Federal Tax

Taxfree Exchanges Under Section 1031 (Portfolio 567)

  • The Portfolio, Taxfree Exchanges Under Section 1031, analyzes the nontaxable exchange provisions of §1031 of the Internal Revenue Code.

Description

Bloomberg Tax Portfolio, Taxfree Exchanges Under Section 1031, analyzes the nontaxable exchange provisions of §1031 of the Internal Revenue Code. The Portfolio’s analysis of §1031 includes a discussion of the types of property that do and do not qualify for nonrecognition treatment; the concepts of “like-kind,” “boot” and “exchange”; the deferred exchange rules; the rules relating to the allocation of boot; and the determination of the basis and holding period of properties received in such exchanges. The Portfolio also discusses the problems involved in sale and leaseback transactions, multi-party exchanges, multi-asset exchanges, and reverse exchanges.

Section 1031 provides that the exchange of certain types of property will not result in the recognition of gain or loss. The property exchanged and received in the transaction must be of like kind and must be held either for investment or for productive use in the taxpayer’s trade or business; however, such property does not include stock in trade or other property held primarily for sale, partnership interests, stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, and other securities or evidences of indebtedness or interest.

Gain is recognized in a transaction which otherwise qualifies under §1031 if, in addition to nonrecognition property, the taxpayer receives other property, so-called “boot.” Losses, as a general rule, are not recognized in a transaction that qualifies under §1031. However, if the taxpayer surrenders boot in addition to qualifying property, gain or loss is recognized on the boot surrendered. Although a liability of the transferor assumed by the transferee is deemed boot to the transferor, the regulations permit netting of boot given by the transferor against such a liability.

Section 1031 establishes certain basis rules: in general, the property received acquires the basis (and holding period) of the properties surrendered, (i) reduced by any money received or liabilities assumed by the transferee to the exchange, and by any loss recognized to the transferor, and (ii) increased by the amount of gain recognized to the transferor. The basis as thus computed is allocated first to the “boot” property received to the extent of fair market value, and the remaining basis is allocated among the nonrecognition properties received, apparently in proportion to relative fair market values as of the date of the exchange.

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Table of Contents

DETAILED ANALYSIS — 

I. Introduction

II. Statutory Requirements

    A. In General

        1. Nonrecognition of Gain or Loss for Certain Exchanges of Real Property

        2. Qualifying Property

        3. Timing

        4. Basis and Holding Period of Replacement Property

    B. Relinquished Property and Replacement Property Must Be “Held for” Qualifying Purposes

        1. In General

        2. Qualifying Holding Purpose

            a. Productive Use in Trade or Business

            b. Investment

            c. Personal Use of Property and “Mixed-Use” Property, Including Vacation Homes

                (1) In General

                (2) Vacation Homes and “Dwelling Units”

                    (a) Safe Harbor for “Dwelling Units” Under Rev. Proc. 2008-16

                    (b) Vacation Homes That Fall Outside of the Safe Harbor

                    (c) Personal Use of Replacement Property Other Than Vacation Home

                    (d) Property Used Partly for Personal Residence and Partly in Trade or Business

        3. Recent Acquisitions or Construction Before Exchange and Dispositions Subsequent to Exchange

            a. In General

                (1) Holding Purpose as Opposed to Holding Period

                (2) Pre-Arranged Plan

            b. Subsequent Taxable Sales or Exchanges; Construction Before Exchange

            c. Nonrecognition Transactions with Business Entities

                (1) Partnerships — Magneson

                (2) Corporations — Bolker

                (3) Post–Magneson/Bolker Authority

                (4) Potential “Carryover” Nature of Holding Purpose in Transactions between Partners and Partnerships and Corporate Reorganizations (Mergers)

