Tag: Section 1031

Estate of Bartell v. Comm’r, 147 T.C. 140 (2016): Reverse Like-Kind Exchanges Under Section 1031

Estate of Bartell v. Commissioner, 147 T. C. 140 (2016)

In Estate of Bartell v. Commissioner, the U. S. Tax Court ruled that Bartell Drug Co. ‘s reverse like-kind exchange of properties qualified for tax deferral under Section 1031. The company had used a third-party facilitator to hold title to the replacement property, enabling the exchange to proceed without immediate recognition of gain. This decision reinforces the flexibility afforded to taxpayers in structuring exchanges, affirming the use of facilitators to park property in reverse exchanges.

Parties

Estate of George H. Bartell, Jr. , deceased, George David Bartell and Jean Louise Bartell Barber, co-personal representatives, and Estate of Elizabeth Bartell, deceased, George David Bartell and Jean Louise Bartell Barber, co-personal representatives, et al. (Petitioners) v. Commissioner of Internal Revenue (Respondent)

Facts

In 1999, Bartell Drug Co. (Bartell Drug), an S corporation owned by the petitioners, entered into an agreement to purchase the Lynnwood property from a third party, Mildred Horton. In anticipation of structuring a like-kind exchange under Section 1031 of the Internal Revenue Code (IRC), Bartell Drug assigned its rights under the purchase agreement to EPC Two, LLC (EPC Two), a single-purpose entity formed to facilitate the exchange. EPC Two purchased the Lynnwood property on August 1, 2000, with financing guaranteed by Bartell Drug. Bartell Drug managed the construction of a drugstore on the Lynnwood property using the loan proceeds and leased the property from EPC Two upon substantial completion of construction in June 2001. In late 2001, Bartell Drug contracted to sell its existing Everett property and assigned its rights in both the sale agreement and the agreement with EPC Two to Section 1031 Services, Inc. (SS), another qualified intermediary. SS sold the Everett property, applied the proceeds to acquire the Lynnwood property, and transferred title to Bartell Drug on December 31, 2001.

Procedural History

The IRS examined Bartell Drug’s 2001 corporate return and proposed adjustments disallowing tax deferral treatment under Section 1031. Petitioners contested this determination by filing petitions with the U. S. Tax Court. The Tax Court consolidated the cases for trial and issued its opinion on August 10, 2016, holding that the transaction qualified as a like-kind exchange under Section 1031.

Issue(s)

Whether Bartell Drug’s disposition of the Everett property and acquisition of the Lynnwood property in 2001 qualified for nonrecognition treatment under Section 1031 of the IRC as a like-kind exchange?

Rule(s) of Law

Section 1031 of the IRC allows taxpayers to defer recognition of gain or loss 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. The essence of an exchange is the reciprocal transfer of property between owners, and a taxpayer cannot engage in an exchange with itself. Caselaw has afforded taxpayers significant latitude in structuring such exchanges, including the use of third-party facilitators to hold title to the replacement property.

Holding

The Tax Court held that Bartell Drug’s disposition of the Everett property and acquisition of the Lynnwood property in 2001 qualified for nonrecognition treatment under Section 1031 as a like-kind exchange, with EPC Two treated as the owner of the Lynnwood property during the period it held title.

Reasoning

The court’s reasoning centered on the application of existing caselaw to reverse exchanges. It relied on cases such as Alderson v. Commissioner and Biggs v. Commissioner, which established that a third-party exchange facilitator need not assume the benefits and burdens of ownership of the replacement property to be treated as its owner for Section 1031 purposes. The court rejected the IRS’s contention that EPC Two must have held the benefits and burdens of ownership to be considered the owner, emphasizing that the facilitator’s role was to hold bare legal title to facilitate the exchange. The court also noted that Bartell Drug’s temporary possession of the Lynnwood property under a lease from EPC Two did not preclude the transaction from qualifying as a like-kind exchange. The court recognized the flexibility historically afforded to taxpayers in structuring Section 1031 exchanges and concluded that the transaction at issue fell within this scope.

Disposition

The Tax Court entered decisions for the petitioners, affirming that the transaction qualified for nonrecognition treatment under Section 1031.

Significance/Impact

The Estate of Bartell decision is significant for its affirmation of the use of third-party facilitators in reverse like-kind exchanges, providing clarity and guidance on the treatment of such transactions under Section 1031. It underscores the lenient approach courts have historically taken toward taxpayers’ attempts to come within the terms of Section 1031, particularly in the context of reverse exchanges. This ruling may encourage taxpayers to structure similar transactions, using facilitators to hold title to replacement property, thereby facilitating tax-deferred exchanges. However, it also highlights the importance of distinguishing between transactions structured with facilitators from the outset and those retrofitted to appear as exchanges after outright purchases, which may not qualify for Section 1031 treatment.

