Like-kind exchanges for AI data center real estate

In short

An AI data center owner who sells the real estate can generally defer federal capital gains tax by buying replacement real estate in a Section 1031 like-kind exchange. The real estate can be another AI data center or a different type of investment real estate such as an industrial warehouse, a net leased retail building, or a multifamily complex. The tax law treats all U.S. real estate held for investment or business as like-kind to all other U.S. real estate held the same way. 26 U.S.C. §1031, 26 CFR §1.1031(a)-1(b) An AI data center is real property for this purpose because its building is an inherently permanent structure and its infrastructure such as wiring, cooling, and fire suppression are structural components under the Treasury regulations. Treas. Reg. §1.1031(a)-3 The biggest practical hurdles for AI data center exchanges are the compressed 45-day identification deadline, the 180-day closing deadline, the complexity of valuing power and cooling infrastructure, and a depreciation recapture trap if the replacement property has less Section 1245 property than the sold data center. IPX1031, 1031 Exchange Deadlines, HUB 1031, 1031 Exchange for Data Center Properties, R.E. Cost Seg, Bonus Depreciation Recapture Trap

What is a like-kind exchange under Section 1031?

A like-kind exchange lets an owner sell investment or business real estate and buy replacement real estate without paying capital gains tax at the time of the sale. The tax on the gain is postponed, not forgiven. It is deferred until the owner eventually sells the replacement property in a taxable sale. IRS Like-Kind Exchanges Under IRC Section 1031

For federal tax purposes, all real estate in the United States held for investment or use in a trade or business is like-kind to all other real estate held the same way. The quality, grade, location, or asset class does not matter. An AI data center in Virginia can be exchanged for a warehouse in Texas, for a net-leased retail strip center in Florida, or for raw land held for investment. 26 U.S.C. §1031(a)(1), 26 CFR §1.1031(a)-1(b)

The property sold, called the relinquished property, must have been held for investment or productive use in a trade or business. It cannot be property held primarily for sale, like a developer’s inventory. 26 U.S.C. §1031(a)(2)

A 1031 exchange is not a direct swap in most modern deals. The owner sells the relinquished property and the sale proceeds go to a qualified intermediary, not to the owner. The qualified intermediary then uses those proceeds to buy the replacement property. This is a deferred exchange, and strict rules govern the timeline and the handling of funds. Treas. Reg. §1.1031(k)-1

After the Tax Cuts and Jobs Act took effect on January 1, 2018, the deferral applies only to real property. Before that, personal property like servers, generators, and equipment could also be part of a 1031 exchange, but that is no longer allowed. IRS Like-Kind Exchanges - Real Estate Tax Tips, T.D. 9935, 85 Fed. Reg. 77365

That change simplified AI data center exchanges in one way. The owner and the tax advisor now focus only on whether the assets being sold and bought are real property. The tricky question is exactly which parts of an AI data center count as real property.

Does an AI data center qualify as real property for 1031?

Yes. An AI data center as a whole qualifies as real property for Section 1031 because its building is an inherently permanent structure and its systems are structural components. The Treasury regulations that define real property for 1031, issued in December 2020, give a broad definition that includes buildings, power generation and transmission facilities, permanently installed telecommunications cables, and structural components such as wiring, HVAC, humidity control, and security systems. Treas. Reg. §1.1031(a)-3

The regulations set out two layers of real property. The first is land and improvements to land. Improvements include inherently permanent structures and their structural components. Treas. Reg. §1.1031(a)-3(a)(2)(i)

An inherently permanent structure is a building or other structure that is a separate asset, permanently attached to real property, and expected to stay attached for an indefinite time. Attachment by weight alone is enough. Treas. Reg. §1.1031(a)-3(a)(2)(ii)(C) The regulation lists many buildings that count, including factories, office buildings, warehouses, and stores. AI data center buildings fall within the regulation’s definition of a building (any structure enclosing space within walls and covered by a roof) and therefore are inherently permanent structures. Treas. Reg. §1.1031(a)-3(a)(2)(ii)(B)

The regulations also separately list certain other inherently permanent structures that appear on AI data center campuses. These include power generation and transmission facilities, permanently installed telecommunications cables, and microwave transmission, cell, broadcasting, and electric transmission towers. Treas. Reg. §1.1031(a)-3(a)(2)(ii)(C)

Structural components are the parts that make up a building. The regulation lists walls, wiring, plumbing, central air conditioning and heating, pipes and ducts, floors, ceilings, fire suppression including sprinklers and alarms, security systems, and humidity control systems. Treas. Reg. §1.1031(a)-3(a)(2)(iii)(B) Every modern AI data center contains nearly all of these.

