A Lease Qualifies For Like Kind Treatment But Watch the Fine Print

A recent court case (VIP Industries, Inc.) spelled out the right and wrong way to exchange a lease for real property. Under Section 1031 you can exchange real property for real property. One of the rules indicates that a lease with 30 years or more left on the lease will qualify for like kind treatment.

In the VIP case, the taxpayer entered into a ground lease for 33 years in 1993. It could not be renewed or extended. The taxpayer sold this lease in 2006 with 21 years remaining on the lease for a gain of about $4.3 million and deferred about $2.1 million of the gain by reinvesting in real estate.

The IRS audited the return and disallowed the deferral. The Tax Court agreed by indicating since the remaining term on the leader was less than 30 years it is not like kind with real estate. Even though the original term was for greater than 30 years, it is the number of years remaining at the time of sale that is critical.

Again, you can exchange a lease for real estate you must watch the fine print.