August 10, 2016
Smalley v. Commissioner of Internal Revenue, 116 T.C. 450 (2001): Deferred Exchanges and Bona Fide Intent under Section 1031

Smalley v. Commissioner of Internal Revenue, 116 T. C. 450 (U. S. Tax Ct. 2001)

The U. S. Tax Court ruled that D. G. Smalley’s deferred exchange of timber rights for land did not trigger immediate income recognition in 1994. The court found Smalley had a bona fide intent to complete a like-kind exchange under Section 1031, despite uncertainties about the like-kind nature of the properties exchanged. This decision clarifies the application of the bona fide intent test for deferred exchanges, allowing taxpayers to defer gain recognition if they reasonably believe the exchange will qualify, even if the ultimate outcome is uncertain.

Parties

D. G. Smalley and Nell R. Smalley (Petitioners) v. Commissioner of Internal Revenue (Respondent)

Facts

In 1994, D. G. Smalley owned 275 acres of timberland in Laurens County, Georgia. Seeking to continue his timber investment, he entered into an agreement with Rayonier, Inc. , on November 29, 1994. Under this agreement, Smalley granted Rayonier a 2-year exclusive right to cut and remove mature timber on 95 acres of his land in exchange for $517,076. The funds from this transaction were placed into a qualified escrow account, as defined in sec. 1. 1031(k)-1(g)(3), Income Tax Regs. Smalley intended to use these funds to acquire replacement properties within 180 days, which he identified and acquired in 1995, consisting of fee simple interests in three parcels of land within 30 miles of the original 95 acres, all containing standing timber.

On their 1994 tax return, the Smalleys treated the transaction as a like-kind exchange under Section 1031, deferring recognition of the $496,076 gain until 1995. The Commissioner of Internal Revenue determined a deficiency, arguing that the gain should be recognized in 1994 because the transaction did not meet Section 1031 requirements.

Procedural History

The Commissioner determined a $139,180 deficiency in the Smalleys’ 1994 federal income tax. The Smalleys filed a petition with the U. S. Tax Court, contesting the deficiency. The Tax Court reviewed the case de novo, considering the arguments and evidence presented by both parties. The court ultimately ruled in favor of the Smalleys, holding that they were not required to recognize income from the deferred exchange in 1994.

Issue(s)

Whether, under Section 1031 and the applicable regulations, the Smalleys were required to recognize income in 1994 from a deferred exchange of timber rights for land, given that the replacement properties were identified and acquired in 1995?

Rule(s) of Law

Section 1031 of the Internal Revenue Code allows for nonrecognition of gain or loss on the exchange of property held for productive use in a trade or business or for investment, if the property is exchanged solely for like-kind property. The applicable regulations, specifically sec. 1. 1031(k)-1(j)(2), Income Tax Regs. , provide that if the taxpayer has a bona fide intent to enter into a deferred exchange at the beginning of the exchange period, the taxpayer is not in actual or constructive receipt of property for purposes of Section 453 (installment sale rules) if the funds are held in a qualified escrow account. The bona fide intent requirement is met if it is reasonable to believe, based on all the facts and circumstances at the beginning of the exchange period, that like-kind replacement property will be acquired before the end of the exchange period.

Holding

The Tax Court held that the Smalleys were not required to recognize income from the deferred exchange in 1994. The court found that Smalley had a bona fide intent to enter into a like-kind exchange at the beginning of the exchange period, despite the uncertainty about whether the properties exchanged were of like kind under Section 1031. This intent was evidenced by the use of a qualified escrow account, the timely identification and acquisition of replacement properties, and Smalley’s reliance on expert advice.

Reasoning

The court’s reasoning focused on the application of the bona fide intent test under sec. 1. 1031(k)-1(j)(2)(iv), Income Tax Regs. The court noted that the regulation requires only a reasonable belief that like-kind property will be acquired within the exchange period, not a guarantee that the properties will ultimately be deemed like kind. The court found that Smalley’s belief was reasonable based on several factors:

1. The transaction was conditioned on qualifying as a tax-free exchange under Section 1031.

2. A qualified escrow account was used, meeting the requirements of sec. 1. 1031(k)-1(g)(3), Income Tax Regs.

3. Smalley identified and acquired the replacement properties within the required time frames under Section 1031(a)(3).

4. Smalley testified credibly about his intent to have a like-kind exchange.

5. Smalley relied on advice from a well-known timber taxation expert and his long-time accountant.

The court also considered the Commissioner’s argument that the properties were not of like kind, but found it unnecessary to resolve this issue definitively. Instead, the court focused on Smalley’s reasonable belief that the transaction would qualify as a like-kind exchange, noting that the Commissioner had not assessed any negligence or accuracy-related penalties, suggesting that the Smalleys had acted in good faith.

The court distinguished this case from previous cases like Oregon Lumber Co. v. Commissioner, where the focus was on the like-kind nature of the properties exchanged. Here, the court emphasized the taxpayer’s intent and the use of the safe harbor provisions in the regulations to avoid immediate gain recognition under Section 453.

Disposition

The Tax Court entered a decision under Rule 155, holding that the Smalleys were not required to recognize income from the deferred exchange in 1994.

