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It remains to be seen whether other FEA Members will put the taxpayer and the Industry ahead of its profit margin, as shortsighted as it may be to do otherwise.
Amendment to Sec.121 May Affect 1031 Exchange Planning
The Housing Assistance Tax Act of 2008, signed by President Bush on July 30, 2008, includes a modification to the Section121 exclusion of gain on the sale of a primary residence. This modification may affect taxpayers who exchange into a residential property, and then later convert the property to a personal residence, as explained below.
Under Code Section 121, a taxpayer can exclude up to $250,000 ($500,000 for married couples filing jointly) of gain realized on the sale of a principal (primary) residence if they have owned and occupied the residence for two years during the five year period preceding the date of sale. Gain related to depreciation deductions taken on the property since May 6, 1997 is not eligible for exclusion.
Effective January 1, 2009, the exclusion will not apply to gain from the sale of the residence that is allocable to periods of “nonqualified use.” Nonqualified use refers to periods that the property is not used as the taxpayer’s principal residence. This change applies to use as a second home as well as a rental.
How does this affect 1031 planning? Suppose the taxpayer exchanged into the residence and rented it for three years, and then moved into it and lived in it for two years. The taxpayer then sold the residence and realized $300,000 of gain. Under prior law, the taxpayer would be eligible for the full $250,000 exclusion and would pay tax on $50,000. Under the new law, the exclusion would have to be prorated as follows (the example does not take into account deprecation taken after May, 1997, which is taxable anyway).
Three-fifths (3 out of 5 years) of the gain, or $180,000, would be ineligible for the $250,000 exclusion.
Two-fifths (2 out of 5 years) of the gain, or $120,000, would be eligible for the exclusion.
Importantly, nonqualified use prior to January 1, 2009 is not taken into account in the allocation. Thus, suppose the taxpayer had exchanged into the property in 2007, and rented for 3 years till 2010 prior to the conversion to a primary residence. If the taxpayer sold the residence in 2012 after two years of primary residential use, only the 2009 rental period would be considered in the allocation. Thus, only one-third (1 out of 3 years) of the gain would be
ineligible for the exclusion.
The allocation rules only apply to time periods prior to the conversion into a
principal residence and not to time periods after the conversion out of personal residence use. Thus, if a taxpayer converts a primary residence to a rental, and otherwise meets the two out of five year test under Section 121, the taxpayer is eligible for the full $250,000 exclusion when the rental is sold. This rule only applies to periods after the last date the property is used as a principal residence. Therefore, if the taxpayer used the property as a principal residence in year one and year two, then rented the property for years three and four, and then used it as a principal residence in year five, the allocation rules would apply and only three-fifths (3 out of 5 years) of the gain would be eligible for the exclusion.
IRS Let. Rul 200805012 held that Transferable Development Rights (“TDR”) are like-kind for purposes of §1031 to a fee interest in real estate.
Taxpayer, a C corp., proposed to sell a fee interest in relinquished property and use the proceeds to acquire TDRs. Those TDRs would be used to enhance construction on property the taxpayer already owned within a designated
receiving zone. Taxpayer sought a ruling that the TDRs were like-kind to a fee interest in real property.
TDRs are relatively modern land use planning tools that are encountered in many jurisdictions. Where they are authorized, governments can grant TDRs in order to limit or to entirely prevent development in special zoning districts. When properly structured, governments can accomplish these land use goals without having to pay for what might otherwise constitute costly partial – or even total – condemnations. TDR programs can also be used to reduce political and legal
opposition to a restrictive zoning plan. In a TDR program, a governmental entity [i.e., state, county, city, water
use district, environmental protection agency, etc.] grants owners of property in the special use zone TDRs in exchange for either voluntary or compulsory new restrictions on the development of property within the zone. These TDRs can be sold on the open market to owners of other real property in a receiving zone, permitting development of the property in the receiving zone beyond what would otherwise have been permitted.
The Service ruled, as a preliminary matter, that the TDRs could be like-kind to a fee interest under §1031(a), despite the fact that the taxpayer intended to use the them to enhance real property it already owned, as long as the TDRs were acquired in an arm’s length transaction. The Service cited Rev. Rul. 68-394, which held that a leasehold with more than 30 years to run on a property the taxpayer already owned was like-kind to a fee interest under §1031(a) as long as the taxpayer
acquired the leasehold in an arm’s length transaction.
Next, relying almost entirely on their classification under state and local law, the ruling holds that the TDRs are like-kind to a fee interest in real property. While TDRs may not be treated identically to real property for all purposes, they are treated like real property in a number of important ways including the fact that their grant is not discretionary, they appear to be
permanent, are transferred in a manner similar to the transfer of a deed or an easement, and are recorded and indexed against the granting and receiving sites. Further, the State’s tax statute and transfer tax provisions seem to define TDRs as real estate.
Because TDR programs vary considerably from one state to another, it is by no means certain that the laws of a particular
jurisdiction will comply sufficiently with the standards presented in this letter ruling. As always the case with
private letter rulings, the ruling itself cannot be cited as precedent, and the Service has the right to rule differently on subsequent occasions. However, the ruling is useful for the purpose of demonstrating the current thinking of the Service on this important subject.
