The Service has ruled that, for purposes of section 1031, neither a limited partnership nor the subsidiary of the real estate investment trust that owns 89 percent of the limited partnership will be required to recognize gain on the sale of relinquished property or the acquisition of replacement property through a qualified intermediary.
The Service has ruled that, for purposes of section 1031, neither a limited partnership nor the subsidiary of the real estate investment trust that owns 89 percent of the limited partnership will be required to recognize gain on the sale of relinquished property or the acquisition of replacement property through a qualified inter-mediary.
This responds to your request for a private letter ruling, dated October 5, 2007, as supplemented, regarding the application of section 1031(f) of the Internal Revenue Code.
Taxpayer is a limited partnership organized in State A that is taxed as a partnership. Through other partner-ships and entities that are disregarded for federal income tax purposes, Taxpayer owns and operates various commercial real estate properties.
Taxpayer is also an affiliate of RT, a publicly held statutory real estate investment trust (REIT) organized in State B. RT elected to be taxed as a REIT beginning with its taxable year that ended on Date C. RT has in-tended to qualify as a REIT at all times since and including such year.
RT operates through an UPREIT structure. RT owns 89% of the common interest of Taxpayer and is its sole general partner. Various outside partners own the remaining 11% interest in Taxpayer which, in turn, owns interests in numerous subsidiaries. RT conducts its operations and owns properties through Taxpayer and subsidiary entities including Company. As a subsidiary of RT, Company is also a related party to Taxpayer for purposes of section 1031(f).1
Taxpayer, through a chain of wholly owned entities, was the owner of an office building (RQ). As part of a deferred like-kind exchange RQ was transferred through a qualified intermediary (QI) to Buyer, an unrelated third party. During the identification period, Taxpayer's QI acquired and transferred to Taxpayer two proper-ties as replacement properties. Because these properties were acquired by Taxpayer during the identification period, they are deemed to have been timely identified pursuant to section 1.1031(k)-1(c)(1) the Income Tax Regulations. Also during the identification period, Taxpayer identified four other replacement properties in accordance with the 200% rule in section 1.1031(k)-1(c)(4)(i)(B). One of the identified replacement properties is a fee interest in a single ground floor retail condominium unit, known as RP6. Taxpayer will acquire RP6 from Company.
Company will be doing its own section 1031 exchange in connection with the sale of RP6 as follows: Com-pany will assign its rights to the contract to sell RP6 to a QI, pursuant to a separate exchange agreement to be entered into between Company and its QI. Company will timely acquire its own replacement property from an unrelated third party through its QI to complete the exchange. Taxpayer expects that the value of Com-pany's replacement property may be somewhat less than the aggregate value of RP6. As a result, some cash will be paid to Company on or after the earlier of the 181st day after the transfer of RQ or the receipt of all property which Company is entitled to receive under its exchange agreement. When cash is received, it will constitute taxable boot to Company. However, under no circumstances will the amount of boot to be re-ceived exceed % of the gain realized.
Neither Taxpayer nor Company will dispose of its respective replacement properties before two years from the later acquisition of the respective replacement properties.
LAW & ANALYSIS
Section 1031(a)(1) 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, in part, that if an exchange would be within the provisions of subsection (a) if it were not for the fact that the property received in exchange consists not only of property permitted to be re-ceived without the recognition of gain, but also of other property or money, then the gain, if any, to the recipi-ent shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
Section 1031(f)(1) provides that if (A) a taxpayer exchanges property with a related person, (B) there is non-recognition of gain or loss to the taxpayer under this section with respect to the exchange of such property (determined without regard to this subsection), and (C) before the date 2 years after the date of the last transfer which was part of such exchange --
- the related person disposes of such property, or
- the taxpayer disposes of the property received in the exchange from the related person which was of like kind to the property transferred by the taxpayer,
there shall be no nonrecognition of gain or loss under this section to the taxpayer with respect to such ex-change; except that any gain or loss recognized by the taxpayer by reason of this subsection shall be taken into account as of the date on which the disposition referred to in subparagraph (C) (the second disposition) occurs.
Section 1031(f)(2) provides, in part, that for purposes of paragraph (1)(C), there shall not be taken into ac-count any disposition -- (C) with respect to which it is established to the satisfaction of the Secretary that nei-ther the exchange nor such disposition had as one of its principal purposes the avoidance of federal income tax.
Section 1031(f)(4) provides that section 1031 shall not apply to any exchange that is part of a transaction (or series of transactions) structured to avoid the purposes of section 1031(f).
