Transcript Like-Kind Exchanges In The Energy Industry

Section 1031
Like-Kind Exchanges
Todd D. Keator
Thompson & Knight LLP
[email protected]
August 27, 2014
Introduction
•
•
•
•
•
Background
Operation of § 1031
Forward Exchanges
Reverse Exchanges
Related Party Issues
2
Background
• General Rule – Gain or loss recognized upon a
sale or exchange of property. § 1001.
• Individuals: Current LTCG tax rate is 20.0%, plus
possible 3.8% additional “NII” tax.
• Corporations: 35%.
• Exception – Since 1924, no gain or loss
recognized if disposition structured as a “1031
exchange” for “like kind” property.
• Purpose – Congress did not want to impose a tax
on theoretical gain where taxpayer continued his
investment in like kind property.
3
2-Party vs. 4-Party
• A 2-party exchange is the most classic form of
a 1031 transaction (a simultaneous transfer).
– Example: Bill owns Whiteacre valued at $100.
Sam owns Blackacre valued at $100. Bill and
Same exchange Whiteacre and Blackacre.
• Today, the more common form is a 4-party
transaction among the taxpayer, a buyer, a
seller, and a “qualified intermediary” who
stands in the middle. This transaction may
span up to 180 days.
4
Excluded Property
• Key exclusions: no stock, partnership
interests, certificates of trust, or “dealer”
property.
– No partnership or LLC interests! [Be careful with
tenancy-in-common interests.]
– Oil and gas tax partnerships must elect out of
subchapter K prior to a 1031 exchange.
– No buying and “flipping” inventory.
• Special rules for related parties (1031(f)).
5
“Boot”
• Boot: taxpayer allowed to receive cash “boot”
in the exchange, but boot is taxable to the
extent of gain realized.
• Liability relief also considered boot, but may
be offset by liabilities assumed in the
exchange or cash paid in the exchange.
• Boot always recognized first without any basis
offset.
– Generally taxable as recapture first, then as capital
gain or 1231 gain.
6
Example
• Taxpayer exchanges Relinquished Land worth
$100 ($60 AB) for Replacement Land worth
$80 plus $20 cash. The $20 of cash is “boot”
and is taxable first to the extent of Taxpayer’s
gain realized (i.e., all $20 is taxable because
gain realized is $40).
• If the cash boot instead were $50, Taxpayer
would recognize only $40 of boot gain (i.e.,
only to the extent gain is realized).
7
Example
• Taxpayer exchanges Relinquished Land worth
$100 ($30 AB), and subject to $20 of debt, for
Replacement Land worth $100, and also subject
to $20 of debt. The $20 of “debt relief” boot is
offset by $20 of replacement liabilities, resulting
in no boot gain.
• If the Replacement Land instead was worth $90
and was subject to $10 of debt, Taxpayer would
recognize $10 of debt boot gain.
8
Basis
• Basis: generally, basis in relinquished property rolls
over into replacement property, with certain
adjustments.
• MACRS – the default MACRS Treatment for
replacement property is to “step into the shoes” of
the relinquished property. Treas. Reg. 1.168(i)-6.
• Disadvantages:
– Higher gain on sale of replacement property;
– Lower depreciation deductions going forward.
9
Example
• Taxpayer exchanges Relinquished Land (FMV
$100; AB $30) for Replacement Land (FMV
$100). Taxpayer’s $30 basis rolls over and
becomes Taxpayer’s basis in Whiteacre too.
• Same, but now Replacement Land has a FMV
of $120, so Taxpayer equalizes the transaction
by paying additional $20 cash at closing. Now,
Taxpayer’s AB in Replacement Land is $50 ($30
rolls over, plus $20 excess cash).
10
Key Elements of § 1031
• § 1031(a) provides: “No gain or loss shall be
recognized on the exchange of property held for
productive use in a trade or business or for investment
if such property is exchanged solely for property of like
kind which is to be held either for productive use in a
trade or business or for investment.”
• 3 prongs of the general rule:
– There must be an “exchange.”
– The exchanged properties must be “held for” productive
use in trade or business or investment (“held for” test).
– The exchanged properties must be of “like kind.”
11
Meaning of “Exchange”
• Reciprocal transfer of property.
