The U.S. Supreme Court has refused to review a case involving like-kind property exchanges. The Ninth Circuit had affirmed a Tax Court decision that denied IRC Sec. 1031 tax-deferred treatment to exchanges of real property. In the case, the taxpayer intended to sell real property at a gain to an unrelated party and buy other property from a related party. The taxpayer used a “qualified intermediary” to accomplish both transactions.
The intermediary bought the first piece of property from the taxpayer and then sold it to the third party. Then the intermediary bought the first piece of property from the taxpayer and then sold it to the third party. The intermediary then used that cash to buy the second piece of property from the related party and sell it to the taxpayer.
The Ninth Circuit held that the transactions were (in form) not between related parties and would not be a nontaxable like-kind exchange. However, the transactions were wrongly structured to avoid the related-party restrictions. Thus, the transactions were denied nontaxable treatment.
IRC Sec. 1031 is a very taxpayer friendly portion of the code as it allows property that is used in a trade or business to be sold without incurring capital gains taxes as long as the property is replaced with a “like-kind” piece of property. If property is exchanged with a related party and then sold within two years, the transaction then loses its tax deferred status. The present case is another illustration of what the IRS call “substance over form”. While the form of the transaction may have been with the intermediary, the substance of the transaction was between two related parties.
By: Basi & Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors