The IRS recently released guidance (PLR 202309007) concluding that certain water rights are "real property" and are “like-kind” to a fee simple interest in real property for purposes of Section 1031, as long as all properties are held for productive use in a trade or business or for investment.
Section 1031(a) generally provides that no gain or loss is recognized on the exchange of like-kind real property held for productive use in a trade or business or for investment.
The taxpayer addressed by the PLR held a license for the unrestricted diversion and use of water in perpetuity with other ranch owners who were the successors in interest to the same water rights. The taxpayer and the other ranch owners operated separate farming and cattle operations, did not carry on a joint business activity, and never joined in filing a partnership return with respect to their ownership of their respective properties. The taxpayer and other ranch owners had an agreement that if all or a portion of the water rights were sold, the proceeds would be allocated amongst them.
The taxpayer planned to sell a portion of the water rights and to reinvest the proceeds in real property and wanted to treat the transaction as a nonrecognition event under Section 1031.
Under state law procedures, the license would be bifurcated into two separate licenses: the first vested in the taxpayer and the second vested in the buyer for the portion of rights that were sold. The cash sales proceeds would be allocated among the taxpayer and other ranch owners pursuant to their agreement.
The IRS looked to Rev. Rul. 55-749, where the IRS concluded that the water rights and the land involved were sufficiently similar to constitute “property of a like-kind” within the meaning of Section 1031, because the water rights were granted "in perpetuity" and were not merely rights “to a specific total amount of water or to a specific amount of water for a limited period."
The IRS contrasted this analysis with the case Wiechens v. United States, in which the U.S. District Court for the District of Arizona found that because a taxpayer’s water rights were narrowly restricted in priority, quantity and duration, the water rights were not sufficiently similar to the fee simple interest that it acquired in farmland to qualify as like-kind property — even though the taxpayer’s water rights constituted an interest in real property.
In PLR 202309007, the IRS determined the pertinent water rights were real property that is like-kind to a fee interest in real property because the water rights were:
- Real property under state law
- Sold under a license granting the ranch owners rights to a set volume of water each year
- Subject only to the right of a state to terminate based on a finding that they are not being put to beneficial use
Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.
More tax hot topics
No Results Found. Please search again using different keywords and/or filters.