Swapping Multiple Properties Can Nix Tax Play

Many companies rely on the 1031 rule to avoid triggering taxable gains until there is a sale. But a new private letter ruling from the IRS may make it virtually impossible to hold on to the full tax benefit when exchanging multiple properties.

Bob Willens 2

The often-used Section 1031 rule allows two companies that swap similar properties to defer recognition of capital gains until a sale takes place. Essentially, if two corporations exchange two properties of “the like kind” the gain is not immediately recognized. The term “of a like kind” usually refers to property that are the same in nature or have the same characteristics, regardless of whether they differ in quality.

The Internal Revenue Code is clear. In Section 1031(a) it states 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 a “like kind” which is to be so held. The 1031 rule also says that if other property or money ‚ aside from the like kind property — was received in the swap and was counted as a gain, then that excess amount must be recognized at its fair market value. (See Section 1031(b).)

In an 1989 revenue ruling (Rev. Rul. 89-121, 1989-2 C.B. 203), an example was offered to illustrate how Section 1031 worked in practice. Essentially, two corporations — Xena Corp. and Yuba Corp. made a deal to exchange television stations they owed. In the deal, Xena swapped its two television stations, WXKK and WXLL, for Yuba’s WYHH. As is prescribed by Section 1031, the deal was completed for good business reasons, and to comply with regulatory imperatives.

An earlier revenue ruling (Rev. Rul. 85-135, 1985-2 C.B. 181), which originally addressed the corporate exchange, held that Xena and Yuba each received property of a like kind, and therefore each corporation qualified for non-recognition under Section 1031(a).

However, in so holding, the first ruling failed to address the manner in which like kind property is determined in the exchange. So the 1989 ruling filled the void, concluding that transfer of assets cannot be treated as an exchange of a single property for another single property in applying Section 1031(a). Rather, to determine whether Section 1031(a) applies, an analysis of the underlying assets exchanged is required. This comminution approach is now firmly embedded in the regulations 1.

More important, a new private letter ruling from the IRS indicates that its possible that some gain must be recognized with respect to a like kind exchange — even when the properties exchanged are of a like kind, and no cash or other property is received in the exchange.

Matching Up Properties

In a IRS letter dated September 29, 2008, (LTR 200901004, ) a situation is describe in which the taxpayer owns an “old facility” and proposes to exchange it for like kind property referred to as the “new facility.” No liabilities will be assumed by either party or transferred from one party to the other in connection with the exchange. No land interest is involved in the transaction.

The letter refers to the 1031 rule — specifically IRS Regulation Section 1.1031(a)-2(b)(1) — with regard to personal property, and goes on to say that depreciable tangible personal property is considered to be exchanged for property of a like kind if the property being swapped is either of like kind or “like class.” Like class, in this case, is defined as properties within the same General Asset Class or within the same Product Class.


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