(Pertinent Letter Ruling)
The IRS has issued an extension Notice for Los Angeles, Orange, Riverside, San Bernardino, San Diego, Santa Barbara and Ventura counties for the October 21st wildfires. [Note that the IRS may add additional counties later as FEMA adds counties. If you are near the affected area, you should check the disaster announcement website for updates. The FEA will not issue announcements if more counties are added.]
Both of the following criteria must be met to get the extension under Revenue Procedure 2007-56, section 17:
(1) The taxpayer is located in one of these counties or is otherwise an affected taxpayer as defined in the Notice, regardless of where the relinquished property or replacement property is located, or otherwise has difficulty meeting the exchange deadlines under the conditions in Revenue Procedure 2007-56, section 17; AND
(2) The relinquished property was transferred (or the parked property was acquired by the EAT in a reverse exchange under Revenue Procedure 2000-37) on or before October 21, 2007. IF the taxpayer meets these criteria, THEN any 45 day or 180 day deadline that falls within the period on or after October 21, 2007 through January 31, 2008, is extended for 120 days from such deadline. It is unclear from the guidance if 180 day deadlines falling after January 31, 2008 are also extended.
Please see Revenue Procedure 2007-56, Section 17, and the notice below for further details.
http://www.irs.gov/newsroom/article/0,,id=108362,00.html
June 25, 2007, Philadelphia, PA – The Federation of Exchange Accommodators (FEA) announced today strong support of the state of Nevada’s SB 476, a bill Governor Jim Gibbons signed on June 14 that becomes effective July 1, 2007.
The FEA is the only national trade organization formed to represent the Qualified Intermediary (QIs) industry and the interests of consumers who use these services. Qualified Intermediaries are professionals who are trained to execute 1031 Exchanges. The FEA also represents the legal/tax advisors and affiliated Tbusinesses that are directly involved in Section 1031 Exchanges. Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment.
SB 476 also places the licensing and regulation of QIs under the Nevada Department of Business and Industry’s Financial Institutions Division, which has oversight of state-chartered lending and depository institutions.
“The FEA was a strong resource for our research team,” said Business and Industry Department Director Mendy Elliott. “We approached the FEA looking for background information on 1031 Exchanges, and their people stood by us throughout the process of drafting this bill. No organization could provide more detailed experience or insight into the potential gaps in the legalities of 1031 Exchanges. We are very appreciative for their commitment to consumer protections.”
Nevada’s new law outlines numerous consumer protections, including:
- Civil and background checks for owners and all money control persons of 1031 Exchange companies.
- State Audits conducted by FID for Qualified Intermediaries.
- Expanded bond and insurance liability coverage.
Additional details on the law can be accessed via Financial Institutions Division’s “2007 Legislative Activity” link on the Web at www.fid.state.nv.us.
“We strongly support any additional consumer protections that can be put in place to establish trust and confidence between customers of 1031 Exchanges and their intermediaries,” said Hugh Pollard, President, FEA. “The law itself uses similar provisions to the FEA’s own Model Law, which holds Qualified Intermediaries to a set of strict ethics expectations.”
In addition to The Association’s Model Law and strict Ethics Code, the FEA offers a professional certification program and numerous continuing education programs for maintaining the highest level of integrity for industry professionals. The Certified Exchange Specialist (CESŪ) Program was established by the FEA in 2003 to formally recognize individuals who have satisfied an experience requirement and demonstrated through testing their comprehensive knowledge of Section 1031 and the facilitation of like-kind exchanges. Currently there are 246 CESŪ Designees nationwide. An announcement was made on June 18, 2007 announcing the most recent group of 15 CESŪ Designees appointed by the FEA.
The Federation of Exchange Accommodators (FEA) is a national trade organization formed to represent qualified intermediaries (QI's), their primary legal/tax advisors and affiliates who are directly involved in Section 1031 Exchanges. Formed in 1989, the FEA was organized to promote the discussion of ideas and innovations in the industry, to establish and promote ethical standards of conduct for QI's, to offer education to both the exchange industry and the general public, and to work toward the development of uniformity of practice and terminology within the exchange profession. The FEA also provides timely input and updates on pending State and Federal legislation, Internal Revenue Service and Treasury Rulings, and Court Decisions.
45 and 180 Day Extensions in Kiowa County , Kansas for May 4th Presidential Disaster
On May 8, 2007, the IRS issued the announcement below for Kiowa County in Kansas. All of the following criteria must be met to get the extension:
(1) The taxpayer is located in this county, regardless of where the relinquished property or replacement property is located, or the taxpayer otherwise has difficulty meeting the exchange deadlines under the conditions in Revenue Procedure 2005-27, section 17; AND
2) The relinquished property was transferred (or the parked property was acquired by the EAT in a reverse exchange under Revenue Procedure 2000-37) on or before May 4, 2007;
3) The 45 or 180 day deadline falls between May 4, 2007 and July 5, 2007.
The extension is for THE LONGER OF 120 days from the last day of the 45 or 180 day deadline, or until July 5, 2007 (and 120 days is longer since July 5 is less than 120 days from the declared disaster).
