval from City B to
apply such transferred development rights to designated receiving sites to allow for
additional floor area than would otherwise be permitted by zoning regulations. TDRs
become permanent in the hands of the TDR Participants when a Certificate of Transfer
of Development Rights is recorded.



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Taxpayer’s pre-application was approved by the City B Council on Date 5; the City B
has approved the site of the Property 2 project as eligible for the use of TDRs. The
Property 2 project consists of an office building, for which Taxpayer anticipates using X
TDR units from District. The agreed upon purchase price for the X TDR units is $Y. The
Property 2 project, once constructed, will be held for the production of rental income by
Taxpayer or by a disregarded entity owned solely by Taxpayer.

Taxpayer has represented that that transferable development rights are considered an
interest in real property under State Z law and has cited statutes and case law
supporting its representation.

                                   LAW AND ANALYSIS

Section 1031(a)(1) provides that 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 real property of like kind which is to be held either for
productive use in a trade or business or for investment.

Treas. Reg. § 1.1031(a)-1(b) provides, in part, that the words “like kind” refer to the
nature or character of the property and not to its grade or quality. One kind or class of
property may not be exchanged for property of a different kind or class. The fact that
any real estate involved is improved or unimproved is not material, for that fact relates
only to the grade or quality of the property and not to its kind or class. Properties to be
exchanged tax free under § 1031 must be of the same kind or class.

Treas. Reg. § 1.1031(a)-1(c) sets forth examples of properties that will be considered
like kind. The relevant examples pertain to real estate and provide that a taxpayer who
is not a dealer in real estate may exchange city real estate for a ranch or farm, a
leasehold of a fee with 30 years or more to run for real estate, or improved real estate
for unimproved real estate.

Treas. Reg. § 1.1031(a)-3 defines the term “real property” for purposes of § 1031 and
the regulations under § 1031. Under § 1.1031(a)-3(a)(1), real property includes land and
improvements to land and, under § 1.1031(a)-3(a)(5), an intangible interest in real
property of a type described in § 1.1031(a)-3 (a)(1) is real property for purposes of §
1031. Section 1.1031(a)-3(a)(5)(i) further provides that intangible assets that are real
property for purposes of § 1031 include land development rights. Finally, § 1.1031(a)-
3(a)(6) provides that, with certain exceptions not relevant to Taxpayer’s facts, property
that is real property under State or local law is real property for purposes of § 1031.

In this case, Taxpayer proposes to acquire TDRs as its replacement property and to use
such rights to enhance Property 2, which Taxpayer owned prior to its acquisition of the


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rights, a structure similar to the one addressed in Rev. Rul. 68-394, 1968-2 C.B. 338. In
Rev. Rul. 68-394, land held by a taxpayer for investment was condemned for a state
freeway. The taxpayer owned adjacent land that he had leased to a second party to use
and develop as a mobile trailer park site. For purposes of replacing the condemned
property, the taxpayer used part of the condemnation proceeds to purchase, in an arm’s
length transaction, the outstanding leasehold, with 45 years remaining, on the adjacent
land. After acquisition of the leasehold, the taxpayer used the land as a mobile trailer
park site.


Although Rev. Rul. 68-394 dealt with deferring gain under § 1033, § 1033 may apply
when a taxpayer replaces condemned property with property that is of like kind, within
the meaning of § 1031, to the condemned property. See § 1033(g). Since, under the §
1031 regulations, the exchange of a fee interest in real property for a leasehold interest
in real property with 30 years or more to run qualifies as a like kind exchange, the ruling
holds that the acquisition of a 30 year or more leasehold interest following the
condemnation of unimproved real estate would likewise qualify as replacement property
of like kind, even though the leasehold interest was on property already owned by the
taxpayer. Consequently, in the present case, the TDRs may qualify as of like kind to
Property 1 for purposes of § 1031, notwithstanding that Taxpayer intends to use the
TDRs on land owned by Taxpayer prior to Taxpayer’s acquisition of the TDRs. Compare
Rev. Rul. 67-255, 1967-2 C.B. 270, holding that a taxpayer’s construction on land
already owned by the taxpayer did not constitute a like-kind replacement.

As discussed above, Treas. Reg. §§ 1.1031(a)-3(a)(5)(i) provides that land
development rights are real property for purposes of § 1031. Moreover, Taxpayer
represents that transferable development rights such as TDRs are real property under
the laws of State Z and that the TDRs Taxpayer intends to acquire as replacement
property become permanent in the hands of the purchaser when a Certificate of
Transfer of Development Rights is recorded. Therefore, based on the above authorities
and the facts and representations that were submitted, we rule that the TDRs are, within
the meaning of § 1.1031(a)-1(b), of like kind to Property 1.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. In particular, we express no opinion as to whether the proposed transaction
qualifies in other respects for tax deferral under § 1031 beyond what is expressly stated
in the above ruling.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.



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In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                       Sincerely,



                                       Stephen J. Toomey
                                       Senior Counsel, Branch 4
                                       Office of Associate Chief Counsel
                                       (Income Tax & Accounting)


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