Section 1031 Like-kind Exchanges: Treatment of Nebraska's Certified Irrigated Acres

• Publication year: 2021

100 Nebraska L. Rev. 295. Section 1031 Like-Kind Exchanges: Treatment of Nebraska's Certified Irrigated Acres

Section 1031 Like-Kind Exchanges: Treatment of Nebraska's Certified Irrigated Acres

Carolyn Davis

Comment ^[*]

TABLE OF CONTENTS

I. Introduction .......................................... 296

II. Background ........................................... 297
A. Natural Resources and Certified Irrigated Acres . . . 297
1. Nebraska Natural Resources Districts .......... 297
2. Water-A Valuable Natural Resource .......... 299
3. Certified Irrigated Acres ....................... 301
B. Changing Tax System and § 1031 .................. 304
1. Overview of Realization and Recognition Rules . 305
2. Section 1031 History ........................... 307
3. Impact of the Tax Cuts and Jobs Act ........... 308
4. Updated Structure of § 1031 ................... 309

III. Analysis .............................................. 310
A. Requirements for a § 1031 Exchange ............... 310
1. What Is an Exchange? ......................... 310
2. Real Property Versus Personal Property ........ 312
3. Determining "Like-Kind" ....................... 313
4. Held for Use in a Trade or Business or for Investment .................................... 314
B. Certified Irrigated Acres Are Real Property ........ 316
1. Federal Tax Law Regarding Water Rights ...... 316
2. Nebraska State Law Regarding Certified Irrigated Acres ................................ 318
C. Certified Irrigated Acres Are Not Real Property . . . . 320

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1. Federal Law Opposing Water Rights as Real Property ....................................... 320
2. Nebraska State Law Opposing Certified Irrigated Acres as Real Property ............... 322
D. Implications ....................................... 322
1. Economic Implications ......................... 323
2. Tax Implications ............................... 324

IV. Conclusion ............................................ 326

I. INTRODUCTION

Water-a powerful resource involved in daily life. Whether it is for personal use or use in production, water is the liquid fueling advancement. While some areas of the United States have abundant water sources, others do not. Ranging in definition, the Midwest region of the United States has various sources of water: groundwater, surface water, and rainwater. ^[1]

A prominent use of these water sources in the Midwest region-and specifically in Nebraska-is irrigation. ^[2] Irrigation is the use of water to encourage growth, otherwise defined as the "watering of land by artificial means to foster plant growth." ^[3] Whether using the daily sprinkler to water the backyard grass or using thousands of gallons of water for one acre of farmland, the purposes of irrigation are endless. However, some farmland cannot be irrigated. Farmers must analyze and evaluate the need to irrigate based on the productive use of their land, the land's location in relation to reliable water sources, and any limitations on water usage established by state, county, or city authorities.

Nebraska, through its twenty-three natural resources districts (NRDs), has placed restrictions on the use of water for irrigation. ^[4] Each NRD determines whether and how many certified irrigated

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acres (CIAs) are issued to landowners within the district. ^[5] These CIAs are acres of farmland held at a premium within an NRD because they are designated with the right to irrigate. ^[6] Thus, landowners prefer to exchange CIAs under § 1031 of the Internal Revenue Code (the Code) to receive tax deferral benefits of like-kind exchanges.

This Comment argues CIAs are considered real property under § 1031. Before the Tax Cuts and Jobs Act of 2017 (TCJA), like-kind exchanges were allowed for both real property and personal property. ^[7] Now, like-kind exchanges are limited to real property only. ^[8] Part II of this Comment provides a detailed explanation of NRDs, CIAs, and § 1031 before and after the TCJA. Part III walks step by step through the § 1031 requirements and argues that CIAs are real property, qualifying for a like-kind exchange with other real property. Part III also addresses the opposing view arguing CIAs are not real property and do not qualify for like-kind exchanges, identifies the implications of both viewpoints, and focuses on the benefits of classifying CIAs as real property. Lastly, Part IV finalizes the discussion with a lasting thought.

