Originally published on Forbes.com July 16th, 2013
Awesome man. Two like-kind exchange (Code Section 1031) posts in the same week. My cup runneth over. Unlike CCA 201325011, the Tax Court decision in VIP’s Industries, Inc. is not a happy one for taxpayers. On the other hand, it is hardly a surprise. There are several requirements that have to be met for a transaction to qualify for 1031 treatment.
For example, both the relinquished property and the replacement property have to be used in a trade or business or held for investment. In the case of deferred exchanges there are tight time requirements and restrictions on who can act as a facilitator. The exchange cannot be of partnership interests or choses in action, whatever they are. There is one requirement that you don’t see litigated very often. The properties have to be of “like kind”. I guess that’s whey they are called like-kind exchanges. Duh.
Of course like-kind is more of a term of art than a common sense concept. The regulations on whether personal property is like-kind to other personal property are pretty complicated. Real estate is much simpler. Most real estate is like-kind to most other real estate. VIP’s Industries managed to find one of the exceptions:
On March 30, 2006, petitioner, through Phoenix Inns, sold its leasehold interest in the Eugene property to a Wall Street investment firm and deposited the proceeds with a qualified intermediary (QI), First American Exchange Co., LLC. The Wall Street firm established PIH Eugene, LLC to hold the leasehold interest in the Eugene property. When Phoenix Inns assigned its interests under the ground lease to PIH Eugene, LLC, a term of 21 years and 4 months remained under the ground lease.
The parties disagree (1) whether petitioner’s leasehold interest in the Eugene property was of like kind to the fee interests in the Bridgeport and Salem properties; and (2) even if the leasehold interest in the Eugene property was not of like kind to the fee interests in the Bridgeport and Salem properties, whether petitioner’s motel improvements on the Eugene property were of like kind to those fee interests.
The taxpayer pointed out that the 30 years is in the nature of a safe harbor. The back-up argument was that even if the ground lease did not qualify as like-kind, the improvements should. The Tax Court was having none of it.
Petitioner exchanged its leasehold interest in the Eugene property with a remaining term of 21 years and 4 months for fee interests in the Bridgeport and Salem properties. We previously have held that leasehold interests with similar or even longer terms than the one at issue here are not equivalent to fee interests. In May Dep’t Stores Co. v. Commissioner, 16 T.C. at 556, we held that a 20-year leasehold was not equivalent to a fee interest. In Standard Envelope Mfg. Co. v. Commissioner, 15 T.C. at 48, we held that a leasehold interest with a term of 1 year and an option to renew for a term of 24 years was not equivalent to a fee interest, and we have held that options to renew are included in determining whether a leasehold interest is equivalent to a fee interest. See Peabody Natural Res. Co. v. Commissioner, 126 T.C. at 275; Century Elec. Co. v. Commissioner, 15 T.C. 581, 591-592 (1950), aff’d, 192 F.2d 155 (8th Cir. 1951).
I can’t help but wonder if it would have worked for VIP’s to have had the exchange facilitator acquire a 21 year leasehold interest in the replacement and then itself acquire the residual interest with non-exchange funds. We may never know.
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Afternote
I’m still playing catch-up. I noted that Tony Nitti has already posted on this case, which normally would have been grounds for skipping it. I try to be thorough in a few areas, though, and Code Section 1031 is one of them.