• Sale and immediate reinvestment of cash does not
qualify – can’t touch the cash!
• No requirement that exchange be simultaneous;
forward and reverse exchanges are allowed (and are
normal).
• Cannot start a 1031 exchange with a lease (but oil &
gas leases are different). Pembroke v. Helvering, 23
B.T.A. 1176 (1931) (99-year lease).
• Oil & gas: Beware retained overriding royalty!
(converts “sale” or “exchange” into a “lease”).
12
Examples
• TP grants a 99-year lease of Blackacre to Tenant
in exchange for the Tenant’s promise to pay
annual rent and to transfer to the TP a fee
interest in Whiteacre. This is a lease, not an
exchange, so the TP’s receipt of Whiteacre is
taxable as pre-paid rent.
• Taxpayer sells Relinquished Land for $100, and
one minute later purchases Replacement Land
for $100. This is a sale followed by a purchase,
and does not qualify as a 1031 “exchange”.
13
• “Drillco” negotiates a deal to sell a 75% working interest to Buyer
for (A) $100,000,000 and (B) retention of an overriding royalty (an
“ORRI”) equal to 25% less all landowner royalties on the leases
(e.g., on leases burdened by a 20% landowner royalty, the ORRI
will be 5%). Is the transaction eligible for a 1031 exchange?
75% Working Interest
DrillCo.
Buyer
$100,000,000
Retained
ORRI
75%
Working
Interest
10,000 Acres
14
Authorities
• The answer is determined on a lease-by-lease basis. See
Cullen v. Comm’r, 118 F.2d 651 (5th Cir. 1941) (whether a
sale or lease occurs must be determined on a property-byproperty basis).
• The answer is no for any leases upon which DrillCo
retains an ORRI.
– See Crooks v. Comm’r, 92 T.C. 816 (1989) (retention of a royalty
in the “sale” of mineral interests converts the transaction into a
lease for federal income tax purposes; Section 1031 is not
available); Rev. Rul. 69-352.
• The answer is yes for leases upon which DrillCo does
not retain an ORRI.
15
Solutions?
• Can DrillCo change the business deal and fix the
problem?
• Probably so. Some possibilities are:
– Don’t retain an ORRI and instead ask for more cash or
other consideration.
– Sell a smaller working interest for the same cash payment.
– Re-define the retained “ORRI” so that it is not a “royalty”
for federal income tax purposes (e.g., use a term shorter
than the expected life of the burdened properties). What
impact does this have on the Buyer? See Cullen and PLR
9437006 (re. retained production payments).
– Carve off the ORRI and convey it to a separate but related
taxpayer ahead of closing?
16
The “Held For” Requirement
• Both “relinquished property” and “replacement
property” must be held for productive use in a trade
or business or for investment.
• Intent determined at time of the exchange.
• Generally covers all property used in a trade or
business and all property held for investment, but
excludes dealer property (e.g. home lots) and
personal use property (e.g. vacation homes, unless
safe harbor met).
17
Satisfying the “Held For” Requirement
• Test is intent at the time of the exchange; prior
bad intent may be converted to good.
• No bright line tests for holding period of
relinquished or replacement property.
– One year is a good rule of thumb; two years is more
conservative.
• Same taxpayer must start and complete the
1031 exchange (discussed in greater detail
later).
18
Recent Cases re. Homes
• Yates v. Comm’r, TC Memo 2013-28: TPs acquired purported “bed
and breakfast” in 1031 exchange but immediately used it as a
personal residence; 1031 failed.
• Goolsby v. Comm’r, TC Memo 2010-64: TPs acquired purported
rental property, made minimal attempts to rent it, and moved in
as personal residence two months later; 1031 failed.
• Reesink v. Comm’r, TC Memo 2012-118: TPs acquired purported
rental property, made bona fide efforts to rent the property, but
ultimately moved in 8 months later; 1031 sustained. Factors: TPs
placed flyers and showed the property to renters.
• Adams v. Comm’r, TC Memo 2013-7: TP’s purchase of house
rented to his son with proceeds from sale of other rental property
qualified as a 1031 exchange; intent to rent to son was investment
intent; son paid rent of $1200 per month.
