Real Estate Articles » 1031 Exchange

Does A Co Op Cut The Mustard?

By: Amy K. Walsh, CES®
Submitted: 03:00PM on Friday 24 April 2009

Many times the determination of what qualifies as real property for the purposes of §1031 will defer to the state classification of the particular property and whether the properties being exchanged are like-kind. In this situation, the taxpayers were a partnership and a corporation. They each owned shares of stock in cooperative apartments within New York. Cooperative housing corporations actually owned the properties, and the taxpayers then rented out the apartments that their shares represent and derived income from the tenants.

The taxpayers intended to exchange their interests in their respective co-ops for improved and unimproved real properties and submit them as qualifying exchanges. The taxpayers planned to own the replacement properties as tenants-in-common.

After examination, the IRS ruled that the proposed transactions indeed met the requirements for an exchange. This ruling was based partially under the reasoning that, under Reg. Section 1.1031(a)-1(b), an exchange is judged on a property’s nature or character and not on its grade or quality; thus the determination of whether the properties were improved or unimproved is irrelevant. The relevant inquiry regarding the qualification of properties for tax-deferred treatment is whether the intended acquisition property is of the same kind or class as the property being given up. Further on in Reg. Section 1.1031(a)-1(c) are the examples of properties that are considered to be like-kind. In the above-situation, the most relevant illustrations concern real estate and the provision that a taxpayer who is not a dealer may exchange city real estate for a ranch or farm, a leasehold consisting of 30 years or more so long as the taxpayer has the right of renewal, or improved property for unimproved property. Finally, according to the Service, the real test of the qualification of cooperative apartment stock for §1031 tax-deferred treatment lies with the law of New York and its view as to whether it is considered real or personal property. This is much the same as the deferral to state definitions for oil, mineral and gas rights, water rights, or timber rights. Timber rights may be considered real property in some states, but in others they are considered personal property. The Service noted that although New York case law may suggest that there are conflicts concerning whether a cooperation stock interest in real property constitutes real property itself, various New York statutes still treat an interest in a cooperative as the equivalent of an interest in real property.

In the end, simply do the research. In a situation where the property is questionable as to its qualification regarding real or personal, investigate the definition for the state in which the property is located. This will in many cases provide the light at the end of a very murky tunnel.