Please see the notice below for further details.
http://www.irs.gov/newsroom/article/0,,id=108362,00.html
PLR200718028
In a safe harbor reverse exchange pursuant to Rev. Proc. 2000-37, the IRS ruled in PLR 200718028 that it would apply IRS Reg. 1.1031(k)-1(c)(4)(ii)(A) by analogy. That regulation provides in the case of a forward exchange, that any replacement property actually delivered by the QI to the taxpayer during the 45-day identification period is treated as properly identified and qualifies as like-kind property. This ruling addresses whether the same principle would apply in a reverse exchange to relinquished property delivered to a QI within the 45 day period for the reverse exchange, if that relinquished property is not otherwise identified within that period to the EAT as being a possible relinquished property. The IRS ruled that the identification requirement in the reverse exchange was satisfied if the relinquished property was delivered to the QI before the 45th day of the reverse exchange period based on these facts.
On Day 1, Taxpayer began a reverse exchange by acquiring replacement property in the name of an EAT pursuant to Rev. Proc. 2000-37. On the 43rd day after Day 1, Taxpayer sold "Property A" through a QI in what apparently looked like a new forward exchange. The ruling does not state if the forward exchange agreement designated the reverse exchange property as the replacement property in the forward exchange, nor does the ruling state if the forward exchange agreement mentions the reverse exchange. On the 46th day after the start of the reverse exchange, Taxpayer sent a notice to the EAT designating the Property A as one of the possible relinquished properties in the pending reverse exchange. The PLR does not mention if the QI and the EAT were related parties.
As always, this letter ruling cannot be used or cited as precedent.
Mississippi Conforms State Law to Federal Rules for Like-Kind Exchanges
On March 27, 2007 Mississippi ’s governor signed HB 1585 into law, which brings Mississippi into conformity with federal rules for like-kind exchanges. HB 1585 modifies Mississippi Code Section 27-7-9(f)(1)(A) by adding the line:
“…In addition, no gain or loss shall be recognized on any exchange of property if no gain or loss is recognized with regard to such exchange under Section 1031 of the Internal Revenue Code.”
Prior to the change, Mississippi Code Section 27-7-9(f)(1)(A) purportedly allowed for non-recognition of gain for Mississippi state income tax purposes when property held for productive use in business or investment (excluding inventory and stock) was exchanged solely for like-kind property held for use in a business or investment. Unfortunately, Mississippi Regulation 203 severely limited the application of this rule for many exchangers by requiring that replacement property have situs inside Mississippi . HB 1585 clarifies that any exchange, which qualifies for non-recognition treatment under Internal Revenue Code Section 1031, also similarly qualifies for purposes of determining state income tax in Mississippi .
45 and 180 Day Extensions in New York and New Jersey for April 14-18 Storms
On April 26, 2007, the IRS issued the announcement below for Orange, Rockland and Westchester counties in New York, and Bergen, Burlington, Essex, Passaic, Somerset and Union counties in New Jersey. On May 2, 2007, the IRS once again revised the notice to add the following additional six New Jersey counties: Camden , Gloucester , Hudson , Mercer, Middlesex, and Morris.
All of the following criteria must be met to get the extension:
(1) The taxpayer is located in one of these counties, regardless of where the relinquished property or replacement property is located, or the taxpayer otherwise has difficulty meeting the exchange deadlines under the conditions in Revenue Procedure 2005-27, section 17; AND
(2) The relinquished property was transferred (or the parked property was acquired by the EAT in a reverse exchange under Revenue
Procedure 2000-37) on or before April 18, 2007;
(3) The 45 or 180 day deadline falls between April 14, 2007 and June 25, 2007.
The extension is for THE LONGER OF 120 days from the last day of the 45 or 180 day deadline, or until June 25, 2007 (and 120 days appears to be longer since June 25 is less than 120 days from the declared disaster).
Please see the notice below for further details.
http://www.irs.gov/newsroom/article/0,,id=108362,00.html
On April 9, 2007, the IRS issued the announcement below for Curry and Quay counties in New Mexico. All of the following criteria must be met to get the extension:
(1) The taxpayer is located in one of these counties, regardless of where the relinquished property or
replacement property is located, or the taxpayer otherwise has difficulty meeting the exchange deadlines under the conditions in Revenue Procedure 2005-27, section 17; AND (2) The relinquished property was transferred (or the parked property was acquired by the EAT in a reverse exchange under Revenue Procedure 2000-37) on or before March 23rd-24 th, 2007;
(3) The 45 and 180 day deadline falls between March 23 rd – 24 th and June 1, 2007.
The extension is for THE LONGER OF 120 days from the last day of the 45 or 180 day deadline, or until the
date specified in (3) above (and 120 days appears to be longer since the date in (3) is less than 120 days from the declared disaster).