19
Vacation Homes
• Moore v. Commissioner, T.C. Memo 2007-134: TP exchanged
one vacation home for another. Neither home was rented; both
were used only for personal purposes. TP claimed “investment”
intent. Court held properties held for personal use; 1031 failed.
• Rev. Proc. 2008-16 – Vacation Properties
– “Dwelling unit” must pass “qualifying use” test
– “Qualifying use” generally means:
• Owned by TP for at least 24 months before (for RLP) or
after (for RPP) the exchange
• For each 12 month period, TP must rent dwelling unit to a
3P at fair rental value for 14 days or more
• TP’s personal use cannot exceed greater of (i) 14 days or
(ii) 10% of number of days dwelling unit is rented to 3Ps
» 33 days maximum if TP rented for 332 days
20
“Held For” Requirement
“Drop & Swap” Solution
•
•
•
•
•
Potential solution to exclusion of exchanges of partnership
interests.
Prior to exchange, partnership “drops” undivided interests in
property to exchange partners. Afterwards, exchange
partners “swap” pursuant to § 1031.
Issue: Did exchange partners satisfy the “held for”
requirement with respect to the relinquished property?
The Tax Court and 9th Circuit have ruled in favor of TPs on this
issue, but the IRS continues to challenge these transactions
(e.g., recent amendment to Form 1065, Schedule B).
May also be challenged under Court Holding doctrine.
21
Meaning of “Like Kind”
Real Property
• Broadly defined:
– “The words ‘like kind’ have reference to the nature or
character of the property and not to its grade or
quality. . . . The fact that any real estate involved is
improved or unimproved is not material, for that fact
relates only to the grade or quality of the property
and not to its kind or class.”
• Any real property usually qualifies.
• By statute, foreign and domestic properties are
never of “like kind.”
• Disregarded entities are “disregarded.”
• Oil and gas royalty trusts???
22
Examples of “Like Kind”
Real Property
• A 25,000 acre farm for the Empire State
Building;
• A 30-year+ lease of real property for a fee
interest in real property;
• Perpetual water rights for an easement;
• Mineral properties for a hotel; and
• Working interests in two leases;
23
VIP Industries v. Comm’r, TC Memo 2013-157
• TP exchanged ground lease with 21 years
remaining + motel improvements (that TP built)
for fee interest in motel and office building;
court held 1031 failed because 21-year ground
lease is not like kind to fee interest. Also, motel
improvements could not separately qualify
because they were of a short term nature and
reverted to lessor on expiration of lease. Thus,
“short term real property” interest is not of like
kind to a fee interest.
24
Meaning of “Like Kind”
Personal Property and Intangibles
• Personal property, intangibles, and equipment are not
like kind to real property, but might be like kind to other
personal property and equipment acquired in the
exchange.
• The rules governing what types of personal property
are considered like-kind are much more specific than
the rules that apply to real property.
25
Meaning of “Like Kind”
Personal Property and Intangibles, cont’d.
• To qualify for exchange treatment, the Relinquished and
Replacement Properties must be either “like-kind” or
“like-class.”
– “Like-kind” refers to assets that have the same “nature and
character,” such as an airplane exchanged for an airplane, or a
backhoe exchanged for a backhoe.
– “Like-class” refers to tangible, depreciable personal property
that falls within the same General Asset Class or within the
same Product Class, sharing the same 6-digit NAICS code.
Treas. Reg. §1.1031(a)-2. The Product Classes are found in
Sectors 31 through 33 of the North American Industry
Classification System (NAICS).
26
Personal Property and Intangibles
Examples of “Like Kind”
• Personal computer for a printer; grader for a scraper; sanding
machine for a lathe. T.R. Sec. 1.1031(a)-2(a)(7).
• Steer calves for Aberdeen Angus livestock (Wylie v. U.S., 281 F.
Supp. 180 (N.D. Tex 1968).
• Passenger vans and SUVs for cars (PLR 200450005).
• Not like kind:
–
–
–
–
Airplane for heavy general purpose truck. T.R. Sec. 1.1031(a)-2(a)(7).
Gold bullion and silver bullion (Rev. Rul. 82-166)
Light duty truck for a car (PLR 200240049).
Lithographs for oil paintings and watercolors (PLR 8127089).