Significance/Impact

This decision is significant for clarifying the application of the bona fide intent test under Section 1031 and its regulations. It provides taxpayers with greater certainty in structuring deferred exchanges, allowing them to defer gain recognition if they have a reasonable belief that the exchange will qualify, even if there are uncertainties about the like-kind nature of the properties involved. The case also highlights the importance of using qualified intermediaries and escrow accounts to meet the safe harbor provisions of the regulations, which can protect taxpayers from immediate gain recognition under the installment sale rules of Section 453. The decision may encourage more taxpayers to engage in deferred exchanges, knowing that their good faith efforts to comply with Section 1031 will be respected by the courts.

June 14, 2001
DeCleene v. Commissioner, T.C. Memo. 2001-25: Determining Ownership in Like-Kind Exchanges

DeCleene v. Commissioner, T. C. Memo. 2001-25

In a like-kind exchange, the party receiving property must have the benefits and burdens of ownership to qualify for nonrecognition of gain under Section 1031(a).

Summary

Donald DeCleene attempted a reverse like-kind exchange by selling his McDonald Street property and acquiring the improved Lawrence Drive property. The Tax Court held that the transactions resulted in a taxable sale of the McDonald Street property because WLC, the intermediary, did not acquire the benefits and burdens of ownership of the Lawrence Drive property. Consequently, DeCleene could not defer the gain under Section 1031(a). However, the court ruled in favor of DeCleene on the penalty issue, finding he reasonably relied on professional advice.

Facts

Donald DeCleene owned a business on McDonald Street and purchased unimproved land on Lawrence Drive in 1992. In 1993, he arranged with Western Lime & Cement Co. (WLC) to build a new facility on Lawrence Drive. DeCleene quitclaimed the Lawrence Drive property to WLC, who then built the facility and conveyed it back to DeCleene in exchange for the McDonald Street property. DeCleene reported the transaction as a like-kind exchange on his 1993 tax return, treating the sale of Lawrence Drive as a taxable event and the exchange of McDonald Street as non-taxable.

Procedural History

The IRS audited DeCleene’s 1993 tax return and issued a notice of deficiency, determining that the McDonald Street property was sold rather than exchanged, resulting in a taxable gain. DeCleene petitioned the U. S. Tax Court, which upheld the IRS’s determination regarding the sale but found in favor of DeCleene on the penalty issue.

Issue(s)

1. Whether the transactions between DeCleene and WLC resulted in a taxable sale of the McDonald Street property or a like-kind exchange under Section 1031(a).

2. Whether DeCleene is liable for the accuracy-related penalty under Section 6662(a).

Holding

1. Yes, because WLC did not acquire the benefits and burdens of ownership of the Lawrence Drive property during the period it held title, the transaction resulted in a taxable sale of the McDonald Street property.

2. No, because DeCleene reasonably relied on the advice of competent professionals in structuring the transaction and preparing his tax return.

Court’s Reasoning

The court applied the principle that for a like-kind exchange to qualify for nonrecognition of gain under Section 1031(a), the other party must have the benefits and burdens of ownership of the property received. WLC did not have any economic risk or benefit from holding the Lawrence Drive property; it was merely a parking transaction. The court cited Bloomington Coca-Cola Bottling Co. v. Commissioner to support its analysis, emphasizing that WLC never acquired beneficial ownership of the Lawrence Drive property. The court disregarded the conveyance and reconveyance of the Lawrence Drive property as having no tax significance. On the penalty issue, the court found that DeCleene met the three-prong test for reasonable reliance on professional advice, negating the penalty under Section 6662(a).

Practical Implications

This case underscores the importance of ensuring that the other party in a like-kind exchange genuinely acquires the benefits and burdens of ownership of the exchanged property. For practitioners, this decision highlights the need for careful structuring of transactions, particularly reverse exchanges, to avoid unintended tax consequences. Businesses considering similar transactions should ensure that any intermediary has true ownership risks and benefits. The ruling also reinforces that taxpayers can avoid penalties by relying on competent professional advice, even if the advice leads to an incorrect tax position. Subsequent cases, such as Rev. Proc. 2000-37, have provided safe harbors for reverse exchanges, which were not applicable here but may guide future transactions.

November 17, 2000
Chase v. Commissioner, 92 T.C. 874 (1989): Application of Substance Over Form Doctrine in Like-Kind Exchanges

Chase v. Commissioner, 92 T. C. 874 (1989)

The substance over form doctrine applies to deny nonrecognition treatment under Section 1031 when the form of the transaction does not reflect its economic realities.

Summary

In Chase v. Commissioner, the U. S. Tax Court applied the substance over form doctrine to determine that the sale of the John Muir Apartments was by the partnership, John Muir Investors (JMI), rather than by the individual taxpayers, Delwin and Gail Chase. The Chases attempted to structure the sale to qualify for nonrecognition under Section 1031, but the court found that the economic realities did not support their claimed ownership interest. The court also ruled that the Chases were not entitled to installment sale treatment under Section 453, as the issue was raised untimely, and only Gail Chase qualified for a short-term capital loss under Section 731(a) upon liquidation of her partnership interest.