            d. Gifts; Estates and Transfers at Death

                (1) Gifts

                (2) Estates and Transfers at Death

        4. Mid-Exchange Transfers and “Same Taxpayer” Issue

            a. Business Entities

            b. Estates and Trusts; Transfers at Death

    C. The Exchange Requirement

        1. In General

        2. Section 1031 Exchange Not Always Desirable

        3. Sales Treated as Exchanges

        4. Receipt of Recently Constructed Property

        5. Receipt of Improvements on Taxpayer-Owned Land

        6. Sale-Leaseback

        7. Exchange vs. Lease Bonus

        8. Multiparty Transactions

        9. Related-Party Transactions

        10. Natural Resources

            a. Oil and Gas Unitization Agreements

            b. Timber

        11. Exchange of Property to Avoid Foreclosure

    D. Special Rules for Exchanges with Related Parties — §1031(f)

        1. In General

            a. Operation of §1031(f), Generally

            b. Applicable Relationships

            c. Exceptions to the Application of §1031(f)

            d. Indirect Exchanges Between Related Parties and the Anti-Abuse Rule — §1031(f)(4)

            e. Extended Holding Period if Substantial Diminution of Risk — Section 1031(g)

        2. Suggested Situations Where §1031(f) Should and Should Not Apply

            a. In General

            b. Situations Where Related-Party Rules Should Apply

            c. Situations Where the Exception in §1031(f)(2)(C) Should Apply

            d. Situations Where the Anti-Avoidance Rule of §1031(f)(4) Should and Should Not Operate

                (1) Situations Where Anti-Avoidance Rule Should Operate

                (2) Situation Where the Anti-Avoidance Rule Should Not Operate

        3. IRS Guidance

        4. Teruya Brothers, Ltd. v. Commissioner

        5. Ocmulgee Fields, Inc. v. Commissioner

        6. Malulani Group, Ltd. v. Commissioner

        7. Related-Party Leasehold Improvements

    E. Exchange Property and Transferred Property Must Be of Like Kind

        1. In General

        2. Real Property

            a. Distinguishing Real Property From Personal Property

            b. Effect of State and Local Law Treatment

            c. Interests in Cooperative Housing Corporations (Co-Ops)

            d. Undivided (Tenancy in Common) Interests

            e. Certain Entity Interests Treated as Real Property

            f. Improvements to Land

            g Leasehold Interests

            h. Conservation Easements

            i. Development Rights

            j. Air Rights

            k. Water Rights

            l. Mitigation Credits

            m. Other Natural Resources

            n. Foreign Real Estate

            o. Miscellaneous

                (1) Easement Together With Right to Receive Rental Income

                (2) Billboard

        3. Pre-2018 Exchanges of Personal Property

            a. Pre-2018 Exchanges of Personal Property: In General

            b. Pre-2018 Exchange of Personal Property: Use of NAICS System

            c. Pre-2018 Exchange of Personal Property: Livestock

            d. Pre-2018 Exchange of Personal Property: Functional and Nonfunctional Currency

            e. Pre-2018 Exchange of Personal Property: Artwork

            f. Pre-2018 Exchange of Personal Property: Foreign Personal Property

        4. Pre-2018 Exchanges of Intangible Property

            a. In General

            b. TAM 200602034 and CCA 200911006

            c. Notice 2006-34

            d. FCC Licenses

            e. Rights to Manufacture and Distribute Certain Tangible Personal Property

    F. Excluded Property

        1. In General

        2. Real Property Held Primarily for Sale

            a. In General

            b. Factors under Phelan v. Commissioner

            c. “Dual Use” Property Held Either for Rent or for Sale

        3. Pre–TCJA Excluded Property and Application to Post-2017 Exchanges

            a. Stock in Trade

            b. Stocks, Bonds, Etc.