27
Intangible Examples, Cont’d
• Intangibles:
– The exchange of a LA radio station for 3 St.
Louis radio stations qualified for 1031. See
Deseret Management Corp. v. U.S., 11 AFTR 2d
2013-530 (respecting purchase price
allocation).
– Major league sports contracts (Rev. Ruls. 71123; 71-137).
– Airport slots at different airports. GCM 39606.
• Goodwill is specifically excluded. T.R. Sec.
1.1031(a)-2(c)(2).
28
Classifying Property as
Real or Personal
• Generally, state law determines whether
property is real or personal.
• Fixtures are regarded as real property in most
states, however, the treatment of some types
of property are not consistent.
• In some instances, the IRS has ruled whether
the item is real or personal property for 1031
exchange purposes, overriding state law
classifications.
29
Classifying Property as
Real or Personal- Example
• The Red River Shootout:
– In Texas, pipelines are real property if they are buried.
– In Oklahoma, pipelines are personal property.
• Can a pipeline in TX be “like kind” to a pipeline in
OK?
• IRS has alleviated the conflict in state law by
ruling that pipelines are real property for 1031
exchange purposes, regardless of the state law
classification. ILM 20123807
30
Real World Example
• Can gas gathering lines and a gas processing plant
located in Louisiana be of like kind? Analysis:
– Personal property under state law? [Yes.]
– Must be of “like kind” or “like class”
• Like kind? Maybe, but no guidance on point. Same “nature
and character”?
– Both contain pipes, tubing, pumps, compressors and move raw gas to
market.
• Like class? Both described in NAICS product code 237120
(listing “gathering line” and “gas processing plant,” but this is
outside sectors 31-33.
– But, LAFA 20072101F says still relevant for “like kind” determination.
31
“99-6” Rulings
• PLR 200807005
TP
100% LP Interests
QI
P1
P2
P3
LP
• Based on Sit. 2 of Rev. Rul. 99-6
Replacement Property
32
“99-6” Rulings
• PLR 200909008
Partner
TP
50%
EAT
50%
LP
Replacement Property
• Based on Sit. 1 of Rev. Rul. 99-6
50% LP Interest
(day 1)
33
Typical Exchange Structures
• “Forward” Exchanges are products of IRC
1031(a)(3) and generally use a “Qualified
Intermediary” (and sometimes a “qualified
trust” or “qualified escrow”).
• “Reverse” Exchanges have no Code authority
and rely on safe harbor Rev. Proc. 2000-37,
generally using an “Exchange Accommodation
Titleholder” or EAT.
• 45-day “identification” and 180-day closing
required.
34
Forward Exchanges
• A non-simultaneous exchange whereby TP disposes of
relinquished property first, and acquires replacement
property at a subsequent date.
• May be a 2-party exchange, but generally is a 4-party
exchange involving (1) TP, (2) Qualified Intermediary
(“QI”), (3) Buyer of TP’s relinquished property, and (4)
Seller of TP’s replacement property.
• QI cannot be a “disqualified person” (including a
related party). See Blangiardo v. Comm’r, TC Memo
2014-110 (1031 failed because TP’s son (a lawyer)
attempted to act as QI for TP’s exchange).
35
Requirements for a Forward
Exchange
• TP must identify the replacement property(ies) within
45 days after transfer of relinquished property.
• TP must acquire the replacement property(ies) by the
earlier of (i) 180 days after transfer of relinquished
property, or (ii) the due date (with extensions) for the
TP’s tax return for the year in which TP transferred the
relinquished property. Generally, 180-day limit
applies.
• TP must not be in actual or constructive receipt of
cash during this time.
• These are hard deadlines.
36
“Identification” of Replacement Property
• Identification must be made in writing within the 45day period.
• Identification is limited to:
– 3 properties (without regard to the FMV) OR
– Any number of properties so long as aggregate FMV
does not exceed 200% of FMV of the relinquished
property.
– There is also safety valve 95% rule
• Must specifically identify replacement property.
• Replacement property must be “substantially the same
property” as was identified.
37
Real-World Example
• TP properly identifies in writing certain 100ton “coal gondola railcars,” each with 4,400
cubic foot capacity, manufactured by X in 1998
as replacement property for a 1031 exchange.
