The short answer
A data center's land, building and the electrical, cooling and fire suppression systems built into it are generally real property for a 1031 exchange, while servers, racks, removable raised floors and the colocation business are not. The Treasury's own examples treat a backup generator installed during construction as a structural component and a removable raised floor as personal property, which is the line most data center allocations follow. Because those same power and cooling systems are often section 1245 property for depreciation, your replacement choice decides whether that recapture stays deferred.
At a glance
| Backup generator | Structural component in the regulation's example when installed during construction |
|---|---|
| Raised flooring | Not real property in the regulation's example when built to be removed and reused |
| Power plant on site | Power generation and transmission facilities are listed inherently permanent structures |
| Servers and storage | Information systems carry a 5-year recovery period |
| Cooling for equipment | Can be section 1245 property for depreciation under the sole-justification rule |
| Tenant concentration | Largest data center REIT: top 20 customers are about 51% of recurring revenue |
| Lease length | Same filer: average remaining lease term about five years |
The shell, the switchgear and the chilled-water plant are usually real property; servers, racks and raised floors are not
Treas. Reg. section 1.1031(a)-3 treats a building's wiring, central air conditioning and heating, pipes and ducts, fire suppression, security and humidity control systems as structural components, and it analyzes interconnected assets that serve the building, such as the systems that provide electricity, as one distinct asset. It also lists power generation and transmission facilities among inherently permanent structures, which covers an on-site substation you own.
Two of the regulation's examples read as if written for this asset class. Example 5 holds that a backup generator installed during construction and designed to remain in place is a structural component even though it could be removed without major damage. Example 6 holds that a raised flooring system installed to support equipment, designed to be removed and reused without damage, is not real property even though floors are a listed component.
Servers, storage arrays, network gear and cabinets are personal property; IRS Publication 946 puts computers and peripheral equipment in asset class 00.12 with a 5-year recovery period. If you sell a colocation business with customer contracts, IRC section 1060 allocation applies and the contracts are Class VI intangibles under the Form 8594 instructions.
Power and cooling can be real property for the exchange and section 1245 property for recapture at the same time
Paragraph (a)(7) of the real property regulation says its definition has no bearing on depreciation or on sections 1245 and 1250. For depreciation, Treas. Reg. section 1.48-1(e)(2) excludes from structural components machinery whose sole justification is meeting temperature or humidity requirements essential to the operation of other machinery, which is how cost segregation studies move computer-room cooling into short recovery classes that qualified for bonus depreciation; our cost segregation page covers what that does at sale.
On a sale, section 1245 taxes the gain on that equipment as ordinary income up to the depreciation taken. In an exchange, section 1245(b)(4) limits the recapture to gain recognized plus the value of property you receive that is not section 1245 property, so replacing a cost-segregated data center with buildings that hold no comparable equipment can let the recapture through. Section 1250 handles the shell: depreciation above straight-line is ordinary income and the straight-line part is unrecaptured gain taxed at up to 25%.
Hypothetical: a single-tenant powered shell bought for $30,000,000 with $8,000,000 of electrical and cooling systems treated as section 1245 property and fully expensed sells for $45,000,000, with $6,000,000 allocated to those systems. The $6,000,000 is section 1245 gain that a building-only replacement may not shelter, while the shell and land gain defers in a complete exchange. Run your own numbers with your CPA before choosing the replacement.
Buyers underwrite power, the tenant's renewal and who paid for the fit-out
Digital Realty's 2025 Form 10-K frames the market. It reports 310 data centers, its largest customer at about 11.7% of annualized recurring revenue, its 20 largest at about 51%, and 20 buildings occupied by single customers. It also reports an average remaining lease term of about five years and warns that its ability to lease vacant space can be constrained by its ability to provide sufficient electrical power.
Those disclosures are the buyer's checklist for your building: the utility's committed capacity and the timeline for more, the tenant's renewal history, and whether the critical systems belong to you or to the tenant. The same filing notes that many of its data centers contain significant improvements installed at customers' expense, which is common in single-tenant leases and changes what you are actually selling.
