Can I sell a rental house and 1031 into commercial property, land or a DST?

Grade and quality are irrelevant, and Treasury says so in one sentence

Treas. Reg. 1.1031(a)-1(b) puts it plainly: "As used in section 1031(a), the words like kind have reference to the nature or character of the property and not to its grade or quality." A tired three-bedroom rental and a leased medical building share the same nature. They are both real property.

The regulation then gives its own worked examples of taxpayers who qualify. A person who is not a dealer in real estate exchanges city real estate for a ranch or farm; exchanges a leasehold of a fee with thirty years or more to run for real estate; or exchanges improved real estate for unimproved real estate.

The IRS repeats the point in its own guidance, saying that improvement or the lack of it makes no difference to the analysis. Nobody has to match a duplex to a duplex.

Business use and investment use are interchangeable in both directions

The other half of the test is what you do with each side, and here too the rule is generous. Treasury's reading of 1.1031(a)-1(a)(1), quoted by the IRS in Rev. Proc. 2008-16, is that property held for productive use in a trade or business may be exchanged for property held for investment, and property held for investment may be exchanged for property held for productive use in a trade or business.

So a rented single-family house, held for investment, can be replaced by a warehouse your own operating company will occupy, and the exchange still works. What you may not do is take the replacement out of business and investment use altogether.

If the tenant is your own company or a relative, the lease has to be real and the rent has to be fair, which is a separate discipline covered at Can I rent my replacement property to my child, my parents or my own business?.

What counts as real property has had a written definition since December 2, 2020

Treas. Reg. 1.1031(a)-3 defines real property as land and improvements to land, unsevered natural products of land, and water and air space superjacent to land. Improvements are inherently permanent structures and their structural components, and the regulation lists houses, apartments, factories, warehouses, stores, roads, paved parking areas, fences, railroad tracks, pipelines and grain silos among them.

It also names the intangible interests that count as real property in their own right, which is what lets a 1031 reach past a fee simple deed. A property is real property if it is real property under the law of the state or local jurisdiction where it sits on the date it is transferred.

The section applies to exchanges beginning after December 2, 2020, so anything you are selling now is measured against it.

• Fee ownership and co-ownership, which is what a tenancy-in-common interest is
• A leasehold, and specifically one with thirty or more years left to run
• An option to acquire real property, and an easement
• Land development rights, and stock in a cooperative housing corporation
• Shares in a mutual ditch, reservoir or irrigation company, under conditions the regulation sets

A DST interest works because the trust is a grantor trust, not a business entity

Rev. Rul. 2004-86 answered this directly. Strip the trustee of any managerial power to improve the investors' position in the market and the Delaware Statutory Trust is an investment trust under Treas. Reg. 301.7701-4(c)(1); sections 671 and 677 then put each beneficial owner in the position of a fractional owner of the underlying real estate, and the ruling concludes that the exchange "is the exchange of real property for an interest in Blackacre, and not the exchange of real property for a certificate of trust or beneficial interest."

That ruling is why a seller with no appetite for another set of tenants can land in institutional real estate instead. The mechanics from your side look like any other closing, because the intermediary wires to the trust's closing agent; Do I need a qualified intermediary to exchange into a DST? walks that part through.

The trustee's hands are tied by design, and those restrictions are the price of the ruling. Do DST interests really qualify as like-kind property? and our traditional DST page take the structure apart.

One house can become several replacements, or part of one

Nothing in the like-kind test requires a one-for-one trade. A hypothetical $700,000 rental house with no debt could become a $400,000 net-leased building and a $300,000 DST position, or four DST positions in four asset classes, so long as the identification rules are respected.

The limits that actually bite are the counting rules, not the character rules: see How many replacement properties can I identify? and Can I exchange one property into several, or several into one?.

Splitting between a property you manage and a trust you do not is common enough to have its own page, Can I split my exchange between a DST and a property I buy directly?.

The two edges: the national border, and the sofa in the furnished unit

Section 1031(h) draws the only geographic line that matters: "Real property located in the United States and real property located outside the United States are not property of a like kind." A rental in Phoenix cannot become a flat in Lisbon. Can I 1031 foreign property, or exchange into Puerto Rico, Guam or the USVI? handles the territories.

Personal property no longer qualifies on its own, but Treas. Reg. 1.1031(k)-1(g)(7)(iii) forgives personal property transferred with the real estate where it is typically conveyed together in standard commercial transactions and its value is no more than fifteen percent of the replacement property's fair market value. Is the furniture in a furnished rental boot? sets out what happens above that line.

Everything else shut out of section 1031 is catalogued at What does not qualify for a 1031 exchange?. Put the specific asset in front of your CPA or attorney while the contract is still in draft.