            c. Choses in Action

                (1) In General

                (2) Contract Rights

                (3) Franchises, Patents, Copyrights, Trademarks, and Trade Names

            d. Certificates of Trust or Beneficial Interest and Other Securities or Evidence of Indebtedness or Interest

            e. Certain Grantor Trust Interests

            f. Partnership Interests

III. Multiple Asset Exchanges

    A. Background

    B. Regulations

        1. General Principles

            a. Grouping

            b. Recognition of Gain and Loss

            c. Basis

            d. Examples

        2. Holding Period

        3. Application of §1245 to Multiple Asset Exchanges

        4. Relevance to Post–2017 TCJA Exchanges?

        5. Fragmentation

IV. Special Problems Relating to Partnerships and Co-Ownerships

    A. Section 761(a) Election

    B. Undivided Interests

        1. Rev. Proc. 2002-22

            a. In General

            b. Multiple Properties

            c. Submission Requirements

            d. Conditions of the Co-Ownership Arrangement

                (1) Co-Owners Must Be Local Law Tenants in Common

                (2) Number of Co-Owners

                (3) No Treatment of Co-Ownership as an Entity

                (4) Co-Ownership Agreement

                (5) Voting

                (6) Restrictions on Alienation

                (7) Sharing Proceeds and Liabilities Upon Sale of Property

                (8) Proportionate Sharing of Profits and Losses

                (9) Proportionate Sharing of Debt

                (10) Options

                (11) No Business Activities

                (12) Management and Brokerage Agreements

                (13) Leasing Agreements

                (14) Loan Agreements

                (15) Payments to Sponsor

        2. Guidance Subsequent to Rev. Proc. 2002-22

            a. PLR 200327003

            b. PLR 200513010

            c. PLR 200625009, PLR 200625010, PLR 200826005, PLR 200829012, and PLR 200829013

            d. PLR 201622008

            e. PMTA 2010-005

        3. Open Issues Under Rev. Proc. 2002-22

    C. Delaware Statutory Trusts

        1. In General

        2. Rev. Rul. 2004-86

            a. Facts

            b. Classification of the DST for Federal Tax Purposes

            c. Exchange of Real Property for Interests in the DST Under §1031

            d. Significance of the Ruling

    D. When Partners Desire Separate Treatment on §1031 Exchanges

        1. Distribution of Undivided Interests in Property

            a. Liquidation of Partnership

            b. Distribution of Undivided Interest to Partner Desiring Cash

            c. Partnership Division

        2. Part-Exchange/Part-Installment Sale and Distribution of Installment Note

        3. Special Allocation of Gain

V. Multi-Party Exchanges

    A. In General

        1. IRS Recognition

        2. Current Issues and Practical Problems

    B. Trend of Cases

        1. Rutland v. Commissioner

        2. Everett v. Commissioner

        3. Biggs v. Commissioner

        4. Garcia v. Commissioner

        5. DeCleene v. Commissioner

        6. Dobrich v. Commissioner

        7. True v. United States

    C. Participation of Taxpayer in Location, Negotiation, and Acquisition of Exchange Property

        1. In General

        2. IRS Position

        3. Court Decisions

    D. Necessity for Exchangor to Have Legal Title

    E. Escrow and Trust Arrangements

        1. Closings Effected Through Escrows

        2. Rogers v. Commissioner

        3. Barker v. Commissioner

        4. Allen v. Commissioner

        5. Garcia v. Commissioner

        6. Hillyer v. Commissioner

        7. Klein v. Commissioner

        8. St. Laurent v. Commissioner

        9. Florida Industries Investment Corp. v. Commissioner

    F. Use of Safe Harbors in Simultaneous Exchanges

VI. Delayed (Forward) Exchanges

    A. In General

        1. IRS Position

        2. Pre-Starker Authority

    B. Starker v. United States

    C. Aftermath of Starker

        1. In General

        2. Ancillary Issues

        3. Improvements Constructed After Exchange

        4. Rutherford v. Commissioner

    D. Delayed Exchanges After Tax Reform Act of 1984

        1. Overview

            a. General Requirements of Statute

            b. Effective Date

            c. Issuance of Final Regulations

        2. Identification and Receipt Requirements

            a. In General

            b. Identification Procedures

            c. Identification of Multiple Properties

                (1) Alternative vs. Multiple

                (2) Multi-Asset Exchanges — Three-Property and 200% Rule

                (3) When Can Multiple Buildings Be Treated as One Property?