If the tenant owns the UPS, the cooling and the cabinets, you are selling a shell with a lease, the allocation question shrinks and so does the price per square foot. If you own them, the buyer is paying for systems with a shorter life than the building, and the price you negotiate for them is the section 1245 gain you will report.
Replacement options: another powered shell, a diversified DST, or a fund for the recapture layer
Buying another data center keeps section 1245 equipment on both sides of the trade and can keep the recapture deferred, but it concentrates the equity in one tenant and one utility feed. Our data center DST page explains why trusts in this sector are rare and what a DST that holds one would look like.
Most sellers move the proceeds into a diversified traditional DST or a net-lease DST, accepting that some section 1245 gain may be recognized. Rev. Rul. 2004-86 bars a trustee from new leases, renegotiation and more than minor non-structural changes, which is a poor fit for an asset that needs periodic power and cooling upgrades.
For recapture that will be recognized, an accelerated depreciation fund that acquires qualifying property after January 19, 2025 may generate first-year deductions under the 100% allowance confirmed in Publication 946, subject to the passive activity rules your CPA applies.
Buying a data center as replacement property: power, the lease and the systems schedule before day 45
Get the utility commitment in writing: the contracted megawatts, the substation and feed redundancy, and any pending request for more capacity. A building that cannot get more power cannot grow its rent, and the largest public owner says as much in its filing.
Then read the lease for who owns and replaces the critical systems. Ask for the tenant's financial statements or parent guarantee, the remaining term and renewal options, and the replacement schedule for UPS batteries, generators and chillers. If those systems are yours, budget for their replacement inside the hold, because under Rev. Rul. 2004-86 you cannot later move the property into a DST and expect the trustee to fund upgrades.
On depreciation, Treas. Reg. section 1.168(i)-6 carries the old schedule over to the exchanged basis, and only excess basis starts fresh, so a cost segregation study on the replacement works mainly on new money. Name a backup under the three-property rule in Treas. Reg. section 1.1031(k)-1(c)(4), because a power study or lender review can outrun 45 days.
Related questions
Are the generators and UPS systems part of the real property?
Generators installed during construction and designed to stay are structural components under the regulation's Example 5. UPS units and batteries are analyzed under the same four factors, and units built to be swapped out may be personal property.
My tenant installed the cooling and power systems. Do I owe recapture on them?
No, if the tenant owns and depreciates them, they are not your property and not part of your sale. Check the lease's surrender clause, since some leases transfer tenant improvements to the landlord at expiration.
Can I exchange a data center for an apartment building?
Yes. All real property held for investment or business use is like-kind, but any section 1245 recapture on cost-segregated systems may be recognized if the apartment building holds no comparable section 1245 property.
Are there DSTs that own data centers?
They are uncommon; our data center DST page explains why the DST rules fit poorly with assets that need capital upgrades, and we have not verified a current open offering in the sector.
How is the equipment sale reported if the building is exchanged?
The Form 8824 instructions direct a multi-asset exchange to attach a statement showing realized and recognized gain, and recognized section 1245 gain is reported on Form 4797.
Sources
Checked against these publications on September 30, 2026. Rules and figures change; confirm the current version with your CPA or attorney before you act. This page is general information, not tax or legal advice.
- Treas. Reg. section 1.1031(a)-3, Definition of real property (Examples 5 and 6)
- Treas. Reg. section 1.48-1, Definition of section 38 property (structural components)
- IRS Publication 946, How To Depreciate Property (asset class 00.12)
- IRC section 1245, Gain from dispositions of certain depreciable property
- IRC section 1250, Gain from dispositions of certain depreciable realty
- IRC section 1060, Special allocation rules for certain asset acquisitions
- IRS, Instructions for Form 8594
- IRS, Instructions for Form 8824
- Treas. Reg. section 1.168(i)-6, Like-kind exchanges and involuntary conversions
- Treas. Reg. section 1.1031(k)-1, Deferred exchanges
- Rev. Rul. 2004-86
- Digital Realty Trust, Form 10-K for 2025