Facts

Delwin Chase formed John Muir Investors (JMI), a California limited partnership, to purchase and operate the John Muir Apartments. Triton Financial Corp. , in which Delwin held a substantial interest, was later added as a general partner. In 1980, JMI accepted an offer to sell the Apartments. To avoid tax, the Chases attempted to structure the transaction as a like-kind exchange under Section 1031 by having JMI distribute an undivided interest in the Apartments to them, which they then exchanged for other properties through a trust. However, the court found that the Chases did not act as owners of the Apartments; they did not pay operating expenses or receive rental income, and the sale proceeds were distributed according to their partnership interests, not as individual owners.

Procedural History

The Commissioner of Internal Revenue determined a deficiency in the Chases’ 1980 federal income tax. The Chases petitioned the U. S. Tax Court for a redetermination. The court heard the case and issued its opinion on April 24, 1989.

Issue(s)

1. Whether the Chases satisfied the requirements of Section 1031 for nonrecognition of gain on the disposition of the John Muir Apartments.
2. Whether the Chases are entitled to a short-term capital loss under Section 731(a)(2) upon the liquidation of their limited partnership interest in JMI.

Holding

1. No, because the substance over form doctrine applies, and the transaction was in substance a sale by JMI, not an exchange by the Chases.
2. No for Delwin Chase and Yes for Gail Chase, because Delwin did not liquidate his entire interest in JMI, whereas Gail liquidated her entire interest.

Court’s Reasoning

The court applied the substance over form doctrine, finding that the Chases’ purported ownership of an interest in the Apartments was a fiction. The court noted that the Chases did not act as owners: they did not pay operating costs, receive rental income, or negotiate the sale as individual owners. The sale proceeds were distributed according to their partnership interests, not as individual owners. The court concluded that JMI, not the Chases, disposed of the Apartments, and thus, the requirements of Section 1031 were not met because JMI did not receive like-kind property in exchange. The court also rejected the Chases’ argument that JMI acted as their agent in the sale, finding it unsupported by the record. Regarding the capital loss issue, the court held that Delwin Chase did not liquidate his entire interest in JMI due to his continuing general partnership interest, while Gail Chase did liquidate her entire interest and was thus entitled to a short-term capital loss.

Practical Implications

This decision underscores the importance of the substance over form doctrine in tax planning, particularly in like-kind exchanges under Section 1031. Taxpayers must ensure that the economic realities of a transaction match its form to qualify for nonrecognition treatment. Practitioners should advise clients to carefully structure transactions and document ownership and control to avoid similar challenges. The ruling also clarifies that for Section 731(a) to apply, a partner must liquidate their entire interest in the partnership, not just a portion. This case has been cited in subsequent decisions involving the application of the substance over form doctrine and the requirements for like-kind exchanges and partnership liquidations.

April 24, 1989
Magneson v. Commissioner, 81 T.C. 767 (1983): When Property Exchanged for Partnership Interest Qualifies for Like-Kind Exchange Treatment

Magneson v. Commissioner, 81 T. C. 767 (1983)

An exchange of real property for an undivided interest in other real property, followed by immediate contribution of that interest to a partnership, can qualify for nonrecognition of gain under Section 1031 if the property received is held for investment.

Summary

In Magneson v. Commissioner, the Tax Court held that an exchange of a fee simple interest in real property for an undivided interest in other real property, which was then immediately contributed to a partnership, qualified for nonrecognition of gain under Section 1031. The key issue was whether the taxpayers held the property received for investment purposes, despite the subsequent contribution to the partnership. The court ruled that the exchange was a continuation of the taxpayers’ investment, not a liquidation, thus meeting the Section 1031 criteria. This decision underscores the importance of the nature of the taxpayer’s holding in determining the applicability of like-kind exchange treatment.

Facts

The taxpayers, Norman and Beverly Magneson, owned an apartment building in San Diego, California, which they exchanged for a 10% undivided interest in a commercial property known as the Plaza Property. Immediately after acquiring the Plaza Property interest, they contributed it to U. S. Trust Ltd. , a partnership, in exchange for a 10% general partnership interest. Both properties were held for investment purposes, and the parties agreed that the properties were of like kind.

Procedural History

The Commissioner of Internal Revenue determined a deficiency in the taxpayers’ 1977 federal income tax, asserting that the exchange did not qualify for nonrecognition under Section 1031 because the taxpayers did not hold the Plaza Property for investment. The taxpayers petitioned the U. S. Tax Court, which decided in their favor, holding that the exchange qualified for nonrecognition treatment.

Issue(s)

1. Whether the exchange of the Iowa Street Property for an undivided 10% interest in the Plaza Property, followed immediately by the contribution of that interest to a partnership, qualifies for nonrecognition of gain under Section 1031(a).

Holding

1. Yes, because the taxpayers held the Plaza Property for investment purposes, and the contribution to the partnership was a continuation of their investment rather than a liquidation.