Property that is real property under the state law where it sits is also real property for Section 1031. This is called the state law plus approach. Treas. Reg. §1.1031(a)-3(a)(6), Tax analysis In most states, an AI data center building and its permanently installed infrastructure are real property under state law.

The IRS has not published any ruling that specifically addresses an entire operating AI data center and its classification under 1031. The determination rests on applying these general definitions to the specific facts of each facility. Treas. Reg. §1.1031(a)-3

Because no single ruling answers the question directly, many practitioners rely on a detailed analysis of the facility under the regulations. They also often perform a cost segregation study to identify which assets might be considered short-lived property for depreciation. That study can be helpful but it does not control the 1031 classification.

The incidental personal property safe harbor

Any real estate deal will include some personal property. In an AI data center sale, the seller may transfer movable test equipment, office furniture, or small tools along with the building. The regulations provide a safe harbor. If personal property is typically transferred with the real property in standard commercial transactions and its aggregate fair market value does not exceed 15 percent of the aggregate fair market value of the replacement real property, that personal property is disregarded in determining whether the taxpayer is in constructive receipt of exchange funds held by a qualified intermediary, but the taxpayer must still recognize gain on the personal property under section 1031(b). T.D. 9935, 85 Fed. Reg. 77365

The cost segregation wrinkle and the Section 1245 recapture risk

Many AI data center owners use a cost segregation study to accelerate depreciation on parts of the building. A cost segregation study reclassifies portions of the total project cost from 39-year straight-line depreciation to shorter lives, 5 year, 7 year, or 15 year. Typical studies for AI data centers reclassify 20% to 40% of total project cost into these faster categories. Seneca Cost Segregation

The reclassified assets often include power distribution units, busway systems, automatic transfer switches, dedicated generator wiring, computer room air handlers, in row cooling units, chillers dedicated to IT thermal management, raised access flooring, cable trays, hot and cold aisle containment, and clean agent fire suppression systems. Seneca Cost Segregation Servers, networking hardware, and IT equipment are separate personal property and are not part of the cost segregation study for the real estate. Seneca Cost Segregation

These reclassified assets are treated as Section 1245 property for depreciation. When such property is sold, the gain up to the amount of depreciation taken is recaptured as ordinary income, taxed at rates up to 37%. R.E. Cost Seg The remaining gain on real property is Section 1250 gain, which for individuals is subject to a maximum federal rate of 25% for unrecaptured depreciation, plus the lower capital gain rates.

Before the final regulations, many practitioners worried that a cost segregation study would backfire in a 1031 exchange. The worry was that if the IRS treated a reclassified asset as personal property for depreciation, it might also treat it as personal property for 1031. If that happened, the asset would not qualify for the exchange and could trigger current tax as boot.

The 2020 regulations put that worry to rest. They expressly state that the definition of real property for Section 1031 does not control the classification for depreciation under Sections 1245 and 1250. A component can be Section 1245 property for depreciation and still be real property for 1031. 26 CFR §1.1031(a)-3(a)(7) The cost segregation study does not knock assets out of the 1031 exchange. The Tax Adviser, Feb. 2021

But a different risk remains. The exchange still defers the gain, but the character of that gain travels with the replacement property. If the relinquished AI data center has a lot of fully depreciated Section 1245 property, that built-in ordinary income attaches to the replacement property. If the replacement property contains less Section 1245 property, the difference can trigger ordinary income recapture in the year of the exchange.

A simple example shows the problem. Suppose an AI data center owner sells a facility for $50 million. The cost segregation study identified $10 million of Section 1245 property that has been fully depreciated. The replacement property is a newly built warehouse that has minimal Section 1245 components, only $2 million. The exchange of $10 million of 1245 property for $2 million of 1245 property leaves $8 million of Section 1245 gain that may be recognized as ordinary income, taxed at up to 37%. The taxpayer may have to recapture prior depreciation as ordinary income if the replacement property contains less Section 1245 property than the relinquished property, even though the overall deal is real property for real property. IPX1031, 2 Key Tax Strategies

This recapture risk is a key part of planning an AI data center 1031 exchange. The owner and tax advisor must compare the Section 1245 property content of the relinquished property and the replacement property. The goal is either to find a replacement with roughly equal or greater 1245 content, or to accept and budget for the recapture tax.