However, to complete the exchange, TP
ultimately acquired identical coal gondola
railcars manufactured by Y in 2000 (having the
same weight, dimensions, and capacity). Did
TP acquire “substantially the same” railcars as
were identified?
38
Typical 4-Party Forward Exchange
Example
• TP owns Blackacre and desires to acquire Whiteacre
from Sarah Seller. However, Sarah Seller wants to sell
Whiteacre for cash, not Blackacre. Bill Buyer, however,
desires to acquire Blackacre, and is willing to pay cash
for it. TP engages QI to facilitate the transaction as
follows: Day 1: TP transfers Blackacre to QI, and QI
sells Blackacre to Bill Buyer for cash. Day 2: QI uses
the cash to purchase Whiteacre from Sarah Seller. Day
3: QI transfers Whiteacre to TP to complete TP’s 1031
exchange.
39
Example 3 – Typical 4-Party Forward
Exchange
Seller Whiteacre
TP
Blackacre
(6) Whiteacre
QI
(1) Blackacre
Buyer - $
40
Reverse Exchanges
•
•
•
Similar to a forward exchange, but the order is reversed.
Typical example: TP desires to exchange Blackacre and acquire
Whiteacre as replacement property in a 1031 exchange. Whiteacre
is placed on the market prior to the time TP is able to find a buyer
for Blackacre, so not wanting to miss his chance, TP instructs a
third party to acquire Blackacre for cash (funded by TP). Once TP
finds a buyer for Blackacre, TP arranges through a QI to sell
Blackacre to the buyer, and then QI uses the cash to purchase
Whiteacre from TP’s third party, and then QI transfers Whiteacre to
TP to complete the 1031 exchange. Third party repays the cash to
TP.
Issue: If the third party is TP’s agent or nominee, then the TP has
exchanged with himself, which does not qualify under § 1031.
41
Reverse Exchange Safe Harbor
• The IRS issued a safe harbor Rev Proc 2000-37 pursuant to
which taxpayers may safely engage in reverse 1031
exchanges.
• Basic requirements: taxpayer and the EAT must enter into a
written QEAA Agreement; if the replacement property is
parked, taxpayer must properly identify the relinquished
property in the same manner as described for forward
exchanges; taxpayer must complete the entire transaction
within 180 days; EAT must report itself as tax owner of the
property it holds during the QEAA period.
• Benefits: TP can safely loan money to the EAT to acquire the
replacement property to be parked, or TP can guaranty loans
to the EAT for such purpose. TP can lease the replacement
property from the EAT pending completion of the exchange
for no rent. TP can manage the replacement property during
such period.
42
Reverse Exchange Safe Harbor –
Diagram
Seller Whiteacre
(1) Loan $
TP
(4) Blackacre
(7) Whiteacre
Blackacre
EAT
(8) Repay loan $
Buyer - $
43
Role of Entities in Exchanges Same Taxpayer Rule
• The same taxpayer that disposed of
relinquished property must acquire
replacement property
– Not explicitly stated in section 1031, but derived
from section 1031(a)(3)
– Applies to Individuals, Partnerships, Corporations,
and Trusts.
– Does not apply to Disregarded entities or Qsubs.
44
Same Taxpayer Rule
Individuals
• If relinquished property was held at
community or separate property, replacement
property should be held as community or
separate property. TAM 8429004.
• If taxpayer dies during exchange period,
exchange may be completed by estate. Rev.
Rul. 64-161.
45
Same Taxpayer Rule –
Partnerships
• Same partnership which sells relinquished property
must acquire replacement property. TAM 9227022.
• Conversion from a GP to LP or LLC should not affect
exchange. PLR 99935065.
• A change in ownership may occur during the
exchange period as long as partnership does not
terminate
– However, no guidance on IRC 708(b)(1) terminations
• Notably, partners in a partnership cannot complete
an exchange started by the partnership.
46
Same Taxpayer Rule
Corporations
• If corporation owned relinquished property,
corporation (not shareholders) must acquire
replacement property
• If a corporation undergoes a tax-free reorganization,
successor corporation may acquire replacement.
TAM 9252001, PLR 200151017.
• Changes in stock ownership should not affect
exchange
• Consolidated group members?