            d. Revocation of Identification

            e. Receipt of Substantially the Same Property and Constructed Property

                (1) In General

                (2) Property Constructed During Exchange Period

                (3) “Substantially the Same” Requirement

            f. Identification of Percentage Interests

        3. Use of Regulatory Safe Harbors

            a. In General

            b. The “(g)(6) Restrictions”

            c. Security or Guarantee Arrangements

            d. Qualified Escrow Accounts and Qualified Trusts

            e. Qualified Intermediaries

            f. Allowable Payments From a Safe Harbor Account

            g. Growth Factor and Reportability and Timing of Interest

            h. Additional Restrictions

            i. Premature Distributions

            j. Disqualified Person

                (1) Agent

                (2) Routine Financial Services

            k. Open Issues Under the Deferred Exchange Regulations

                (1) Intermediary as Express Agent

                (2) Replacement of Intermediary, Escrow Agent, or Trustee

                (3) Fragmentation and Consolidation — Part of the “Same” Exchange

                (4) Transfers by Partnerships

                (5) Deposits on Relinquished and Replacement Properties

                (6) Representations and Warranties

                (7) Receipt of Note to Fund Replacement Property

                (8) Pay Down/Pay Up/Transactions

                (9) Ability of Taxpayer to Direct Investments in Exchange Account

                (10) Joint Signatures on Exchange Account

                (11) Taxpayer’s Pledge of His Rights in Exchange Agreement

                (12) Substantial Compliance

                (13) Transfers in Foreclosure

            l. Potential Liability of Intermediaries

                (1) Tax and Reporting Liability

                (2) Nontax Liabilities

                (3) State Regulation Liability

            m. QI Bankruptcy

            n. Deferred Exchanges Outside the Regulatory Safe Harbors

        4. Mass Asset Exchanges — Pre–2017 TCJA

            a. Private Rulings

            b. Rev. Proc. 2003-39

            c. Rev. Proc. 2003-39 Safe Harbors

                (1) Separate and Distinct Exchange Safe Harbor

                (2) Constructive Receipt Safe Harbor

                (3) Qualified Intermediary and Assignment Safe Harbor

        5. Granting of Options and Leases Before Exchange

            a. Granting of an Option

            b. Granting of a Lease

VII. Reverse Exchanges

    A. In General

        1. Parking Arrangements

        2. Two-Party Reverse Exchange

        3. Second ABA Report

    B. Rev. Proc. 2000-37

        1. Benefits and Scope of the Safe Harbor

        2. Requirements of a Qualified Exchange Accommodation Arrangement (QEAA)

            a. EAT Holds Qualified Indicia of Ownership

            b. Bona Fide Intent for Use of Property in Exchange

            c. Qualified Exchange Accommodation Agreement

            d. Identification of Relinquished Property Within 45 Days

            e. Transfer of Parked Property in No More Than 180 Days

            f. Combined Parking Period for Replacement Property and Relinquished Property May Not Exceed 180 Days