In the present case, section 1031(f)(1) is not applicable to Taxpayer's exchange of RQ for RP6 because Taxpayer is exchanging property with a QI, who is not a related person. However, section 1031(f)(4) pro-vides that section 1031 shall not apply to any exchange that is part of a transaction, or series of transactions, structured to avoid the purposes of section 1031(f). Both the Ways and Means Committee Report and the 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 prop-erty received, related parties have engaged in like-kind exchanges of high basis property for low basis prop-erty 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 the retained property. The committee believes that if a related party exchange is followed shortly thereafter by a disposition of the prop-erty, 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 con-tain the following example of when section 1031(f)(4) applies:
If a taxpayer, pursuant to a re-arranged plan, transfers property to an unrelated party who then ex-changes 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 nonrecogni-tion treatment under section 1031.
H.R. Rep. No. 247, at 1341; S. Print. No. 56, at 152.
The Senate Finance committee also gave three examples of its intent with respect to the non-tax avoidance exception at section 1031(f)(2)(C):
It is intended that the non-tax avoidance exception generally will apply to (i) a transaction involving an ex-change of undivided interests in different properties that results in each taxpayer holding either the entire interest in a single property or a larger undivided interest in any of such properties; (ii) dispositions of prop-erty in nonrecognition transactions; and (iii) transactions that do not involve the shifting of basis between properties.
S. Print. No. 56, at 152.
In Rev. Rul. 2002-83, 2002-2 C.B. 927, the taxpayer transferred low-basis property to an unrelated buyer through a QI and acquired high basis replacement property from a related party, through the intermediary with the proceeds of the sale of the first property. In analyzing these facts under section 1031(f)(4), the Serv-ice quoted the above legislative history for the proposition that section 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 a case, the original exchange would not be ac-corded nonrecognition treatment. Under the facts in the revenue ruling, the taxpayer and the related party were attempting to sell the relinquished property to an unrelated party while using the substituted basis rule of section 1031(d) to reduce gain on the sale to $ 0. This allowed the parties to cash out of their investment in the relinquished property without recognizing gain. The Service concluded that the transaction was struc-tured to avoid the purposes of section 1031(f)(1) and, therefore, Taxpayer, as the first transferor, recognized all the gain realized on its transfer of the relinquished property.
As mentioned above, pursuant to section 1031(f)(2)(C), any second disposition by exchanging parties will not be taken into account for purposes of section 1031(f)(1) if it can be established to the satisfaction of the Sec-retary 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 non-tax avoidance exception generally will apply to . . . dispositions in nonrecognition transactions . . . ." H.R. Report No. 386, 101st Cong., 1st Sess. 614 (1989).2
In the present case, the only transaction planned by the parties after Taxpayer receives RP6 as its replace-ment property is the acquisition by Company of Company's replacement property in another exchange under section 1031, a nonrecognition transaction. Because Company is also structuring its disposition of RP6 as an exchange for like-kind replacement property, neither section 1031(f)(4) nor Rev. Rul. 2002-83 applies. Tax-payer's exchange and Company's exchange are structured as like-kind exchanges qualifying under section 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 properties they exchanged. Moreo-ver, neither party will have ever been in receipt of cash or other non-like-kind property (other than a limited amount of boot received in the exchange) in return for the relinquished properties. Finally, any receipt of cash or other non-like-kind property by Company from its QI, in an amount not greater than % of Company's realized gain, will not result in gain recognition by Taxpayer.
- Section 1031(f) will not apply to require Taxpayer to recognize the gain realized in Taxpayer's ex-change of RQ for RP6 or Company's exchange of RP6 for Company's replacement property, provided that neither Taxpayer nor Company disposes of their respective replacement properties within two years of the later of Taxpayer's receipt of RP6 or Company's receipt of Company's replacement property.
- Company's receipt of cash or other (non-like-kind) property, in addition to Company's replacement property, from its QI, will not cause Taxpayer to recognize gain under section 1031(f).
Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.
The rulings contained in this letter are based upon information and representations submitted by the tax-payer 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.
A copy of this letter must be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that pro-vides the date and control number of the letter ruling.
Michael J. Montemurro
Chief, Branch 4
(Income Tax & Accounting)
1 Company, a separate partnership for income tax purposes, is owned 99% by Affiliate 1 and 1% by Affili-ate 2, a taxable REIT subsidiary, both of which are 100% owned by Taxpayer.
2 This is the language of the Conference Committee Report which adopted the Senate Amendment, quot-ing from the Senate Finance Committee Print (S. Print No. 56) at p. 152.
END OF FOOTNOTES