Please see the notice below for further details.
http://www.irs.gov/newsroom/article/0,,id=168395,00.html
IRS rules that a taxpayer’s sale of the relinquished property to a related party, followed by sale by the related party does not trigger gain to the taxpayer under 1031(f)
In PLR 200709036, the taxpayer, who was the operating partnership of a publicly traded real estate investment trust (REIT), sold an office and retail property (Relinquished Property) to a related taxable REIT subsidiary (TRS) for cash consideration at a fair market value price. Utilizing an unrelated QI, taxpayer used the proceeds from the sale to acquire replacement property from a third party seller. The TRS planned to sell the Relinquished Property within two years of the exchange.
The IRS held that under IRC §1031(f)(4), these transactions were not designed to avoid application of the related party rules of IRC §1031(f). The legislative history indicates that congress designed IRC §1031(f) to apply to exchanges of low basis property for high basis property followed by a sale of the high basis property. In the present case, taxpayer and TRS did not actually exchange properties because the TRS did not own the replacement property prior to the exchange. Accordingly, taxpayer would not be required to recognize gain under IRC §1031(f)(1)(C)(i), if TRS disposed of the Relinquished Property within two years of the exchange.
This private letter ruling is not precedent and may not be relied upon by anyone other than the taxpayer obtaining the ruling, but it does indicate the current thinking of the IRS on this issue.
45 and 180 Day Extensions in Three Louisiana Counties for Storm and Tornadoes
On March 2, 2007, the IRS issued the announcement below for Jefferson, Orleans and St. Martin counties in Louisiana. All of the following criteria must be met to get the extension:
(1) The taxpayer is located in one of these counties, regardless of where the relinquished property or replacement property is located, or the taxpayer otherwise has difficulty meeting the exchange deadlines under the conditions in Revenue Procedure 2005-27, section 17; AND
(2) The relinquished property was transferred (or the parked property was acquired by the EAT in a reverse exchange under Revenue Procedure 2000-37) on or before February 12 or 13 th, 2007;
(3) The 45 and 180 day deadline falls between February 12th or 13 th and April 24, 2007.
The extension is for THE LONGER OF 120 days from the last day of the 45 or 180 day deadline, or until the date specified in (3) above (and 120 days appears to be longer since the date in (3) is less than 120 days from the declared disaster).
Please see the notice below for further details.
http://www.irs.gov/newsroom/article/0,,id=168395,00.html
45 and 180 Day Extensions in Volusia County, Florida for Christmas Day Storm
On February 20, 2007 the IRS issued the announcement below for Volusia County, Florida. All of the following criteria must be met to get the extension:
(1) The taxpayer is located in Volusia County, regardless of where the relinquished property or replacement property is located,
or the taxpayer otherwise has difficulty meeting the exchange deadlines under the conditions in Revenue Procedure 2005-27, section 17; AND
(2) The relinquished property was transferred (or the parked property was acquired by the EAT in a reverse exchange under Revenue Procedure 2000-37) on or before 12/25, 2006;
(3) The 45 and 180 day deadline falls between 12/25/2006 and April 10, 2006.
The extension is for THE LONGER OF 120 days from the last day of the 45 or 180 day deadline, or until the date specified in (3)
above (and 120 days appears to be longer since the date in (3) is less than 120 days from the declared disaster).
Disposition of Property is Not Prohibited REIT Transaction
PLR 200701008
FACTS
In PLR 200701008, Trust is a corporation that elected to be taxed as a REIT. The Trust has a percentage interest in an operating partnership, treated as an UPREIT. Under Section 1031 of the Code, the operating partnership exchanged an improved property in State Y, "Property A," for an improved property in State Z, "Property B." The operating partnership received no consideration other than Property B in the exchange.
LAW AND ANALYSIS
Section 857(b)(6)(A) of the Code imposes a 100-percent tax on a REIT'’s net income from prohibited transactions. Section 857(b)(6)(B)(iii) defines the term quot;prohibited transaction" as the sale or other disposition of property described in 1221(a)(1) which is not foreclosure property. Section 1221(a)(1) describes "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business," sometimes referred to as "dealer property."
In this case, Trust's proposed transaction appears to be consistent with the Congressional intent of allowing REITs to modify their portfolios without incurring a prohibitive tax. Moreover, Trust has represented that the exchange satisfies the requirements of Section 1031 of the Code. As a result, Property A should not be treated as having been "sold" for purposes of 857(b)(6)(C)(iii).
CONCLUSION
The Service has ruled that a like-kind exchange by an operating partnership in which a REIT is a partner will not be taken into account as a sale of property and, therefore, is not a prohibited transaction for purposes of the 100-percent penalty under section 857(b)(6).
Properties Transferred to Partnership Upon Termination of Private Testamentary Trust Still Qualify for Deferral
In PLR 200651030, the IRS determined that properties that are subject to a contract for disposition and that are transferred from a trust to a limited liability company ("LLC") taxed as partnership for federal tax purposes before said disposition still qualify for like-kind exchange treatment. Upon decedent's death, a trust was established to administer his assets. Under the terms of the decedent’s will, the trust will terminate 20 years after the death of the decedent’s last surviving child. Under a plan for terminating the trust, a percentage of the trust’s net asset value will be contributed to a single-member LLC, with the trust acting as the sole member of the LLC and the LLC will be a disregarded entity for Federal tax purposes. Once the trust is terminated, all of the shares in the LLC will be distributed among certain of the remaining beneficiaries and the LLC will then become a multi-member LLC and therefore a partnership for Federal tax purposes.
