1031 Exchanges for Cell Towers and Utility Structures: How Leases Qualify for Tax Deferral

Fiber-optic cables, wind turbines, and certain other structures can be included in a 1031 exchange for real property, but leases for these structures only qualify under certain conditions. The same conditions apply to a 1031 exchange for cell towers.

While 1031 exchanges are often thought of as a method for deferring taxes on the sale of residential and commercial real estate, taxpayers perform like-kind exchanges on more than just land and buildings. For example, fractional ownership in a Delaware Statutory Trust (DST) is eligible for 1031 tax deferral, as are oil, gas, and mineral rights.

It used to be that any property held for business or investment use was eligible under Section 1031. That changed with the Tax Cuts and Jobs Act of 2017, which limited 1031 exchanges to real property. “Real property,” also called real estate, is defined by the IRS as “land and generally anything built on or attached to it.” This includes buildings, but can also include other structures like cellular towers, fiber-optic cables and utility structures.

As communication needs force providers to expand their reach, property owners can earn steady income by leasing the right to use these structures on their land. Depending on the type of utility and the details of the agreement, rights for cell towers, fiber-optic cable, wind turbines and other utility structures can be eligible for Section 1031 tax deferral treatment.

1031 exchange for cell towers and utility structures: what qualifies as like-kind property?

While Section 1031 of the Internal Revenue Code is rather brief, like-kind exchanges have been around for more than a century, so there is a long case history that can be drawn upon to understand how the IRS is likely to interpret a specific scenario.

Three key rules for 1031 exchange qualification

There are three major rules that every 1031 exchange must follow in order to qualify for tax deferral:

• The properties being exchanged must be held for business or investment use.
• The exchanged properties must be “like kind”.
• The property exchanged must be real property (not personal property such as vehicles, aircraft, or farm equipment).

1031 exchanges are for investment properties, not your primary residence – but even this can become complicated if you use part of your property for business and part of it for personal use. For more on meeting this stipulation, read our guide to Section 1031 and Section 121 and how they can be used in conjunction.

When it comes to the rights to cell towers, wind turbines, solar arrays, or other utility structures, the business use is apparent. Even if the land underneath was originally purchased as personal property, their function should more than qualify as business use, regardless of whether you are selling the land or are merely leasing the rights to the structure’s use.

As to whether cell towers can gain like-kind qualification, this is where things can get tricky. Section 1031 does not outline every possibility, so we have to rely on IRS rulings and court decisions. In general, the IRS uses a rather broad definition of like kind so that most business or investment property is considered to be of a like kind to any other.

What the IRS does care about is the nature, character, and class of a property. It doesn’t matter if you exchange a house for an apartment building or undeveloped land for a factory, but it may matter if you’re exchanging a vacation home for a fiber-optic cable lease.

IRS Guidance on cell towers and utility structures

IRS Private Letter Ruling 201706009 addresses a situation where land containing cell towers was exchanged for “fiber-optic and copper cables installed either above or below ground and various other associated properties, including telephone poles for carrying the cables.”

One thing the ruling takes into account is whether the structures could be severed from the land and retain their value. For the towers, the ruling states “all of Taxpayer’s Towers are permanently affixed to the land or would be extensively damaged if removed.” Similarly, “the Cable Distribution Systems are permanently affixed to the land or are intended never to be removed until the end of their respective useful lives.”

The ruling ultimately concludes that because they only have one purpose and one location where they can be used without damage, they are similar in character and therefore of a like kind: “neither the Towers nor the Cable Distribution Systems are used for other activities. In addition, the Towers and the Cable Distribution Systems are, or are intended to be, permanently affixed to land. Under these facts, Taxpayer’s Towers and the Cable Distribution Systems are like kind property for purposes of 1031.”

As for whether they qualify as real property, the ruling answers in the affirmative, referring to the cell towers as “real property improved with Towers” and the cable as “real property improved with Cable Distribution Systems.”

This is good news for those exchanging the land along with the utility structures, but what if one were only leasing the right to construct or use such a structure on land that is being retained by the owner?

Leases vs ownership in 1031 exchanges

Private Letter Ruling 201149003 clarified that easements and long-term leases (typically 30+ years) are considered real property, similar to water or ditch rights. Short-term leases or royalty agreements may not qualify for tax deferral, so understanding the lease type is crucial.

Rules for cell towers, fiber-optic cables, and other utility structures in 1031 exchanges

It’s important to understand that, as the ruling states, “this ruling applies only to Towers and the Cable Distribution Systems,” and does not speak to any other type of structure. Furthermore, its interpretation is limited to towers and cable systems “that are affixed or embedded in real property held in fee simple or similar interest or under a long-term lease, easement, right of way or similar long-term right of use arrangement, in each case having a duration of thirty years or more including optional renewal periods exercisable by the tenant or right of use holder.”

As with the rights to resources found under the ground such as oil, water, etc., a perpetual easement or long-term lease (usually 30 years or more) will generally be treated as real property. Simply selling the rights to future lease payments without transferring a formal long-term easement may not qualify. It is the length of the lease that matters, as well as the type of agreement. There is a difference between royalties from a cell tower and a long-term or perpetual lease. Make sure you know which you’re investing in before you embark on a 1031 exchange.

A word of caution: the private letter ruling clearly states that it only applies to the situation described, and that “it may not be used or cited as precedent.” This letter offers clues as to how the IRS could interpret a similar situation, but is not a guarantee that your situation will be adjudicated in the same way. There are other private letter rulings that have suggested similar interpretations, but many of them were written before the Tax Cuts and Jobs Act of 2017, when the issue of real property was less important.

While it seems likely that other real property containing cell towers, fiber-optic cables, billboards, wind turbines, solar arrays, or other “improvements” will qualify under Section 1031, there is no definite rule. While one cannot ensure with 100% certainty that an exchange will qualify for tax deferral, there are plenty of things exchangers can do in advance to set themselves up for success.

Maximize your success with a Qualified Intermediary (QI)

Even with legal and tax advisors, a Qualified Intermediary is essential for complex 1031 exchanges involving cell towers, utility structures, or fiber-optic cables. The QI holds the proceeds from your relinquished property sale until they are used to purchase your replacement property. To make sure your 1031 exchange is structured properly and meets all necessary requirements, it’s best to get in touch with a QI before your relinquished property sale.

While there are not many requirements for who can act as your QI, if you’re performing a complex exchange like one involving cell towers or other utility structures, you may find that most QIs have never executed this type of exchange before. 1031 expertise is rare, and with your financial future hanging in the balance, you need a QI that understands your situation.

JTC’s 1031 exchange team has decades of experience handling even the most complex exchanges. All of our 1031 clients receive the same access to our secure Exchange Manager portal with 24/7 visibility, as well as the same security controls we offer to major corporate clients. Whether this is your first exchange or your hundredth, put yourself in a position to succeed by working with those who know Section 1031 inside and out.

Learn about JTC’s 1031 exchange solutions