What are the special challenges for AI data center 1031 exchanges?

AI data center properties present several practical hurdles that can make a 1031 exchange more difficult than a typical commercial real estate exchange.

First, the infrastructure is complex and hard to value. Power systems, backup generators, UPS units, cooling infrastructure, and network connectivity are not peripheral building features. They are central to the asset’s value. A buyer will inspect and test these systems carefully. That due diligence takes more time than a standard warehouse or retail property. The longer due diligence period can eat into the 45-day identification window and the 180-day closing deadline. 1031 exchange timeline guide

Second, AI data center transactions tend to be large. In 2024, total North American data center transaction volume exceeded $6.5 billion. CBRE H2 2024 Many individual deals surpass $100 million. An exchange of that size calls for an institutional-grade qualified intermediary with segregated custodial accounts and principals who have passed annual criminal background checks. QI selection guide, FEA background checks Choosing a qualified intermediary that lacks the strength to handle a large AI data center transaction is a serious risk. If the intermediary fails and the taxpayer is treated as having received the funds, the exchange collapses and the gain becomes taxable.

Third, the current market conditions add pressure. At year-end 2024, U.S. primary market AI data center vacancy hit a record low 1.9%. CBRE H2 2024 There is enormous demand and limited available product. Finding a suitable replacement property, AI data center or otherwise, within 45 days can be hard. Many exchange sponsors look to Delaware Statutory Trusts, or DSTs, to complete the exchange on time.

Fourth, many AI data center sales involve land that has been rezoned and entitled for AI data center development. The Avison Young example in Loudoun County, Virginia, involved 84 acres sold for $100 million. The seller completed a $75 million 1031 exchange into 11 income-producing net lease properties across six states. The remaining $25 million was reinvested in non income producing land. citybiz, Jan. 21, 2026 That cross-asset exchange from raw land to net lease properties is a common strategy to pivot from development risk to stabilized cash flow.

What can you exchange into?

A 1031 exchange from an AI data center is not limited to another AI data center. The owner can exchange into any real property held for investment or productive use in a trade or business. The replacement property types commonly used include industrial and warehouse buildings, logistics facilities, long term net-leased commercial properties, multifamily residential, and self-storage. 1031 replacement property options

One popular vehicle for completing an exchange into a diversified pool of institutional real estate is the Delaware Statutory Trust, or DST. A DST is a trust that holds title to real property. The investor exchanges into a beneficial interest in the trust, and the IRS treats that interest as direct ownership of real property if the trust follows strict rules. Rev. Rul. 2004-86, 2004-2 C.B. 191

Revenue Ruling 2004-86 sets out seven actions that the trustee cannot take. If the trustee can do any of these things, the trust interest fails to qualify as real property for 1031. The prohibited actions are these. The trust cannot accept additional capital contributions after the offering closes. It cannot incur new debt or refinance existing debt. It cannot reinvest the proceeds from a sale of trust property except to distribute them to investors. Capital expenditures are limited to normal repair and maintenance, minor non-structural modifications, and expenditures required by law. The trust must distribute all cash, minus reasonable reserves, at least quarterly. Any cash held by the trust can be invested only in short-term U.S. government securities. The trustee cannot enter into new leases or renegotiations except in the case of a tenant bankruptcy or insolvency. Rev. Rul. 2004-86

DSTs have been used to hold AI data centers. In 2018, Cove Capital Investments acquired an 18,700-square-foot AI data center in Tacoma, Washington, for $8.4 million, fully leased to DaVita, in a DST offering. It later sold for $9.8 million and returned full-cycle proceeds to investors, with more than 75% of the original investors reinvesting into other DSTs. Cove Capital, AltsWire In 2021, Capital Square 1031 offered a DST holding a 16,529-square-foot AI data center in La Mirada, California, leased to Cogent Communications with more than 13 years remaining on the lease and a $50,000 minimum investment. Capital Square Blue Owl markets AI data centers alongside other institutional real estate for 1031 exchange investors. Blue Owl Private Wealth

A DST can close in 3 to 5 business days after the sale of the relinquished property, which makes it a practical tool when the 45-day identification window is closing. Real Estate Transition Solutions The typical minimum investment is $100,000, with some DSTs offering as low as $25,000. Realized1031

The exchange timeline and identification rules

Two deadlines control every deferred 1031 exchange.