The multi-member LLC intends to continue the trust’s real estate investment operations in a manner consistent with past practices, and much of the current managerial and operational structure will remain in place after the trust terminates. In order to exercise their fiduciary duty to increase rental income, the trustees determined that it would be in the best interests of the trust to exchange a few of the trust’s real estate investment properties each year. The trust anticipates that, following the trust’s termination, the LLC will continue to periodically conduct Section 1031 exchanges. The trust has two pending dispositions of relinquished properties that it expects it will be unable to close before its termination and, accordingly, desires to transfer its interests in these relinquished properties to the LLC prior to the trust’s termination, with the resulting multi-member LLC disposing of the relinquished properties and exchanging into replacement property after the termination. In the instant case, each of the relinquished properties will be subject to a contract of disposition at the time the trust terminates and the properties are automatically transferred to the LLC (with the subsequent automatic transformation of the disregarded entity from an LLC to an entity which is taxed as a partnership). The primary concern in PLR 200651030 is that the LLC will not meet the “holding” requirement with respect to the relinquished properties because the properties are subject to contracts for their disposition at the time they are received by the LLC and the LLC is converted to a partnership for Federal tax purposes.
The IRS ruled that the transfer of the relinquished properties to the LLC subject to the contracts for their disposition will not violate the holding requirement of Section 1031(a) with respect to the exchanges. In so holding, the IRS cited the fact that after the trust’s terminating distribution of membership interests in the LLC to multiple beneficiaries, the resulting entity will be functionally like the trust and will be treated as a partnership among the beneficiaries merely for Federal income tax purposes. The IRS also cited the fact that the members of the LLC will be substantially identical to the trust beneficiaries, that the LLC will continue the trust’s real estate investment operations in a manner consistent with past practices, and that primarily the same managerial and operational structure will remain in place after the trust terminates. These facts distinguish this PLR from Rev. Rul. 77-337. Also note that this PLR’s guidance is virtually identical to the guidance of PLR 200521002.
In PLR 200631012, the IRS has once again ruled that stock in a New York state cooperative is like-kind to a direct fee interest in improved and unimproved real property under section 1031. An unrelated S-corporation and a partnership owned multiple cooperative apartments held for rent via their ownership of cooperative stock. They proposed to exchange their stock using a qualified intermediary for direct fee interests in real improved and unimproved property, which they would hold as tenants-in-common. As in PLR 200137032, this ruling turned on the fact that stock in an NY cooperative is considered an interest in real property for most (but not all) state law purposes. There are several state statutes that treat stock in a NY cooperative as real property, but several cases that suggest such an interest is not real property.
The rationale and outcome in PLR 200631012 is very similar to PLR 200137032. In PLR 200137032 the taxpayer proposed to exchange an interest in an apartment held through stock ownership in NY cooperative for a fee interest in the same unit resulting from a condominium conversion. In PLR 200137032 the IRS ruled the NY cooperative interest was like-kind to the fee interest in the condo because an interest in a NY cooperative is considered real property under state law. The only significant difference between the two rulings was the fact the taxpayers in PLR 200631012 intended to hold their replacement property as tenants-in-common after the exchange. However, the IRS did not address the TIC issues in its ruling.
As a practical matter both rulings have somewhat limited application because they only deal with stock in a cooperative under New York state law. However, it would seem to indicate there is a willingness of the Service to recognize cooperative apartments as like kind to a fee interests in real estate whenever a colorable argument can be made that coops are treated as real estate under applicable state law.
Below is the Private Letter Ruling for Review.
PLR 200616005 - IRC Section 1031 - Exchange of Property Held for Productive Use or Investment
IRC Section 1031
Document Date: December 22, 2005
Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200616005
Release Date: 4/21/2006
Third Party Communication: None
Date of Communication: Not Applicable
Index Number: 1031.06-00
Person To Contact:
Telephone Number:
Refer Reply To: CC:ITA:B04 PLR-131347-05
Date: December 22, 2005
Trust =
S Corp =
Buyer =
A =
Dear
This responds to your request for a private letter ruling dated May 6, 2005, regarding § 1031 of the Internal Revenue Code.
STATEMENT OF FACTS:
Trust and S Corp are related persons within the meaning of § 1031(f)(3). Trust owns Building I and S Corp owns Building 2. Trust has transferred Building 1, including land and improvements, the tangible personal property, leases and other assets associated with Building 1, to Buyer. Trust wants to defer the recognition of the gain on the transfer of Building 1. Therefore, Trust will acquire Building 2, including land and improvements, as one of its identified replacement properties in exchange for Building 1 in a transaction intended to qualify for nonrecognition treatment under § 1031. S Corp will also engage in an exchange of Building 2 for other like-kind property in a transaction intended to qualify for nonrecognition treatment under § 1031.