47
PLR 201024036
Step (2) Parent
exchanges NOx Credits
for VOCs Credits
Parent
Step (1) Sub
distributes NOx
Credits to
Parent
Third Party
VOCs
Subsidiary
NOx
48
PLR 201024036
• Rev. Proc. 92-91: Emission allowances are
treated as “like kind” under 1031.
• NOx and VOCs treated as government licenses
or permits and intangible property for federal
tax purposes.
• IRS ruled NOx and VOCs credits were of “like
kind.”
• Parent considered to have, prior to the
exchange, held the NOx credits for productive
use in a trade or business.
49
Same Taxpayer Rule
Grantor Trusts
• Exchanges of trust interests are disqualified under
section 1031(a)(2)(E)
• However, the IRS has softened this position over the
years.
– In Rev. Rul. 92-105, the IRS ruled that a beneficial
interest in an Illinois land trust is real property for
1031 exchange purposes.
– IRS later expanded this ruling to permit grantor trusts
to engage in 1031 exchanges in Rev. Rul. 2004-86.
• Royalty trusts? Prohibited trust interest or
security?
50
Related Party Exchanges
General Rules of § 1031(f)
• Related Party Exchanges are permitted under
1031, but are subject to several restrictions.
• Each related party must hold replacement
property 2 years after exchange or both transfers
are taxed.
– 2 year test is a bright line test.
• On disqualifying disposition, tax incurred by both
in year of disposition
• Anti-abuse provision hits indirect transactions: §
1031(f)(4)
51
Introduction
• Purpose of 1031(f): to prevent abusive basis
shifting.
• Example. Assume A and B are father/son:
Skyscraper
1
A
Farm
(Skyscraper)
($1,000,000 FMV; $0 AB)
B
(Farm)
($1,000,000 FMV; $1,000,000 AB)
Skyscraper
2
Cash
X
(Unrelated 3P)
52
General Rule – 1031(f)(1)
• If a taxpayer:
– exchanges property with a “related person,”
– Section 1031(a) otherwise applies to the exchange
(i.e., there is nonrecognition of gain or loss to the
taxpayer on the exchange), and
– before the 2-year anniversary of the date of the
last transfer that was part of the exchange, either
the related party disposes of such property or the
taxpayer disposes of the property received in the
exchange that was of like kind to the relinquished
property,
then the taxpayer loses nonrecognition treatment
with respect to the exchange.
53
“Related Person” –
1031(f)(3)
•
Under Section 1031(f), “related person” is defined under Sections 267(b) & 707(b)(1).
•
Some common examples of related parties include:
– Members of a family (including siblings, spouse, parents, ancestors, and lineal
descendants).
– An individual and a corporation in which such individual owns more than 50% of the
value of the outstanding stock
– 2 corporations that are members of the same controlled group
– A grantor and a fiduciary of a trust
– An executor and beneficiary of an estate
– A partnership and a person owning, directly or indirectly, more than 50% of the capital
or profits interests.
– 2 partnerships where the same person(s) own, directly or indirectly, more than 50% of
the capital or profits interests.
54
Attribution
• For purposes of determining if persons are related, the attribution
rules of section 267(c) may apply:
• Example:
Son
related
Father
3p
50%
50%
50%
Partnership
50%
Corporation
• Son, through direct ownership only, owns 50% of Corporation (not
more than 50%) and is unrelated to Corporation. However, through
attribution, Son is deemed to own the 25% share in the Corporation
that Father is deemed to own. Thus, Son is deemed to own 75% of
Corporation, and Son and Corporation are related.
55
“Disposition” Exceptions –
1031(f)(2)
• The following dispositions are ignored for purposes
of determining whether a prohibited disposition has
occurred within two years:
– Any disposition after the earlier of the death of the
taxpayer or the death of the related person,
– Any disposition in a compulsory or involuntary conversion
(under section 1033) if the exchange occurred before the
threat or imminence of such conversion, or
– Any disposition where neither the original exchange nor
the subsequent disposition had as one of its principal
purposes the avoidance of federal income tax.
56
Non-Tax Avoidance Purpose - 1031(f)(2)(C)
• According to legislative history, the following
transactions generally do not have a tax
avoidance purpose:
– Transactions involving an exchange of undivided interests in different
properties that results in each taxpayer holding either the entire
interest in a single property or a larger undivided interest in any of
such properties
– Example: (from P.L.R. 199926045)
M
K
50%
• Before:
50%
Timberland
• After:
K
100% of ½ Timberland
M
Sale
100% of ½ Timberland
3P
57
• Dispositions of property in nonrecognition
transactions.
– Example:
Blackacre
Brother
1
Blackacre
Sister
3P
Greenacre
Whiteacre
Blackacre
2
Whiteacre
Greenacre
• Transactions that do not involve the shifting of
basis between parties.
• Example: An exchange of properties that have the
same basis.
58
Anti-Abuse Rule – 1031(f)(4)
• Section 1031(a) does not apply to any exchange
that is structured to avoid the purposes of the
related person rules of section 1031(f).
– Example:
X
2
A
1
B
(Skyscraper)
(Farm)
($1,000,000 FMV; $0 AB) ($1,000,000 FMV; $1,000,000 AB)
• Because these steps are structured to avoid section 1031(f), section 1031(a) will
not apply to A’s exchange with X. A must recognize his $1,000,000 gain.
59
Revenue Ruling 2002-83
•
Caution: Section 1031(f)(1) applies to indirect transfers by related persons
through intermediaries.
– Example: (from Rev. Rul. 2002-83)
A
(Office: $150 FMV; $50 AB)
B
4
(Apartments: $150 FMV; $150 AB)
3
1
Office
C
2
QI
$150 Cash
– IRS ruled that A used QI to circumvent Section 1031(f)(1). Under Section 1031(f)(4), the
transaction was recharacterized as a direct exchange of property between A and B,
followed by a sale by B to C. Thus related persons cannot use a QI to escape Section
1031(f).
60
PLR 200440002
• Assume Same Facts:
A
(Office: $150 FMV; $50 AB)
B
3
5
1
Land
Office
C
2
$150 Cash
(Apartments: $150 FMV; $150 AB)
QI
4
D
$150
Cash
– This transaction is similar to Rev. Rul. 2002-83, except that B receives
like kind replacement property, not cash. Therefore, even if the
transaction is recharacterized as a direct exchange between A and B,
followed by an exchange between B and D, the transaction falls into
the exception for transactions with no principal purpose of tax
avoidance (Section 1031(f)(2)(C), per exception for subsequent
dispositions in nonrecognition transactions).
61
Teruya Brothers, Ltd. v. Commissioner
• Teruya Brothers, Ltd. (“TB”) owned 62.5% of Times Super
Market, Ltd. (“Times”). Thus, TB and Times were related
parties.
• The Ocean Vista Transaction (rounded numbers):
TB
(Ocean Vista: $1.5 m FMV; $100,000 AB)
4
Times
(Pad Sites: $2.85m FMV;
$1.45m AB)
1
3
Ocean Vista
3P
2
$1.5 m cash
QI
62
• The Royal Towers Transaction (rounded
numbers):
TB
(Royal Towers: $12m FMV; $700,000 AB)
4
Times
(Land: $12.6m FMV;
$17.1m AB)
1
3
Royal Towers
3P
2
QI
$12m
cash
63
• The Court held that TB’s transactions were economically equivalent to
direct exchanges between TB and Times, followed by sales of the
properties by Times for cash. The interposition of a QI could not obscure
the end result. Because the taxpayer offered no explanation for structuring
the transactions using a QI, the Court found that TB used the QI to avoid
the consequences of equivalent direct exchanges. Thus, Section 1031(f)(4)
applied.
• The Court also stated that any analysis under Section 1031(f)(4) into
whether a transaction was structured to avoid the purposes of Section
1031(f) must take into account the exception of Section 1031(f)(2)(C) for
non-tax avoidance transactions.
• Finally, the Court analyzed the Ocean Vista transaction under Section
1031(f)(2)(C). TB argued that it had less built-in-gain in the Ocean Vista
property ($1.345 million after expenses) than Times had in the Pad Sites
($1.35 million after expenses) and therefore the transaction lacked a tax
avoidance purpose. However, the Court looked beyond the built-in-gain
figures and analyzed each party’s entire tax picture. TB had no NOLs and
so would have paid tax on the $1.345 million gain at 34%, whereas Times
had NOLs and paid no tax on the $1.35 million gain. Thus, the Court found
a tax avoidance purpose.
