Tag Archives: 1031 exchange

IRS Declines to Follow Tax Court Decision Liberalizing Reverse 1031 Exchanges

Last year on the blog, we reported a Tax Court decision approving “reverse” 1031 Exchanges in which a taxpayer acquires replacement property more than 180 days before disposing of relinquished property.

The IRS recently announced it will not follow the Tax Court decision, and may seek future challenges in other courts to overturn it. This limits the Tax Court decision’s impact until the courts establish more precedent.

The IRS announcement should not, however, deter all taxpayers needing more than 180 days to dispose of relinquished property from attempting 1031 Exchanges. In any reverse 1031 Exchange transaction, a person unrelated to the taxpayer must hold the replacement property or relinquished property until the ultimate buyer acquires the relinquished property. The Tax Court decision and IRS announcement only affect transactions in which an agent or straw man holds the replacement or relinquished property for the taxpayer in the interim period, without bearing risks normally associated with property ownership. Sometimes a taxpayer can find an unrelated person willing to bear some of the benefits and burdens of ownership for the property, differentiating the arrangement from an agent or straw-man structure. This opens the door to a taxpayer taking the position a longer holding period may exist, even if financing or other arrangements remain in place between the interim titleholder and the taxpayer.

The IRS announcement can be read at irs.gov.

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

How to Sell Raw Land or Air Rights to a Real Estate Developer and Receive Back Finished Condominiums Tax-Free

When a land owner sells to a condominium developer, both the land owner and the developer have motivations favoring the developer “paying“ the land owner with finished condominium units instead of cash. Such a transaction reduces the developer’s up-front cash investment while sometimes enabling the developer to use all the land as collateral for senior financing. While more risky than a cash sale, the seller may receive condominium units more valuable than the cash price the seller could realize.

What gets in the way of these transactions?  Often, the seller balks because the seller lacks the cash to pay capital gains tax on the value of the condominium units received back. To alleviate that problem, transactions are sometimes structured as partnership “mixing bowl” co-investments and redemptions, or as combination ground lease-Internal Revenue Code Section 1031 exchange transactions. These structures may defer capital gains tax; however, they also are subject to restrictions and frequently sufficiently convoluted so as to interfere with the developer’s business structure or senior financing.

In some circumstances an alternative sale structure offers a better solution. Under the alternative, the seller takes the positon that the receipt of finished condominiums is exempt from capital gains tax under Internal Revenue Code Section 1038. These same rules exempt a seller from tax when the seller forecloses on a delinquent purchaser on traditional seller financing (in tax parlance, an installment note). Unlike the mixing bowl or combination ground lease-Internal Revenue Code Section 1031 exchange structures, the Section 1038 structure more closely resembles traditional seller financing, making it potentially more palatable to senior development lenders and more simple for all the parties to understand and implement.

To learn more—including understanding scenarios involving air rights rather than raw land—follow this link to materials summarizing all these potential structures originally presented in an American Bar Association Section of Taxation webinar.

Please note that we post these materials with permission from and subject to the copyright of a co-presenting firm, Meltzer, Lippe, Goldstein & Breitstone, LLP.

 

Tax Court Approves Non-Safe-Harbor “Reverse” 1031 Exchange Even Though Titleholder Had No Ownership Benefits or Burdens

A 1031 Exchange is a popular capital gains deferral strategy for business and investment property. Taxpayers use the strategy to defer capital gains tax on property “sold” by acquiring “like kind” replacement property, usually in coordination with an intermediary or accommodation party.

After deliberating for a decade, the U.S. Tax Court has held that an accommodation party with no benefits or burdens of ownership can hold title to real property outside the established IRS “reverse” 1031 Exchange safe harbor without disqualifying the taxpayer’s 1031 Exchange.  The case arose from transactions spanning from 1999 to early 2001, before the IRS issued its safe harbor ruling for such transactions.  The accommodation party held the potential 1031 Exchange replacement property for over one year (longer than the 180-day period allowed by the IRS safe harbor) before transferring it to the taxpayer, following the taxpayer’s sale of its intended relinquished property.  During this period, the taxpayer funded all costs (including acquisition and construction costs) associated with the property, and entered into arrangements that constructively prevented the titleholder from realizing the benefits of owning the property.

