This Post Has Not Been Updated to Include Changes from the “Tax Cuts and Job Act” passed on December 22, 2017.
Property Types and Asset Classes:
Very recently, members of our tax team had a lively debate about what qualifies as real property – and tax is our job! How would an average taxpayer know what qualifies as real property?
Like so many things in tax, detail matters. In the case of real property, it may seem obvious what real property is – and that is usually true. A home is real property, as is a commercial mall. We all know that 40 acres of pasture is real property, and the barn is real property. But what about the oil under the field? What about the air above the field? Is a cell tower, or a wind turbine, or an easement lease real property?
The IRS generally regards business use property differently from private use property and investment property, and business use property is generally considered either real property or personal property. Business use property is generally expensed or capitalized (depreciated) as allowed by law, and when it is sold, the sale is generally subject to income tax. When purchasing and selling business use property, the type of property is important to determine how it should be taxed.
"Real Property" Defined
There are a variety of places in the tax code where we see rules for property type, including rules regarding depreciation and like-kind exchanges. In 2016, the Treasury Department clarified its stance on real property in an amendment to the Regulations. This definition applies for the purpose of Real Estate Investment Trusts (REITs), but should generally be applicable across the IRS. The regulations give us both guidance for making arguments and a safe harbor list of assets generally considered real property.
Real property is defined as “land and improvements to land.” Here, land includes water and air above the land and any natural products on or in the land until they are removed from the land. Improvements to the land is defined as “inherently permanent structures” and their structural components. The rules get detailed and wonky at this point, but they do list specific structures they consider inherently permanent under safe harbor rules. They also offer a list of questions to determine whether an asset is real property, including questions about time and expense of removing an asset from land, whether the removal would damage the land, whether the asset will remain if a tenancy is vacated, and the manner the asset is affixed to the land. The new regulations also make an important toward a classification of active and passive assets. The IRS leaves open the possibility that the asset will do both, thereby leaving us with a bit of gray area to work in.
Determining the Difference
As a way to demonstrate the difference, a silo is considered to be real property, but a grain bin is not. Fencing is listed in the safe harbor rules as an inherently permanent structure, but we have space to argue if a need arises. We may be able to make some arguments to one side or the other, but this distinction may give you a better feel for the gist of the rules.
Tax professionals generally prefer when the IRS and Congress do not issue firm definitions on these matters. While it may be frustrating at times, our ability to make arguments that an asset is real or personal based on the tax treatment we feel is necessary in a given situation is vital to serving taxpayers. Additionally, new technologies and novel techniques can make firm distinctions moot.
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