1031 Exchanges Involving Permits and Leases

We continue to receive inquiries about potential real estate transactions involving federal and state grazing permits and leases and other special use permits that may involve the U.S. Forest Service (U.S. Department of Agriculture), Bureau of Land Management (Department of the Interior) and various state agencies, to name a few.

The typical situation arises when an (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger has sold a ranch or farm property along with Federal or State grazing permits and/or leases and the transfer of the permits and/or leases was included as part of the entire real property exchange transaction. Prior to December 2020, the conventional wisdom was that those Federal permits could be viewed as similar to long-term leases of 30+ years, which are viewed by the IRS as “like-kind” to fee ownership interests in real property and therefore qualified as part of the overall real property transaction. Typically, the Federal permits are issued for a term of from 10 to 12 years with provisions allowing for renewal as long as the permittee is in good standing with the agency. Many of those permits may have been held by the permittees for 50 years or more. However, there was no clear consensus on whether that interpretation would be upheld.

New 1031 regulations were issued in December 2020 by the IRS and Treasury that clarified which types of intangible real property interests might qualify as “like kind” real property for purposes of effecting a 1031 exchange and tax deferral on the transaction. Specifically, the new regs at § 1.1031(a)-3 state that “Under paragraph (a)(5) of this section, an intangible interest in real property of a type described in this paragraph (a)(1) is real property for purposes of section 1031 and this section.” The referenced paragraph (a)(5) goes on to state that interests such as leaseholds, options to acquire real property, easements, and stock in a cooperative housing corporation qualify as 1031 real property interests. The paragraph goes on to provide as follows: “Similar interests are real property for purposes of section 1031 and this section if the intangible asset derives its value from real property or an interest in real property and is inseparable from that real property or interest in real property.”

In a subsequent subparagraph, paragraph (a)(5), the IRS further clarifies “(ii) Licenses and permits. A license, permit, or other similar right that is solely for the use, enjoyment, or occupation of land … and that is in the nature of a leasehold, easement, or other similar right, generally is an interest in real property under this section.” The IRS then cites some examples, one of which is similar to grazing permits and reads as follows:

“Example 11: Land use permit. K receives a special use permit from the government to place a cell tower on Federal Government land that abuts a federal highway. Government regulations provide that the permit is not a lease of the land, but is a permit to use the land for a cell tower. Under the permit, the government reserves the right to cancel the permit and compensate K if the site is needed for a higher public purpose. The permit is in the nature of a leasehold that allows K to place a cell tower in a specific location on government land. Therefore, the permit is an interest in real property under paragraph (a)(5) of this section. (Note: highlighted portions added by the author)

Based upon the foregoing information, a strong argument can be made that any value attributable to permits that are part of a much larger land transaction as referenced above qualifies for 1031 tax deferral so long as the (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger uses the funds within the 1031 exchange timeline to acquire qualifying replacement property.

Depending on the type of grazing or other special use permits at play, some additional information may be required to fully assess the situation, which could include any of the following:

• Allotment names and identifying numbers
• USFS Ranger District info for the allotments
• BLM District Office info for the allotments
• Name of (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger entity or entities that are the listed permittee(s)

We are aware of fairly recent variations on the more common scenario outlined above where a conservation or environmental entity will pay a landowner/Federal permittee a sum of money to waive or assign some, or all, of their grazing permits or other special use permits, back to the Federal agencies that issued the permits. The apparent goal of the payor entity is to encourage the Federal permittees to cease grazing their livestock on public lands and return the public lands to a more “natural” state. This enticement may make sense if the permittee can use the proceeds from the transaction to acquire other grazing lands and defer the taxable event by using 1031 exchange.

A couple of factors that make this scenario unique to the more common one discussed above include the following:

• The (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger will not be selling commensurate base property or permitted livestock to effect the permit waivers or transfers in question.
• The Exchanger will also not be conveying the permits to the The purchaser of the taxpayer's relinquished property. Buyer as a new permittee. Rather the permits simply revert to the respective agencies.

Whether this type of transaction has any merit from a conservation standpoint or complies with the various Federal laws allowing for livestock grazing on public lands is open for debate. However, it appears that the taxpayer/permittee in such a situation can probably parlay the monetary consideration they receive into a valid 1031 exchange.