64
Ocmulgee Fields, Inc. v. Comm’r, 132 T.C. 6 (3/31/2009)
Taxpayer
(Wesleyan Station: $7.25m FMV; $700k AB)
Related Party
4
(Barnes & Noble Corner:
$6.8m FMV; $2.5m AB)
3
W.S.
3P
2
1
QI
$6.8m (net after expenses)
– Had TP sold W.S. directly, gain = $6.1m; but if TP and RP exchange, and RP sells
W.S. to 3P, gain = $4.3m ($1.8m less).
– Under 1031(f)(4), Court recast as direct exchange between TP and RP,
followed by sale of W.S. by RP to 3P. Court then tested 1031(a)(2)(C)
exception and found that, due to basis shifting, transaction had principal
purpose of tax avoidance. Thus, Court denied 1031 exchange.
65
Ocmulgee Fields, Inc. v. Comm’r, 613 F.3d 1360 (11th Cir. 2010)
• Under 1031(f)(4), Court recast as direct exchange between
Taxpayer and Related Party, followed by sale of Wesleyan
Station by Related Party to the third party. The Court then
tested 1031(a)(2)(C) exception and found that, due to basis
shifting, transaction had principal purpose of tax avoidance.
• Factors: (1) Parties cashed in on the low-basis property, but
paid tax only on the gains from the sale of the high-basis
property; (2) Related Party’s partners paid tax at only 15%; (3)
one partner in related party fully-offset his share of the gain
with a charitable deduction; and TP selected Barnes & Noble
Corner just 6 days after engaging the QI.
• Notably, Court hinted that lack of basis-shifting could save a
transaction under a similar fact pattern.
• See also North Central Rental & Leasing v. U.S., 112 AFTR 2d
2013-7099 (1031(f)(4) applied to equipment exchange; court
relied on Teruya and Ocmulgee).
66
PLR 201027036
Relinquished
Equipment
Taxpayer
Related Party
Buyers
$100x
QI
$100x
Equipment
Replacement
Equipment
Unrelated
Seller
67
PLR 201027036
• IRS ruled 1031(f)(1) not applicable because
Taxpayer exchanged with QI.
• 1031(f)(4) also not applicable because
Taxpayer and Related Parties did not exchange
properties. Reason: Related Party did not
own any property Taxpayer acquired in the
exchange.
• [Contrast acquisitions of replacement
property from a related party.]
68
PLR 201048025 –
“Serial Exchanges”
Related
Party
TP
RLP2/
RPP1
Third
Party
Affiliate
RLP3/
RPP2
RPP3
$100x
RLP1
QI
RLP1
$100x
QI
$100x
QI
$100x
Buyer
69
PLR 201048025
• IRS upheld Taxpayer’s exchange provided all parties remained
invested in replacement properties for at least 2 years.
• IRS ruled transactions were valid 1031 exchanges because
related parties did not cash out and remained invested in like
kind property.
• IRS relied on exception in IRC Sec. 1031(f)(2)(C) allowing
subsequent dispositions that do not have a tax avoidance
purpose. Legislative history makes clear that the non-tax
avoidance exception includes subsequent dispositions in
nonrecognition transactions.
• De minimis boot allowed.
70
Example. A and B each own 80 acres of contiguous mineral property,
each with a FMV of $100 and basis of $0. State implements a
unitization program and forces A and B to combine their 80 acre
tracts into one 160-acre unit. A and B each receive a 50% interest
in the 160-acre unit. Is this a 1031 exchange? Yes. Rev. Rul. 68186; GCM 33536.
Before Unitization
A – 80
acres
B – 80
acres
After Unitization
A – 50%
B – 50%
71
Same example, but now assume that A and B are father and son,
and that one year later A sells his 50% interest in the unit for
$200. The original 1031 exchange may no longer be valid. See
IRC 1031(f)(1). Does the “no tax avoidance purpose” exception
apply? See IRC 1031(f)(2)(C).
Before Unitization
A – 80
acres
B – 80
acres
After Unitization
A – 50%
Sale to C
for $200
B – 50%
C
72