To facilitate their exchanges, Trust and S Corp will enter into exchange agreements with a
qualified intermediary ("QI") described in § 1.1031(k)-1 (g)(4). Pursuant to Trust's exchange agreement, QI will, for purposes of § 1031 and the regulations thereunder, be treated as the seller of Building 1 to Buyer. Moreover, QI will be treated as acquiring Building 2 from S Corp and transferring it to Trust in exchange for Building 1. Similarly, pursuant to S Corp's exchange agreement, QI will be treated as acquiring property to replace Building 2 ("S Corp's Replacement Property") and transferring it to S Corp in exchange for Building 2. S Corp's Replacement Property is, prior to its transfer to QI, owned by a party that is not related to either Trust or S Corp.
Once all the transactions are completed, Trust will own Building 2, S Corp will own S Corp's Replacement Property, and Buyer will own Building 1. Trust represents that it will not dispose of Building 2 within two (2) years of its receipt as replacement property. S Corp represents that it will not dispose of S Corp's Replacement Property received in exchange for Building 2 within two (2) years of its receipt as replacement property. For purposes of these representations, both taxpayers assert that the principles of § 1031(f)(2) apply. Trust and S Corp each seek a ruling regarding the application of § 1031(f) to their respective exchanges.
After Trust acquires Building 2, QI will still hold approximately $A of the proceeds of the sale of Building 1 to Buyer. Trust has designated and intends to acquire additional like-kind properties from unrelated third parties in the transaction that will qualify under § 1031. In the event that Trust is unable to acquire such like-kind property, these funds will be distributed by QI to Trust. Trust also requests a ruling that if it receives such cash proceeds, they will cause Trust to recognize gain on the transfer of Building I but not in excess of the amount of cash distributed outright to Trust from QI.
STATEMENT OF LAW:
Section 1031(a)(1) generally provides that 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.
Section 1031(b) provides that if an exchange would be within § 1031(a)(1) but for the fact that cash or other non-like kind property is received in the exchange, gain is recognized but in an amount not in excess of the cash or other non-like kind property received in the exchange.
Section 1031(f) sets forth special rules for exchanges between related persons. Section 1031(f)(1) provides that if (A) a taxpayer exchanges property with a related person; (B) there is nonrecognition of gain or loss to the taxpayer in accordance with § 1031 with respect to the exchange; and (C) within 2 years of the date of the last transfer that was part of the exchange either the taxpayer or the related person disposes of the property received in the exchange, then there is no nonrecognition of gain or loss in the exchange. In other words, the gain or loss that was deferred under § 1031 must be recognized. Any gain or loss the taxpayer is required to recognize by reason of § 1031(f)(1) is taken into account as of the date of the disposition of the property received in the exchange (the second disposition).
Section 1031(f)(2) provides that certain dispositions will not be taken into account for purposes of § 1031(f)(1)(C). These include any disposition (A) after the earlier of the death of the taxpayer or the death of the related person, or (B) in a compulsory or involuntary conversion (within the meaning of § 1033) if the exchange occurred before the threat or imminence of such conversion. The excepted dispositions also include a disposition with respect to which it is established to the satisfaction of the Secretary that neither the exchange nor the second disposition had as one of its principal purposes the avoidance of federal income tax.
Section 1031(f)(4) provides that § 1031 shall not apply to any exchange that is part of a transaction, or series of transactions, structured to avoid the purposes of § 1031(f). Thus, if a transaction is set up to avoid the restrictions on exchanges between related persons, § 1031(f)(4) operates to prevent nonrecognition of the gain or loss on the exchange.
In Rev. Rul. 2002-83, 2002-2 C.B. 927, a taxpayer transfers relinquished property to a qualified intermediary in exchange for replacement property formerly owned by a related party. As part of the transaction, the related party receives cash for the replacement property. The ruling holds that because the taxpayer's use of the qualified intermediary was to avoid the application of § 1031(f)(1), the taxpayer, under § 1031(f)(4), was not entitled to nonrecognition treatment under § 1031.
ANALYSIS:
In the present case, § 1031(f)(1) is not applicable to currently tax Trust's disposition of Building I because Trust is exchanging property with a qualified intermediary, who is not a related party. However, § 1031(f)(4) provides that § 1031 shall not apply to any exchange that is part of a transaction, or series of transactions, structured to avoid the purposes of § 1031(f). Thus, § 1031 will not apply if Trust's exchange is structured to avoid the "purposes" of§ 1031(f). Both the Ways and Means Committee Report and the Senate Finance Committee Print describe the policy concern that led to enactment of this provision:
Because a like-kind exchange results in the substitution of the basis of the exchanged property for the property received, related parties have engaged in like-kind exchanges of high basis property for low basis property in anticipation of the sale of the low basis property in order to reduce or avoid the recognition of gain on the subsequent sale. Basis shifting also can be used to accelerate a loss on retained property. The committee believes that if a related party exchange is followed shortly thereafter by a disposition of the property, the related parties have, in effect, 'cashed out' of the investment, and the original exchange should not be accorded nonrecognition treatment.
