A recent client was contacted by a qualified land trust to acquire the development rights to his 500 acre tract of forest/meadow land. The property had long been identified by the conservation community as a key wildlife migration path to adjoining protected property. Our client had been approached numerous times but resisted a sale that would trigger tax and negate his ability to continue to enjoy the property. The land trust had successfully acquired similar property and encouraged our client to seek advice about how he could utilize Section 1031 to meet their mutual goals.
When he contacted us, we explained the real estate concept known as the “bundle of rights” that lends itself to the sale of one individual right without disturbing the remaining rights. We tend to think of real estate as the physical land and any and all structures attached thereto, however, it is much more. It is often described as a bundle of sticks and each stick represents individual rights; for example, the right to lease, to mortgage, to ditch, to develop, to farm, to bequeath, to grant rights of way, surface or sub-surface rights, etc. If you own all of the rights inherent with the land, your ownership is described as being “fee simple” or without limitations or restrictions. If you own less than the whole, you hold a partial interest and any deeded rights will be described in the chain of title. The sale of any one or combination of these rights can leave the underlying land intact from a physical standpoint. However, the sale of any of the rights require that it be properly accounted for and taxed.
Knowing that our client did not desire to sell his whole ownership we discussed how the sale of the development rights would allow the parcel to remain intact, restrict his future use, but would provide a path to exchange the value for other real estate. He was surprised to learn that a partial interest in real estate is “like-kind” to any real property. The possibility of converting one of the “rights” for an asset that would allow him to acquire other property was the deciding factor for him to proceed with an exchange.
The first step was to have the property appraised so that the development rights could be quantified by a disinterested third party. It was determined that the whole parcel was valued at $950,000 and the development rights accounted for $500,000 of the total value. The trust agreed to acquire a conservation easement protecting the property for future generations and raised the $500,000.
Knowing that he had limited time select his replacement property, he contemplated numerous combinations ultimately deciding to acquire income producing property. Once the closing was scheduled, our client had a maximum of 45 days to identify the property(ies) he wanted to purchase with his exchange funds and up to 180 days to make the acquisitions. Because the transaction was facilitated by a Qualified Intermediary as a Section 1031 Exchange, no state or federal tax was paid.
He continues to enjoy his 500 acre parcel and reap the benefits on the ownership of three new investment properties.