II. BACKGROUND

A. Natural Resources and Certified Irrigated Acres

Every state is responsible for managing the natural resources within its boundaries. In Nebraska, one of the most important natural resources is water. However, water rights and CIAs create a layer of complexity in determining whether § 1031 applies to their exchange. This Section provides a background into natural resource conservation in Nebraska and concludes with an explanation of CIAs and their use.

1. Nebraska Natural Resources Districts

Less than twenty years after Nebraska became a state, residents' concern about the state's natural resources grew, prompting early measures to protect precious natural resources, not only on the surface of the land, but hundreds of feet below. ^[9] The Nebraska Legislature created different institutions to protect natural resources

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including Irrigation Districts in 1895, Drainage Districts in 1905, and Soil Conservation Districts in 1937 (after the Great Depression and the Dust Bowl hit the heartland with great force and power). ^[10] In 1969, Nebraska condensed the control of 154 special-purpose entities by creating twenty-four NRDs, simplifying into twenty-three NRDs in 1989. ^[11] By splitting the control of Nebraska's natural resources, the NRDs aim "to solve flood control, soil erosion, irrigation run-off, and groundwater quantity and quality issues." ^[12]

NRD boundary lines are drawn around Nebraska's eight major river basins and five major rivers including: the Missouri River, flowing along the State's eastern border; the Platte River, stretching the length of Nebraska; the White River, located in the Nebraska panhandle; the Niobrara River, bringing water to the driest portions of northern Nebraska; and the Republican River, located in southern Nebraska. ^[13] On average, each district covers just over two million acres of land. ^[14] The Lower Loup NRD, located in central Nebraska, is

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the largest NRD-covering just over five million acres of land. Conversely, the Lewis & Clark NRD, located in northeast Nebraska, is the smallest NRD-covering less than one million acres of land. ^[15] Although each NRD is charged with governing the natural resources located within its boundaries including, but not limited to, the management of water, soil, minerals, and forests, the most important natural resource in Nebraska is water. ^[16] With almost 80,000 miles of rivers flowing through the State and over 7,500,000 acres of irrigated land, Nebraska strives to protect this valuable resource through conservation and management. ^[17]

2. Water-A Valuable Natural Resource

A main source of water in Nebraska is the High Plains Aquifer, otherwise known as the Ogallala Aquifer. ^[18] Extending beneath Colorado, Kansas, Nebraska, New Mexico, Oklahoma, South Dakota, Texas, and Wyoming, sixty-five percent of the Ogallala Aquifer's volume is located in Nebraska. ^[19] Another main source of water in Nebraska is the Platte River, one of the five major rivers in Nebraska mentioned above. ^[20] The Platte River includes both the North Platte River, which flows over the North Platte River Basin, and the South Platte River, which flows over the South Platte River Basin. ^[21] The two sections of the Platte River unite in North Platte, Nebraska, creating the Center Platte River Basin. ^[22]

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In addition to the rules and regulations of each NRD, the Nebraska Legislature implemented water well regulations in 1957 with an eye on conserving these important resources. ^[23] In 1975, less than twenty years later, the Nebraska Legislature implemented a larger system to conserve and manage the water within the state. ^[24] Under the Nebraska Ground Water Management and Protection Act, the Nebraska Legislature determined the following:

[N]atural resources districts have the legal authority to regulate certain activities and, except as otherwise specifically provided by statute, as local entities are the preferred regulators of activities which may contribute to ground water depletion.

Every landowner shall be entitled to a reasonable and beneficial use of the ground water underlying his or her land subject to the provisions of Chapter 46, article 6, and the Nebraska Ground Water Management and Protection Act . . . ^[25]

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An irrigating landowner using more than their "reasonable and beneficial" share of the groundwater in comparison to their residential neighbor causes concern for Nebraska residents. Nebraska's focus on water conservation leaves the use of irrigation around the State continually up for discussion. ^[26] As stated at the outset of this Comment, irrigation is the use of water to encourage growth, otherwise defined as the "watering of land by artificial means to foster plant growth." ^[27] Artificial means of watering land include, but are not limited to, the use of sprinkler systems, gravity systems, and drip systems. ^[28] The most common irrigation method in...