The identification period is 45 calendar days from the date the relinquished property closes. The taxpayer must identify the replacement property in writing, signed, and delivered to the qualified intermediary or another party to the exchange within 45 days. 26 U.S.C. §1031(a)(3)(A), 26 C.F.R. §1.1031(k)-1(c)(2)

The exchange period is the sooner of 180 calendar days from the closing of the relinquished property, or the due date, including extensions, of the taxpayer’s federal income tax return for the year of the sale. 26 U.S.C. §1031(a)(3)(B) For a calendar-year taxpayer who sells in January, that 180-day deadline may be before the extended return due date and therefore controls. For a sale late in the year, the filing deadline can be the shorter one.

The taxpayer may identify replacement property using one of three rules. The three-property rule allows identifying any three properties without regard to their value. The 200% rule allows identifying more than three properties if their total fair market value does not exceed 200% of the fair market value of the relinquished property. The 95% exception allows identifying any number of properties if the taxpayer acquires at least 95% of the aggregate value of all identified properties by the end of the exchange period. Treas. Reg. §1.1031(k)-1(c)(4)

The qualified intermediary must hold the sale proceeds. The exchange agreement must expressly limit the taxpayer’s right to receive, pledge, borrow, or otherwise obtain the benefits of the money or other property held by the qualified intermediary. Treas. Reg. §1.1031(k)-1(g)(4)(ii) If the taxpayer has actual or constructive receipt of the funds, the exchange fails.

The taxpayer files IRS Form 8824 for the year of the exchange to report the transaction. IRS Form 8824, IRS Instructions for Form 8824

A special rule applies when the parties are related. In an exchange between related persons, defined by Section 267(b) or 707(b)(1), if either party disposes of the property within two years, the deferred gain is recognized. 26 U.S.C. §1031(f) This rule prevents basis-shifting transactions between related taxpayers.

Could Congress cap 1031 exchanges?

Section 1031 has survived many attempts to limit or repeal it. In the fiscal year 2025 budget proposal, the White House proposed capping the annual deferral at $500,000 per taxpayer. JTC Group That proposal was not enacted. A $500,000 cap would effectively eliminate 1031 exchanges for commercial real estate exchanges. AI data center land transactions can reach tens or hundreds of millions of dollars, as illustrated by a $75 million 1031 exchange. Connect CRE No similar cap has been enacted in any year since.

The industry tracks this threat closely. Trade groups including the Federation of Exchange Accommodators, the National Association of Realtors, NAIOP, and the American Land Title Association lobby to preserve Section 1031. NAIOP, NAR, FEA, ALTA An Ernst & Young study from 2021 found that 1031 exchanges support roughly 568,000 jobs and generate $2.8 billion in annual state and local tax revenue. ALTA one-pager Research by professors David Ling and Milena Petrova found that 10 to 20 percent of commercial real estate transactions involve a 1031 exchange, and 40 percent of 1031 exchanges involve rental property. ALTA one-pager Those numbers give the provision political resilience.

Key takeaways

• An AI data center is real property for Section 1031 under the broad definition in the final regulations. The building is an inherently permanent structure and its dedicated systems are structural components. Treas. Reg. §1.1031(a)-3
• A cost segregation study that reclassifies components as Section 1245 property for depreciation does not disqualify those components from 1031 treatment. The classification for 1031 is separate. 26 CFR §1.1031(a)-3(a)(7)
• But a 1031 exchange can still trigger ordinary income recapture if the replacement property contains less Section 1245 property than the relinquished AI data center. Model the difference carefully. IPX1031, 2 Key Tax Strategies, Tax alert
• The identification deadline is a hard 45 calendar days. The acquisition deadline is 180 days or the extended tax return due date, whichever is earlier. 26 U.S.C. §1031(a)(3)
• Due diligence on AI data center infrastructure can compress the timeline. Start the search for replacement property before the sale closes, and consider DSTs as a backup. Data center 1031 exchange due diligence, Replacement property identification planning
• The 15% incidental personal property safe harbor helps when small amounts of personal property transfer with the real estate. Under the incidental property rule, keep the aggregate fair market value of incidental personal property at or below 15 percent of the replacement real property value. T.D. 9935, 85 Fed. Reg. 77365
• The replacement property does not need to be an AI data center. Any U.S. investment real estate qualifies. Many sellers pivot into net-leased retail, industrial, or office assets. ICSC, 1031 Investors Target Net Lease Assets
• Use a qualified intermediary with the financial strength and experience to handle large, complex AI data center transactions. Check for segregated custodial accounts and meaningful fidelity bond coverage. QI due diligence guide, 1031 exchange guide
• A related-party exchange triggers a two-year holding period. If either side disposes within two years, the gain becomes taxable. 26 U.S.C. §1031(f)(1)
• The DST structure, governed by Revenue Ruling 2004-86, lets an exchanger acquire a fractional interest in an institutional-quality property. DSTs may hold real property and qualify as replacement property in 1031 exchanges. Rev. Rul. 2004-86
• The proposed $500,000 annual cap on 1031 deferral has not been enacted, but the political risk is real and bears watching. NAIOP

