Leasehold Interests and 1031 Exchanges Frequently Asked Questions

A leasehold interest with a term of 30 years or more is like-kind to a fee interest in real estate (Reg. §1.1031(a)-1(c)(2)). Renewal options under the lease are counted for purposes of determining if the lease has 30 years or more to run. Accordingly, a 30 year leasehold interest can be exchanged for a fee interest in real estate or vice versa - a fee interest in real estate can be exchanged for a 30 year leasehold interest.

Leasehold interests with less than 30 years remaining under the lease are not like-kind to a fee interest in real estate. But, they can qualify as like-kind to other leasehold interests with either 30 years remaining under the lease or less than 30 years.

What is the difference between a lease and a leasehold interest?

A Leasehold Interest is an interest in real estate which is acquired and possessed by a person who is the lessee of the property under the terms of a lease. The Lessor is the owner of the property. The Leasehold Interest might be bare land or land with improvements. Sometimes the leasehold improvements are in place when the lease is executed and sometimes the improvements are constructed by the lessee after the lease is executed.

A Lease is the legal instrument documenting the terms and number of years of possession by the lessee.

What is the tax basis of a leasehold interest acquired as replacement property in a 1031 Exchange?

Tax basis is the purchase cost of obtaining the lease minus the deferred gain resulting from the exchange. If improvements are constructed on the leasehold, tax basis will include the cost of such construction or improvements.

How is the tax basis of a leasehold interest depreciated?

The tax basis of a leasehold interest is amortized over the number of years the lease has to run, including options for renewal of the lease.

If I exchange bare land for a 30 year lease of a commercial building, I can amortize the tax basis attributable to the bare land over 30 years?

Yes, the tax basis of the leasehold interest is amortized over the life of the lease, including options for lease renewal.

What if the term of the lease is for 30 years plus an option to renew for an additional 30 years (60 years in total)? Am I required to amortize a commercial office building which ordinarily could be depreciated over 39 years over 60 years?

The building can be depreciated over the ;">MACRS recovery period (39 years in this case) if the life of the lease, including renewal options is longer than the MACRS recovery period (Reg. §1.178-1(b)(3)). The cost basis allocable to the land would be amortized over the life of the lease, including renewal options.

What if the term of the lease is for 20 years plus an option to renew for an additional 20 years (40 years in total) and I do not intend to exercise the renewal option?

Amortization of the tax basis of the lease over 20 years is possible if the taxpayer can establish that is “more probable than not” that the lease will not be renewed, extended or continued (Reg. §1.178-1(b)(2).

See our Exchange Manual or give us a call us at 888-367-1031 if we can help with any questions you may have about 1031 Exchanges.