Do Options Qualify as "Real Property" Under Section 1031?

by Maura Snabes, Esq., CES, NTP

Yes—in the right circumstances, an option to acquire real estate can qualify as “real property” for purposes of a Section 1031 like-kind exchange.

Under the final Section 1031 regulations issued November 23, 2020 (T.D. 9935), the IRS formally clarified that certain intangible rights tied directly to real estate are treated as real property. Specifically, Treas. Reg. §1.1031(a)-3(a)(5) explicitly includes “an option to acquire real property” among the intangible assets that qualify—alongside leaseholds, easements, land development rights, and similar real estate interests.

Key Requirements for a 1031-Eligible Option

To qualify, the option must meet the same foundational standards as other 1031 property, including:

• Held for Investment or Business Use
  The option must be held for productive use in a trade or business or for investment (the “qualified use” requirement).
• Capital Asset or Section 1231 Property
  For the option to be treated as real property under 1031, it must be a capital asset in the hands of the option holder (or qualify as Section 1231 property when held for business use).
• Not Dealer Property / Not Held Primarily for Sale
  If the option is held by a dealer or primarily for resale (inventory), it generally does not qualify.

How Options Can Be Used in Like-Kind Exchanges

It is generally agreed that an option can be real property under the regulations, it may be exchanged for:

• another option right,
• fee title to traditional real estate, or
• other real property rights, such as 30+ year leaseholds, timber rights, mineral rights

as long as both the relinquished and replacement rights are held for investment or business purposes. However, a taxpayer should always consult with its/their CPA on whether such property will qualify for 1031 purposes.

Practical Considerations

While options are included in the definition of real property, facts and circumstances still matter. For example, the IRS evaluates the nature, duration, and security of the right—meaning a long-term enforceable property right is more likely to be treated as real property than a short-term or revocable permit-type interest.

Bottom Line

An option to acquire real property can qualify under Section 1031, but only when it functions as a legitimate investment or business-use interest in real estate. And, again, a taxpayer should always consult with its/their CPA on whether its/their property will qualify for 1031 purposes.

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