Court’s Reasoning

The court’s decision hinged on the interpretation of the “held for investment” requirement under Section 1031. The court emphasized that the new property must be a continuation of the old investment, not a liquidation. It distinguished between holding property for sale, personal use, or gift, which would not qualify, and holding for investment, which does. The court found that the taxpayers’ immediate contribution of the Plaza Property to the partnership did not constitute a liquidation but rather a change in the form of ownership, which is treated as a continuation of the investment. This was supported by the fact that the partnership’s basis and holding period for the property were determined by the taxpayers’ original investment. The court also noted that other tax provisions, such as those related to investment credit and depreciation recapture, treat contributions to partnerships as mere changes in form rather than dispositions, further supporting the nonrecognition treatment under Section 1031.

Practical Implications

This case expands the scope of like-kind exchanges by allowing taxpayers to exchange property for an undivided interest and then contribute that interest to a partnership without losing Section 1031 benefits. Practitioners should note that the key is whether the property received in the exchange is held for investment, even if it is immediately contributed to a partnership. This ruling can facilitate tax planning strategies for real estate investors looking to restructure their investments through partnerships while deferring tax liabilities. However, the decision also sparked dissent, highlighting the complexity of determining when a change in ownership form constitutes a continuation of investment versus a liquidation. Subsequent cases and IRS guidance may further refine these principles, impacting how similar transactions are analyzed in the future.

October 20, 1983
Bolker v. Commissioner, 81 T.C. 782 (1983): Like-Kind Exchange Following Corporate Liquidation
81 T.C. 782 (1983)

A like-kind exchange of property received in a corporate liquidation qualifies for nonrecognition of gain under Section 1031 if the shareholder held the property for investment purposes and the exchange is demonstrably made by the shareholder, not the corporation.

Summary

Joseph Bolker, sole shareholder of Crosby, liquidated the corporation under Section 333 of the Internal Revenue Code and received real property. Shortly after, Bolker exchanged this property for other like-kind properties in a transaction facilitated by Parlex, Inc. The Tax Court addressed whether the exchange was attributable to the corporation and taxable at the corporate level, or properly attributed to Bolker and eligible for non-recognition under Section 1031. The court held that the exchange was made by Bolker individually and qualified for nonrecognition because the property was held for investment. This case clarifies that a shareholder can engage in a valid like-kind exchange even when the exchanged property is received shortly before in a corporate liquidation, provided the shareholder demonstrates intent to hold the property for investment.

Facts

Petitioner Joseph Bolker was the sole shareholder of Crosby, Inc., which owned undeveloped land (Montebello property). Bolker had initially planned to develop apartments on the land but faced financing difficulties. Following divorce proceedings where Bolker became the sole shareholder, he decided to liquidate Crosby under Section 333 to take the property out of corporate form, aiming to utilize potential losses. After liquidation on March 13, 1972, Bolker received the Montebello property. Prior to the liquidation plan adoption, Crosby had engaged in failed negotiations to sell the property to Southern California Savings & Loan Association (SCS). After the liquidation but in continuation of resumed negotiations, Bolker, acting individually, agreed to exchange the Montebello property with SCS. To facilitate the exchange, Bolker used Parlex, Inc., an intermediary corporation formed by his attorneys. On June 6, 1972, Bolker exchanged the Montebello property for like-kind properties through Parlex. Bolker reported the exchange as tax-free under Section 1031.

Procedural History

The Commissioner of Internal Revenue determined deficiencies in Bolker’s income taxes, arguing that the exchange was actually made by Crosby before liquidation, thus taxable to the corporation, and alternatively, that Bolker did not hold the Montebello property for investment. Bolker petitioned the Tax Court, contesting the deficiency.

Issue(s)
1. Whether the exchange of the Montebello property should be imputed to Crosby, Inc., Bolker’s wholly owned corporation, or be recognized as an exchange by Bolker individually?
2. Whether, if the exchange is attributed to Bolker, it qualifies for nonrecognition treatment under Section 1031 of the Internal Revenue Code?
Holding
1. No, the exchange was made by petitioner Joseph Bolker, not Crosby, Inc., because the negotiations and agreement were demonstrably conducted and finalized by Bolker in his individual capacity after the liquidation.
2. Yes, the exchange qualifies for nonrecognition treatment under Section 1031 because the Montebello property was held by Bolker for investment purposes.
Court’s Reasoning

Exchange Attributed to Shareholder: The court distinguished this case from Commissioner v. Court Holding Co., emphasizing that unlike in Court Holding, Crosby did not actively negotiate the final exchange terms. Referencing United States v. Cumberland Public Service Co., the court underscored that a corporation can liquidate even to avoid corporate tax if the subsequent sale is genuinely conducted by the shareholders. The court found that the 1969 negotiations between Crosby and SCS had failed and new negotiations in 1972 were initiated and conducted by Bolker post-liquidation. The court noted, “the sine qua non of the imputed income rule is a finding that the corporation actively participated in the transaction that produced the income to be imputed.” Here, Crosby’s involvement was minimal, and Bolker demonstrably acted in his individual capacity.