        3. Arrangements Between Taxpayer and EAT

        4. Exchanges for Improvements on Affiliate’s Property

            a. Rev. Proc. 2004-51

            b. Exchanges for Improvements on Land Leased From an Affiliate

        5. Further Observations and Open Issues

    C. Parking Arrangements/Reverse Exchanges Outside the Safe Harbor

        1. In General

        2. TAM 200039005

        3. DeCleene v. Commissioner

        4. PLR 200111025

        5. FAA 20050203F

        6. Bartell v. Commissioner

VIII. Sale-Leaseback Transaction

    A. In General

    B. Value of Leasehold

    C. IRS Position

    D. Judicial Authority

        1. Leasehold Has Value

        2. Leasehold Has No Value

        3. No True Lease

IX. Boot

    A. In General

    B. Giving Boot

    C. Receiving Boot

        1. In General

        2. Liabilities

            a. In General

            b. Definition of Liability

            c. Treatment of Contingent Liabilities

            d. Multi-Asset Exchanges

        3. Netting Boot and Refinancing

            a. In General

            b. Refinancing

            c. Application of the Netting Rule

            d. Partnership Gain

            e. Purchase Money Mortgage

            f. Non Mortgage Expenses

        4. Offsetting Boot by Exchange Expenses

        5. Placing of Mortgage Just Prior to Exchange

            a. Garcia v. Commissioner

            b. PLR 8434015

            c. Fredericks v. Commissioner

            d. Proposed and Final Regulations

        6. Placing of Mortgage Just After Exchange

    D. Apportionment of Boot

    E. Installment Method

        1. Before the Installment Sales Revision Act of 1980

        2. Installment Sales Revision Act of 1980

            a. In General

            b. Proposed Regulations

            c. Deferred Exchanges

    F. Loss From Exchanges Not Solely in Kind

        1. Giving of Boot

        2. Receiving Boot

X. Basis

    A. In General

    B. Multi-Asset Exchanges

        1. Before April 11, 1991

        2. Netting of Boot

        3. Multiple Property Exchanges After April 10, 1991, and Before January 1, 2018 (Subject to Transitional Rules)

        4. Post–December 31, 2017 Multiple Property Exchanges

    C. Allocation Problem

        1. Multiple Use Properties

        2. Shifting Basis

            a. In General

            b. Business Swapping

    D. Bargain Sale to Charity

    E. Reinvestment of Proceeds From Involuntary Conversion

XI. Holding Periods

    A. In General

    B. Allocation Problems

        1. Nonqualifying Property Received

        2. Transfers of Assets With Different Holding Periods

XII. Disregarded Entities

    A. Reasons for Using

    B. Illinois Land Trusts

        1. Background

        2. Treatment Under §1031

    C. Grantor Trusts

    D. Delaware Business Trust

    E. Single-Member LLC

    F. Two-Member LLC With a Single Owner

        1. PLR 199911033

        2. PLR 200201024

        3. Rev. Rul. 2004-77

    G. Delaware Series LLC

XIII. Depreciation Recapture

    A. Section 1245

    B. Section 1245 Recovery Property

    C. Section 1250

    D. Section 1254

XIV. Relation to Other Code Sections

    A. In General

    B. Section 50

    C. Section 1239

    D. Section 897

    E. Section 341

    F. Section 1033

    G. Section 469

    H. Section 1374

    I. Section 168

        1. In General

        2. Depreciation — Acquisition of MACRS Property

            a. General Operating Rules

            b. Conventions

            c. Year of the Exchange

            d. Excess Basis

            e. Deferred and Reverse Exchanges

            f. Nondepreciable Property

            g. Election Out

            h. Multiple Property Exchanges

            i. Election to Treat Certain Replacement Property as MACRS Property

        3. Related-Party Exchanges Involving “Tax-Exempt Use Property”

        4. Section 470(e)(4)

        5. Bonus Depreciation

        6. Cost Segregation Study — Effect on §1031

    J. Sections 877 and 877A

    K. Section 904(f)

    L. Section 954

    M. Section 467

    N. Section 1502

    O. Section 121

    P. Former §1400N

    Q. Section 1411

    R. Section 199A

    S. Sections 1400Z-1 and 1400Z-2

        1. Investment in Qualified Opportunity Zones, Generally

        2. Comparison to, and Interaction with, Like-Kind Exchanges

XV. Reporting Requirements

XVI. State Taxation of Like-Kind Exchanges

TABLE OF WORKSHEETS

Aaron Gaynor
Aaron Gaynor
Associate
Roberts & Holland LLP
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Howard Levine
Partner
Roberts and Holland LLP
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