Frequently asked questions

Q:Can I exchange an AI data center for a different type of real estate?

A:Yes. All U.S. real estate held for investment or business is like-kind. You can exchange an AI data center for a warehouse, a shopping center, apartments, or raw land held for investment. 26 U.S.C. §1031(a)(1)

Q:Does the IRS treat an AI data center as real property for 1031?

A:There is no specific ruling on the entire AI data center asset class. But the general definition in the regulations treats the building as an inherently permanent structure and its dedicated systems as structural components. The regulation defines real property to include inherently permanent structures and buildings. Treas. Reg. §1.1031(a)-3 The IRS has not published a contrary ruling.

Q:What happens if the personal property in the sale exceeds 15% of the total value?

A:The excess personal property is treated as non-like-kind property, or boot. Gain is recognized on the exchange to the extent of the value of that boot. If personal property exceeds the 15 percent limitation, it is not disregarded in determining whether the safe harbors apply, though the exchange does not automatically fail. T.D. 9935, 85 Fed. Reg. 77365

Q:How does a cost segregation study affect my 1031 exchange?

A:It does not disqualify the reclassified assets from 1031 treatment. The study is for depreciation. But the recapture potential travels with the exchange, so you must model the Section 1245 content of both sides. 26 CFR §1.1031(a)-3(a)(7), IPX1031, 2 Key Tax Strategies

Q:What is a Delaware Statutory Trust and why use one?

A:A DST is a trust that holds real property. Investing in a DST qualifies as direct ownership of real property for a 1031 exchange. It allows an investor to exchange real property for a beneficial interest in a DST without recognition of gain or loss under §1031, because the interest is treated as a direct ownership interest in the underlying real property. Rev. Rul. 2004-86 Minimum investments can be as low as $25,000. Realized1031

Q:How strict are the 45-day and 180-day deadlines?

A:They are absolute. The IRS does not grant extensions. If you miss the identification, the exchange fails and the gain is taxable that year. IRS Fact Sheet FS-2008-18

Q:Can I do a 1031 exchange with a related party?

A:Yes, but a special rule applies. Both sides must hold the property for at least two years after the exchange. If either party disposes of the property received in the exchange within two years, the deferred gain or loss is recognized. 26 U.S.C. §1031(f)(1)(C)

Q:Is the 1031 exchange at risk of being repealed?

A:There have been proposals to cap or repeal it, such as a $500,000 annual cap proposed in FY 2025. None have passed. The provision has strong industry support and shows resilience. NAIOP, NAR

Q:What do I report on my tax return?

A:File Form 8824 with your tax return for the year of the exchange. It reports the properties, the dates, the boot received if any, and the basis carried over. IRS Fact Sheet, Like-Kind Exchanges

Q:Can I exchange fee simple for a leasehold interest?

A:Yes, a long-term leasehold interest in real property is treated as like-kind to fee ownership, provided the lease term is 30 years or longer, including renewal options. A leasehold with a remaining term of 30 years or more is given as an example of like-kind property. Treas. Reg. §1.1031(a)-1(c) Practitioners should check the regulations carefully.

Subscribe to The Compute Law Brief

The Compute Law Brief is a free weekday newsletter on the law of AI infrastructure across tax, real estate, construction, power, and deals. The big US build markets and federal law. Three minutes a morning. No paywall, and no email gate to read the blog. Subscribe if you want it in your inbox.

Junde Liu, JD, LL.M. (Taxation) candidate at UF Law. Originally published on Compute Law Blog. This article is general information and does not constitute legal advice. Reading it does not create an attorney client relationship. The reader should not act on the basis of any content here without first consulting a licensed attorney in the relevant state. Last reviewed for accuracy May 23, 2026.