Section 1031 Qualification: The court followed its decision in Magneson v. Commissioner, which held that contributing property received in a like-kind exchange to a partnership qualifies as ‘holding for investment.’ The court reasoned that the reciprocal nature of Section 1031’s ‘held for investment’ requirement applies equally to property received and property relinquished. Quoting Jordan Marsh Co. v. Commissioner, the court stated Section 1031 applies when the “taxpayer has not really ‘cashed in’ on the theoretical gain, or closed out a losing venture.” Bolker’s receipt of the Montebello property via Section 333 liquidation and immediate like-kind exchange demonstrated a continuation of investment, not a cashing out. The court rejected the IRS’s argument that Bolker did not ‘hold’ the property for investment because of the immediate exchange, finding that the brief holding period in the context of a like-kind exchange following a tax-free liquidation was consistent with investment intent.

Practical Implications

Bolker v. Commissioner provides important guidance on the interplay between corporate liquidations and like-kind exchanges. It establishes that a shareholder receiving property in a Section 333 liquidation is not automatically barred from engaging in a subsequent tax-free like-kind exchange under Section 1031. For attorneys and tax planners, this case highlights the importance of structuring transactions to clearly demonstrate that the exchange is conducted at the shareholder level, post-liquidation, and that the shareholder intends to hold the property for investment. The decision reinforces that the ‘held for investment’ requirement in Section 1031 is not negated by a brief holding period when the subsequent exchange is part of a continuous investment strategy. This case is frequently cited in cases involving sequential tax-free transactions and remains a key authority in understanding the boundaries of the corporate liquidation and like-kind exchange provisions.
October 20, 1983
Pappas v. Commissioner, 78 T.C. 1078 (1982): Nonrecognition of Gain in Like-Kind Exchanges of Partnership Interests

Pappas v. Commissioner, 78 T. C. 1078 (1982)

Gain from like-kind exchanges of general partnership interests is not recognized under Section 1031 of the Internal Revenue Code.

Summary

Peter Pappas exchanged his general partnership interests in two different partnerships for interests in the St. Moritz Hotel partnership. The IRS argued that these exchanges should be taxable under Section 741, which treats partnership interest sales as capital asset transactions. However, the Tax Court held that Section 1031’s nonrecognition provision for like-kind exchanges applied, as the exchanges involved general partnership interests of like kind. The court also determined that Pappas did not intend to demolish the St. Moritz Hotel upon acquisition, allowing full depreciation deductions. Additionally, Pappas was liable for an addition to tax due to unreported income from a partnership interest received for services.

Facts

In January 1976, Pappas exchanged a one-third general partnership interest in Elmwood for a one-half interest in the St. Moritz Hotel partnership. In July 1976, he exchanged a one-third interest in Parkview for the remaining one-half interest in St. Moritz. Additionally, Pappas and others formed Kenosha Limited Partnership, where Pappas contributed services for a 2% general partnership interest, while others contributed the Parkview interest they received from Pappas. Pappas also acquired the St. Moritz Hotel while seeking zoning variances for a new hotel but continued operating it without demolition plans. Pappas failed to report income from a partnership interest received for services in 1976.

Procedural History

The Commissioner determined deficiencies and additions to Pappas’s tax for 1973, 1976, 1977, and 1978. Pappas filed petitions with the Tax Court, which consolidated the cases. The court addressed issues related to the tax treatment of partnership interest exchanges, depreciation of the St. Moritz Hotel, and additions to tax for unreported income.

Issue(s)

1. Whether Pappas’s exchanges of general partnership interests qualify for nonrecognition treatment under Section 1031.
2. Whether Pappas received “boot” in the exchanges that would require recognition of gain.
3. Whether Pappas acquired the St. Moritz Hotel with the intent to demolish it.
4. Whether Pappas is liable for additions to tax under Section 6653(a) for 1973 and 1976.

Holding

1. Yes, because the exchanges involved general partnership interests of like kind, qualifying under Section 1031.
2. No, because no boot was received except for liabilities assumed, which Pappas conceded.
3. No, because Pappas did not intend to demolish the hotel upon acquisition.
4. Yes, because Pappas failed to report income from a partnership interest received for services in 1976, resulting in additions to tax for both 1973 and 1976.

Court’s Reasoning

The court applied Section 1031, which allows nonrecognition of gain for like-kind exchanges, to the general partnership interest exchanges. It rejected the IRS’s argument that Section 741, which treats partnership interest sales as capital asset transactions, overrides Section 1031. The court found that the exchanges were supported by clear documentation and that the substance of the transactions aligned with their form. On the issue of intent to demolish, the court considered the factors listed in the regulations under Section 1. 165-3 and found that Pappas did not have the requisite intent when he acquired the hotel. For the unreported income, the court determined that Pappas did not meet his burden of proof in showing reliance on professional advice, thus upholding the additions to tax.

Practical Implications

This decision clarifies that Section 1031 applies to like-kind exchanges of general partnership interests, providing a significant tax planning tool for restructuring partnership interests without immediate tax consequences. Practitioners should ensure that the substance of transactions matches their form to maintain nonrecognition treatment. The ruling on intent to demolish emphasizes the need for clear evidence of intent at the time of acquisition for depreciation deductions. The case also serves as a reminder of the importance of accurately reporting income from partnership interests received for services, as failure to do so can lead to additions to tax. Subsequent cases have followed this precedent in analyzing like-kind exchanges of partnership interests.

