A real estate investor who is contemplating an exchange of a fee-simple property into a leasehold interest (ground lease) property needs to be careful that the new or remaining term of the ground lease, together with available options to extend the lease, totals at least 30 years.
The reason is that a fee-simple property must be exchanged for a fee-simple property in order to satisfy the like-kind requirement of S. 1031.
Leasehold properties with at least 30 years remaining on the lease are considered by the IRS to be equivalent – for exchange purposes only – to a fee interest. Leasehold interests with less than 30 years remaining on the lease (including options) are not considered to be equivalent to a fee-simple interest. An exchange between the two would be considered an exchange of unlike properties, which would invalidate the exchange. A leasehold property with less than 30 years remaining is exchangeable only for another leasehold property.
Investors who have already acquired a leasehold interest also need to be alert to the time remaining on the lease (with options). Their interest is exchangeable for a fee-interest property so long as the time remaining (including options) is at least 30 years. Otherwise they will be limited to the replacement of their present leasehold property with another leasehold property, a significant restriction.