In order to 1031 Exchange real estate, those items must be of like-kind.
The exchange of Water Rights for Farmland does not qualify for IRS Section 1031 Exchange because they are not like-kind. A recent U.S. district court granted the government’s cross-motion for summary judgment after deciding that the exchange of water rights for farmland is not a like-kind exchange under section 1031.
Here is a description of the case:
Donald, Gary, and Deborah Wiechen were all partners in a partnership, Wiechens Properties Limited Partnership, that owned land in an irrigation district. The partnership obtained the right to receive Colorado River water to irrigate its land and it was permitted to sell the water rights to the government without selling the land. The partnership retained the land but exchanged its water rights for an interest in farmland. The partners didn’t report any income from the transaction, believing that it qualified for nonrecognition treatment under section 1031. The IRS made assessments against the partners for their 1993 taxes. The partners filed suit for a refund in district court. The parties filed motions for summary judgment. The partners argue that their water rights are an interest in real property, that the properties exchanged were of like-kind, and the exchange qualifies for nonrecognition treatment.
U.S. District Judge Stephen M. McNamee agreed with the partners that the water rights were an interest in real property. However, the parties disputed the duration of the water rights. The partners asserted that the water rights were perpetual, that they originated from the Supreme Court decision in State of Arizona v. State of California, 373 U.S. 546 (1963), and that the water rights were established by a Department of Interior water allocation notice, 48 Fed. Reg. 12446 (Mar. 24, 1983). Sustaining the government, the court dismissed the partners’ reliance on the opinion and concluded that under a 1984 subcontract the partners were entitled to water rights for a 50-year period. Thus, the court concluded that the water rights are limited in quantity, priority, and to a 50-year duration.
Judge McNamee was persuaded by the government’s argument and followed Rev. Rul. 55-749, 1955-2 C.B. 295, which discussed the exchange of water rights for a fee simple interest in land and advised that water rights of a limited amount or duration aren’t sufficiently similar under §1031 to a fee simple interest in land. Thus, the court held that an exchange of nonperpetual water rights for a fee simple interest in land does not satisfy §1031. Judge McNamee denied the partners’ motion for partial summary judgment and granted government’s cross-motion for summary judgment.