June 17, 1982
Click v. Commissioner, 78 T.C. 225 (1982): Intent to Hold Property for Investment Required for Like-Kind Exchange

Click v. Commissioner, 78 T. C. 225 (1982)

A like-kind exchange under section 1031 requires that the property received be held for productive use in a trade or business or for investment.

Summary

Dollie Click exchanged her farmland for two residential properties, cash, and a note, intending to gift the residences to her children. The IRS challenged the exchange’s nonrecognition treatment under section 1031, arguing Click lacked investment intent. The Tax Court agreed, ruling that Click’s primary intent was to provide homes for her children, not to hold the properties as investments. The decision underscores the necessity of demonstrating investment intent at the time of a like-kind exchange to qualify for tax deferral.

Facts

Dollie Click owned farmland that she exchanged on July 9, 1974, for two residential properties, cash, and a note from Marriott Corp. Her children and their families moved into the residences on the same day. Approximately seven months later, Click gifted the residences to her children. Click reported the exchange on her 1974 tax return as a like-kind exchange under section 1031.

Procedural History

The IRS issued a statutory notice of deficiency to Click on August 4, 1978, for the taxable year 1974. Click paid the deficiency and subsequently filed a petition with the U. S. Tax Court on October 26, 1978, challenging the IRS’s determination. The IRS amended its answer on January 13, 1981, increasing the deficiency, and Click amended her petition to request a refund of the paid deficiency and interest.

Issue(s)

1. Whether Click’s exchange of farmland for two residential properties, cash, and a note qualifies for nonrecognition treatment under section 1031(a) of the Internal Revenue Code?

Holding

1. No, because Click did not intend to hold the residential properties received for productive use in a trade or business or for investment.

Court’s Reasoning

The court focused on the requirement under section 1031 that the property received must be held for investment or productive use. It found that Click’s primary intent was to gift the residences to her children, not to hold them as investments. The court noted Click’s suggestion to her children to find “swap” properties, her estate planning activities around the time of the exchange, and the lack of personal involvement with the properties post-exchange. The court concluded that Click’s intent was to provide homes for her children, not to invest in the properties, thus disqualifying the transaction from section 1031 treatment.

Practical Implications

This decision emphasizes the importance of demonstrating a clear intent to hold exchanged property for investment or productive use at the time of the exchange. Attorneys advising clients on like-kind exchanges must ensure that clients can substantiate their investment intent, particularly when personal use of the property by family members is involved. The case also highlights the IRS’s scrutiny of exchanges where subsequent gifts are made, suggesting that taxpayers should carefully document their intent and use of exchanged properties to avoid similar challenges.

February 16, 1982
Long v. Commissioner, 77 T.C. 1045 (1981): Like-Kind Exchanges of Partnership Interests and Recognition of Gain

Long v. Commissioner, 77 T. C. 1045 (1981)

A like-kind exchange of partnership interests qualifies under section 1031, but gain must be recognized to the extent of boot received in the form of liability relief.

Summary

Arthur and Selma Long, and Dave and Bernette Center exchanged their 50% interest in a Texas partnership, Lincoln Property, for a 50% interest in a Georgia joint venture, Venture Twenty-One. The Tax Court held that the exchange qualified as a like-kind exchange under section 1031(a), as both interests were in general partnerships. However, the court ruled that the entire gain realized on the exchange must be recognized due to the excess of liabilities relieved over liabilities assumed, treated as boot under sections 752(d) and 1031(b). The court also upheld the taxpayers’ right to increase the basis of the partnership interest received by the amount of recognized gain, as per section 1031(d).

Facts

Arthur and Selma Long, and Dave and Bernette Center, residents of Georgia, were 50% partners in Lincoln Property Co. No. Five, which owned rental real estate in Atlanta. They exchanged their interest in Lincoln Property for a 50% interest in Venture Twenty-One, which also owned rental real estate in Atlanta. The exchange occurred on May 9, 1975. Prior to the exchange, both partnerships faced financial difficulties, prompting the partners to renegotiate their agreements to reallocate partnership liabilities and eliminate guaranteed payments.

Procedural History

The Commissioner of Internal Revenue determined deficiencies in the taxpayers’ federal income tax for 1975 and 1976, asserting that the exchange resulted in a taxable gain. The taxpayers petitioned the Tax Court for a redetermination. The Tax Court upheld the exchange as qualifying under section 1031(a) but found that the entire gain must be recognized due to the boot received from liability relief.

Issue(s)

1. Whether the exchange of an interest in a Texas partnership for an interest in a Georgia joint venture qualifies as a like-kind exchange under section 1031(a)? 2. If the exchange qualifies under section 1031(a), whether gain should be recognized to the extent of the boot received under section 1031(b)? 3. If gain is recognized, whether the basis of the partnership interest received should be increased by the full amount of the gain recognized under section 1031(d)?

Holding

1. Yes, because both interests exchanged were in general partnerships and the underlying assets were of a like kind. 2. Yes, because the excess of liabilities relieved over liabilities assumed constitutes boot under sections 752(d) and 1031(b), requiring full recognition of the gain realized. 3. Yes, because section 1031(d) mandates an increase in the basis of the partnership interest received by the amount of gain recognized.