The “owner” of property for federal income tax purposes usually is the party with the “benefits and burdens” of ownership, not legal title.  Application of that standard would have disqualified the 1031 Exchange by treating the taxpayer as owning the replacement property before acquiring the relinquished property. But the Tax Court found that different rules apply in the 1031 Exchange context, such that the arrangement was acceptable to treat the temporary accommodation titleholder as the income tax owner until the taxpayer completed its 1031 Exchange.

The Tax Court’s reasoning relied heavily on a decision of the U.S. Court of Appeals for the Ninth Circuit, the appellate court with jurisdiction over California and other western states.  While the Tax Court also relied on other precedent, there remains a risk cases in other geographic areas could have different outcomes.  The case is nevertheless significant, bolstering the substantial flexibility taxpayers enjoy in structuring 1031 Exchanges.

Here is a link to the Tax Court opinion in Estate of Bartell v. Commissioner: http://www.ustaxcourt.gov/USTCInOP/OpinionViewer.aspx?ID=10868.

Some Tax-Motivated Couples Don’t Marry Under the Law, Even If They Are Bound In Their Hearts

The Supreme Court’s decision authorizing nationwide same-sex marriage further extends marital rights. But some extraordinarily-tax-motivated same-sex couples may make the same choice that some opposite-sex couples have made for years, to avoid marriage to take advantage of tax planning opportunities married couples cannot.

Marriage brings with it many tax benefits, especially under the federal income tax for families of all income levels with a single wage earner, and under the federal estate and gift tax, where even wealthy spouses are allowed unlimited tax-free transfers between themselves. But married couples are also treated as “related parties” under the Internal Revenue Code. Related party treatment prevents spouses from engaging in many tax motivated transactions that unmarried persons—even those who for all practical purposes function like a married couple—cannot.

For example, unmarried persons who co-own a corporation can more freely engage in redemption transactions in which their corporate share income tax basis offsets distribution income. Married couples are more restricted in this regard. Unmarried persons can buy and sell property between themselves free of related-party rules that re-characterize lower-tax long-term capital gain as higher-tax-rate ordinary income or prevent the purchaser from re-depreciating purchased assets. Members of unmarried couples can serve as counterparties in tax-deferred 1031 exchanges, whereas married couples are restricted in this regard.

The number of persons who would avoid marriage for tax reasons is limited. In our experience, however, some individuals—particularly those with substantial real estate holdings–take these tax planning opportunities into account when deciding whether to marry under the law, even if they are committed in their hearts. Those taxpayers turn Congressional policy on its head, causing tax laws intended to prevent abusive tax avoidance by closely connected individuals into an unintended deterrent to marriage.

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

Use New Construction on Property You Already Own for 1031 Exchange Capital Gains Tax Deferral

A 1031 Exchange is a popular capital gains deferral strategy for business and investment property. When properly implemented, a 1031 Exchange defers tax on property “sold” if the taxpayer acquires new property within a 180-day window, usually in coordination with an intermediary. Related-party rules typically prohibit use of property owned by the taxpayer or a related party as the purchased property.

A newly-released IRS ruling enables some taxpayers to circumvent the related-party rules, to indirectly use property owned by the taxpayer or a related party to complete a 1031 Exchange. This is accomplished by leasing the property to an intermediary, using the proceeds from the property “sold” for new construction, and then acquiring the newly constructed property and the leasehold, all within the 180-day exchange period.

Here is a link to the ruling: www.irs.gov/pub/irs-wd/1408019.pdf. Here is a more technical summary of the ruling:

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