H.R. Rep. No. 247, 101st Cong. 1st Sess. 1340 (1989); S. Print No. 56, at 151. The Committee Reports also included the following example of when § 1031(f)(4) applies: If a taxpayer, pursuant to a pre-arranged plan, transfers property to an unrelated party who then exchanges the property with a party related to the taxpayer within 2 years of the previous transfer in a transaction otherwise qualifying under section 1031, the related party will not be entitled to nonrecognition treatment under section 1031.
H.R. Rep. No. 247, at 1341; S. Print No. 56, at 152.
In Rev. Rul. 2002-83, the Service discussed and applied § 1031(f)(4) to the following facts:
Individual A owns real property (Property 1) with a fair market value of $150x and an adjusted basis of $50x. Individual B owns real property (Property 2) with a fair market value of $150x and an adjusted basis of $150x. Both Property I and Property 2 are held for investment within the meaning of § 1031(a). A and B are related persons within the meaning of § 267(b). C, an individual unrelated to A and B, wishes to acquire Property I from A. A enters into an agreement for the transfers of Property I and Property 2 with B, C, and a qualified intermediary (QI). QI is unrelated to A and B. Pursuant to their agreement, on January 6, 2003, A transfers Property 1 to QI and QI transfers Property 1 to C for $150x. On January 13, 2003, QI acquires Property 2 from B, pays B the $150x sale proceeds from Ql's sale of Property 1, and transfers Property 2 to A.
In analyzing these facts under § 1031(f)(4), the Service quoted the legislative history cited above for the proposition that § 1031(f)(4)is intended to apply to situations in which related parties effectuate like- kind exchanges of high basis property for low basis property in anticipation of the sale of the low basis property. In such case, the original exchange should not be accorded nonrecognition treatment. Under the facts in the revenue ruling, A and B were attempting to sell Property 1 to an unrelated party while using the substituted basis rule of § 1031(d) to reduce the gain on such sale from $100x to $0. This allowed the parties to "cash out" of their investment in Property 1 without the recognition of gain. The Service concluded that the transaction was structured to avoid the purposes of § 1031(f)(1) and, therefore, A had gain of $100x on its transfer of Property 1.
The legislative history underlying § 1031(f)(2)(C) provides that any second disposition by exchanging parties will not be taken into account for purposes of § 1031(f)(1 ) if it can be established to the satisfaction of the Secretary that neither the initial exchange nor the second disposition had as one of its principal purposes the avoidance of federal income tax. In that regard, the Conference Committee Report, which adopted the Senate amendment, noted that the Senate Finance Committee Report provided that "the non-tax avoidance exception generally will apply to ... dispositions in nonrecognition transactions .... "H.R. Rep. No. 386, 101st Cong., 1st Sess. 613 (1989).
In the present case, the only disposition contemplated by the parties after Trust receives Building 2 as replacement property is the acquisition by S Corp of S Corp's Replacement Property in another exchange under § 1031, a nonrecognition transaction. Thus, because S Corp is structuring its disposition of Building 2 as an exchange for like-kind replacement property so that the gain on the transfer of Building 2 is eligible for nonrecognition treatment under § 1031(a), § 1031(f)(4)and Rev. Rul. 2002-83 are not applicable. Trust's exchange and S Corp's exchange are structured as like-kind exchanges qualifying under § 1031. There is no "cashing out" of either party's investment in real estate. Upon completion of the series of transactions, both related parties will own property that is like-kind to the property they exchanged. Moreover, neither party will have ever been in receipt of cash or other non-like kind property (other than boot received in the exchange) in return for the relinquished property. Finally, under § 1031(b), any receipt of cash by Trust from QI will result in gain to Trust not in excess of the cash received.
Based on the facts and representations submitted by the taxpayer, we rule as follows:
1) Section 1031(f) will not apply to trigger recognition of any gain realized in Trust's exchange of Building I for Building 2 or S Corp's exchange of Building 2 for S Corp's Replacement Property, provided that Trust does not dispose of Building 2 within two (2) years of its receipt as replacement property and S Corp does not dispose of S Corp's Replacement Property received in exchange for Building 2 within two (2) years of its receipt as replacement property.
2) If Trust does not acquire replacement property in addition to Building 2 and receives a distribution of $A from QI, receipt of such cash will cause Trust to recognize gain on the Building I transaction, but not in excess of the $A distributed to it from QI.
DISCLAIMERS
These rulings relate only to the application of § 1031(0 to the exchanges described above. No opinion is expressed regarding whether the other requirements of § 1031 have been satisfied. Further, even if the other requirements of § 1031 are met, nonrecognition treatment does not apply to the extent of any boot in the form of cash or other nonlike-kind real, personal or intangible property received by Trust and S Corp in the exchanges at issue. See § 1031(b); and Rev. Rul. 67-255, 1967-2 C.B. 270. Finally, except as specifically provided above, no opinion is expressed as to the federal tax treatment of the transaction under any other provisions of the Internal Revenue Code and the Income Tax Regulations that may be applicable or under any other general principles of federal income taxation.
The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination. This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.
A copy of this letter must be attached to any income tax return to which it is relevant. We enclose a copy of the letter for this purpose. Also enclosed is a copy of the letter showing the deletions proposed to be made when it is disclosed under § 6110. In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.