Court’s Reasoning

The court determined that the exchange qualified as a like-kind exchange under section 1031(a) by applying the entity approach to partnerships, as established in prior cases. The court rejected the Commissioner’s arguments that the exchange was excluded from section 1031(a) due to the nature of the partnership interests or the underlying assets. The court analyzed the boot received under section 1031(b), considering the partnership liabilities under section 752. The court found that the taxpayers’ attempt to reallocate liabilities close to the exchange date to reduce boot was a sham transaction and disregarded it. The court also upheld the taxpayers’ right to increase their basis in the received partnership interest by the amount of recognized gain under section 1031(d), despite the Commissioner’s argument against a “phantom gain” resulting from the taxpayers’ negative capital account.

Practical Implications

This decision clarifies that exchanges of partnership interests can qualify as like-kind exchanges under section 1031, but gain must be recognized to the extent of boot received, particularly from liability relief. Taxpayers must carefully consider the allocation of partnership liabilities and the timing of any reallocations to avoid being deemed as entering into sham transactions aimed at reducing tax liability. The decision also reaffirms that recognized gain in such exchanges can increase the basis of the partnership interest received, potentially affecting future depreciation deductions. Practitioners should advise clients on the potential tax implications of partnership interest exchanges, including the recognition of gain and the impact on basis, and ensure that any liability reallocations have economic substance beyond tax avoidance.

October 29, 1981
Crowley, Milner & Co. v. Commissioner, 76 T.C. 1030 (1981): Distinguishing Between Sale and Like-Kind Exchange in Sale-Leaseback Arrangements

Crowley, Milner & Company v. Commissioner of Internal Revenue, 76 T. C. 1030 (1981)

A sale-leaseback transaction is treated as a sale rather than a like-kind exchange if the property is sold for its fair market value and the leaseback has no capital value.

Summary

Crowley, Milner & Company sold a store it was constructing to Prudential Insurance Co. of America at fair market value and then leased it back for 30 years. The IRS argued this was a like-kind exchange under Section 1031 of the IRC, disallowing the company’s claimed loss on the sale. The Tax Court disagreed, ruling that the transaction was a bona fide sale because the property was sold for its fair market value and the leaseback had no capital value. The court also ruled that the excess costs over the sales price were not amortizable as lease acquisition costs and that the company was not liable for a late filing penalty.

Facts

Crowley, Milner & Company, a retailer, planned to open a new store in Lakeside Mall, Detroit, as part of a development by Taubman Co. The company preferred leasing over owning real estate. It entered into a sale-leaseback arrangement with Prudential Insurance Co. of America, selling the store for $4 million and leasing it back for 30 years at a fair market rental rate. The construction costs exceeded the sales price by $336,456. 48. Crowley claimed a loss on the sale on its tax return, which the IRS disallowed, asserting it was a like-kind exchange.

Procedural History

The IRS determined a deficiency and added a late filing penalty. Crowley, Milner & Company petitioned the U. S. Tax Court, which held that the transaction was a sale, not an exchange, and allowed the loss deduction. The court also ruled that the excess costs were not amortizable and that the company was not liable for the late filing penalty.

Issue(s)

1. Whether the sale-leaseback transaction with Prudential Insurance Co. of America constituted a like-kind exchange under Section 1031 of the IRC.
2. Whether the excess of the store’s cost over the sales price should be capitalized and amortized over the lease term.
3. Whether Crowley, Milner & Company was liable for a late filing penalty under Section 6651(a) of the IRC.

Holding

1. No, because the transaction was a sale for cash at fair market value, and the leaseback had no capital value.
2. No, because the excess costs were not incurred to obtain the lease but to ensure the sale’s completion.
3. No, because the company had paid more than the tax owed before the filing deadline.

Court’s Reasoning

The court determined that the transaction was a sale rather than an exchange because the store was sold for its fair market value, and the leaseback had no capital value. The court relied on expert testimony that the sales price and rent were at market rates. It distinguished this case from Century Electric Co. v. Commissioner, where the lease had capital value. The court also followed Leslie Co. v. Commissioner, emphasizing that the sale-leaseback was negotiated at arm’s length. The excess costs were not amortizable as they were incurred to complete the sale, not to acquire the lease. The court found that no late filing penalty was due because the company had paid more than the tax owed before the filing deadline.

Practical Implications

This decision clarifies that a sale-leaseback transaction can be treated as a sale for tax purposes if the property is sold for its fair market value and the leaseback has no capital value. It affects how businesses structure similar transactions, emphasizing the importance of negotiating at arm’s length to avoid like-kind exchange treatment. The ruling also impacts the treatment of excess costs in such transactions, which are not amortizable if incurred for reasons other than lease acquisition. The decision’s approach to the late filing penalty underscores the significance of timely payments in avoiding penalties. Subsequent cases, such as those involving similar sale-leaseback arrangements, have cited this case to distinguish between sales and exchanges.

June 17, 1981