Sincerely,
Michael J. Montemurro
Branch Chief (Income Tax & Accounting)
KATRINA EMERGENCY TAX RELIEF ACT OF 2005:
KATRINA AND RITA UP-DATE
IR-2005-109(09/21/05)
Notice 2005-73 (09/21/05)
IR-2005-110 (09/26/05)
IR-2005-112 (09/28/05)
The Katrina Emergency Tax Relief Act of 2005 (H.R. 3768) ("KETRA") was signed into law on September 23, 2005. Among the provisions of KETRA is one extending the due date for affected taxpayers in the Katrina disaster area to file tax returns, pay taxes, and perform time-sensitive acts until February 28, 2006. "Time sensitive acts" include (1) the 45 day identification deadline and the 180 day exchange deadline for delayed exchanges and (2) the deadlines set forth in Rev. Proc. 2000-37 for safe harbor reverse exchanges (i.e., the initial 5 day deadline to enter into a QEAA, the 45 day identification deadline, the 180 day exchange deadline, and the 180 day combination time deadline associated with a combined reverse/delayed exchange).
The new extended deadline contained in KETRA supercedes the deadlines previously announced by the IRS for the Katrina disaster area. In IR-2005-112, the IRS confirms the February 28, 2006, extension date and also the boundaries of the Katrina disaster area. Unfortunately, portions of the Katrina disaster area are treated differently. Some areas receive automatic tax relief benefits under KETRA while others receive the tax relief benefits if requested by the taxpayer. IR-2005-112 identifies these areas on a county by county or parish by parish basis for each state within the Katrina disaster area.
Previously, in IR-2005-109, the IRS had adjusted the starting date for Florida victims of Katrina to August 24, 2005. IR-2005-112 confirms both the special Florida start date (August 24, 2005) and the August 29, 2005, start date for the balance of the Katrina disaster area.
Notice 2005-73 contains extensive information detailing relief granted by the IRS to Katrina victims.
In connection with Hurricane Rita, the IRS issued IR-2005-110 on September 26, 2005. IR-2005-110 has been updated twice to expand its coverage area to now include nine (9) Texas counties and twelve (12) Louisiana parishes. The Rita start date is September 23, 2005. As all of the Louisiana parishes contained within the Rita disaster area are also in the Katrina disaster area, the Rita extension date is also February 28, 2006.
The IRS has established a special toll-free telephone number to answer questions related to Hurricane Katrina. The number is 1-866-562-5227 and operates Monday through Friday from 7:00 a.m. to 10:00 p.m. local time.
Specific information regarding these items can be obtained from the IRS’ webpage at www.irs.gov.
— By Corrie M. Anders for REALTOR® Magazine Online
1031 Changes in Georgia
Prior to April 12, 2005, any Exchanger selling property in Georgia was required to either purchase replacement property in Georgia or pay the 6% Georgia state income tax. This was changed on 4/12/2005 by the Georgia Governor’s signature on House Bill 488. This bill rescinded the requirement to pay the state tax if the replacement property was not Georgia, and this change is retroactive to January 1, 2004. It is always wise to inquire in advance of your exchange as to the state requirements as to taxing, deferring, or withholding. At this time, for example, Maine, New York, Vermont, Maryland, Rhode Island, New Jersey and Mississippi require the settlement agent to withhold taxes at settlement, unless you obtain a waiver in advance.
Utah: Tenant-in-Common Deals Treated as Real Estate
(April 22, 2005) -- The Utah state legislature has approved a bill supported by the Utah Association of REALTORS®, which specifies that tenant-in-common transactions are real estate deals, even though they may be offered as securities.
Real estate practitioners sought the law because regulators at both the state and federal level concluded that tenant-in-common, or TIC, transactions involve the sale of a security—and therefore require real estate practitioners to have both a real estate and securities license, says Christopher Kyler, UAR's executive officer.
The new statute allows TICs to be sold as real estate under state law, although they may be treated as securities under federal law. Practitioners can receive commissions and referral fees for TICs.
State Sen. Al Mansell, who also is the 2005 president of the NATIONAL ASSOCIATION OF REALTORS®, introduced the bill.
Purchase of properties sold as TICs is a trend nationwide. The property is sold to a number of often-unrelated buyers—usually real estate investors involved in a tax-deferred exchange—who receive an undivided, fractionalized interest in the property.
Kyler says the new law “is the first of its kind that we’re aware of,” and may serve as a national model.
The legislation was one of three major real estate bills favored by the Utah Association of REALTORS®. Gov. Jon Huntsman has signed all three into law; they become effective July 1.
Mansell also introduced a measure that spells out a minimum standard of service for practitioners in an exclusive agency relationship. The law requires brokers to present offers, prepare counteroffers, and answer any questions throughout the process—whether they’re on the buyer or seller side of the transaction.
Another law limits the ability of revenue-seeking cities to impose a business license fee on brokers and salespeople. Under the new statute, only a broker with a “bricks-and-mortar” site within the city is subject to a business fee. Neither individual licensees in the broker’s office nor outsiders involved in a transaction within the city limits can be tapped for a business license payment.
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