PLR 1220012: Related parties may complete linked like-kind exchanges

Plain-English summary

The IRS ruled that a taxpayer could receive like-kind replacement property from related parties through a linked series of deferred exchanges without losing the benefits of IRC § 1031. The related parties had to conduct their own like-kind exchanges, hold the replacement properties for at least two years after the last transfer, and generally receive no more than a minimal amount of non-like-kind property. The ruling also treats each party as a separate taxpayer for the 45-day identification period, the replacement period, and the limits on identifying alternative properties. The ruling addresses only the specific proposed transactions and conditions stated by the taxpayer.

Ruling snapshot

• Question: Do related-party exchanges in a linked series remain eligible for like-kind exchange treatment, and how do the identification deadlines apply?
• Outcome: Approved
• Key authorities: IRC § 1031(a) and (f); Treas. Reg. §§ 1.1031(k)-1(c)(4) and (g)(3)(iii)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201220012 Third Party Communication: None
Release Date: 5/18/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1031.02-00 ---------------------------, ID No. ----------------
-----------------
Telephone Number:

                                                            ---------------------

----------------------------------------------- Refer Reply To:
-------------------------------------------------- CC:ITA:B04
------------------------- PLR-134451-11
Date:
February 7, 2012

               TY: --------------------------

Legend

Prime Taxpayer (PT) = ---------------------------------------------------------------------------------
Affiliate = ------------------------------------------------------
Related Party = ----------------------------------------------------
Parent = ---------------------------------
Subsidiary = -------------------------
LLC#1 = -------------------------
Holding = -----------------------------
Affiliate LLC = ---------------------------------------
Unrelated Buyer = --------------------------------------
RQ = ---------------------------------------------------------------------------------
RP (Affiliate RQ) = ---------------------------------------------------------------------------------
Date 1 = -------------------
Date 2 = -------------------
Date 3 = -----------------------
Date 4 = -------------------------
$x = ------------------
$y = ------------------

Dear -------------

This responds to your request for a private letter ruling, dated August 11, 2011,
submitted on behalf of Prime Taxpayer (PT), Affiliate, and Related Party, regarding the
application of § 1031(f) of the Internal Revenue Code to their exchanges of property.
The primary question you raise is whether § 1031(f) makes the benefits of § 1031(a)
unavailable for taxpayers engaging in a series of transactions with related parties when
each transaction in the series otherwise qualifies for deferral under § 1031(a), and none
of the parties receive more than a minimal amount of non-like-kind property in their
PLR-134451-11 2

transactions. PT, Affiliate and Related Party also request rulings on the manner in
which the identification and replacement period rules apply in the transactions.

FACTS:

1. PT’s Organizational Identity and Structure.

PT is a limited partnership. Parent is a real estate investment trust (REIT). PT is the
operating partnership for Parent, which operates through an UPREIT structure. Parent
owns 95.5 percent of the interests in PT and is its sole general partner. Various outside
partners own the remaining 4.5 percent of the interests in PT. PT conducts its
operations and owns properties directly and through various subsidiary entities,
including single-member limited liability companies that are disregarded for federal
income tax purposes. One of these is LLC#1, the owner of PT’s relinquished property
(RQ).

PT also has interests in other subsidiary entities that are not disregarded for federal
income tax purposes. One of these is Affiliate, which is a limited partnership that is
99.99 percent owned by PT. The other .01 percent is held by Holding, a corporation.
PT owns 100 percent of Holding. Parent and Holding have jointly elected to treat
Holding as a taxable REIT subsidiary under § 856(l) of the Code. Another of these
entities is Related Party, a limited liability company 99 percent owned by Taxpayer and
1% by Subsidiary. Subsidiary is a corporation that is wholly owned by Parent.

2. The Exchange Transactions.

   A. PT’s Exchange

PT engaged in a deferred like-kind exchange through a qualified intermediary (QI) and a
qualified trustee (QT) under an exchange agreement and a qualified exchange trust
agreement.1 On Date 1, PT (by its wholly-owned LLC#1), pursuant to the exchange
agreement and a prior sales agreement, conveyed RQ by direct deed to Unrelated
Buyer for $x.

On Date 2, PT timely identified replacement property (RP) as a potential replacement
property for RQ, along with two other potential replacement properties. RP was owned

1
The term “qualified exchange trust agreement” as used in this letter is the type of trust agreement
described in § 1.1031(k)-1(g)(3)(iii) of the Income Tax Regulations. Taxpayer describes specific steps in
these combined transactions, including Taxpayers entering into exchange agreements, qualified
exchange trust agreements, assignments, notices of assignments, etc., and represents that PT, Affiliate
and Related Party are meeting all requirements for deferral in these transactions under the safe harbor
rules of the regulations and other relevant published guidance. Since these steps are not directly relevant
to the rulings sought by Taxpayer, this letter will not describe them with the same amount of detail given
in Taxpayer’s ruling application.
PLR-134451-11 3

by Affiliate through its wholly-owned limited liability company, Affiliate LLC, a
disregarded entity for federal income tax purposes.

On Date 3, PT timely acquired RP when it acquired from Affiliate 100 percent of the
membership interest of Affiliate LLC for $y, an amount exceeding the sales price of RQ.

B. Affiliate’s Exchange

Affiliate entered into an exchange agreement and a qualified exchange trust agreement
to facilitate the exchange of RP (Affiliate RQ) for like-kind replacement property (Affiliate
RP). At the closing of the transfer of RP (which was Affiliate RQ) to PT, the net
proceeds were received by Affiliate’s QI and QT. On Date 4, Affiliate timely identified
three properties as potential replacement properties for Affiliate RQ. One of these
identified properties is held by Related Party.

If Affiliate acquires Affiliate RP at a cost that is less than the amount realized on the
disposition of Affiliate RQ, the difference will result in Affiliate recognizing gain equal to
the difference. However, Affiliate represents that the amount of gain Affiliate will have to
recognize as a result of acquiring Affiliate RP for less than the amount realized for
Affiliate RQ will not exceed 5 percent of the gain realized by Affiliate on its disposition of
Affiliate RQ.

C. Additional Related Party Exchanges

To the extent any Affiliate RP is acquired from Related Party, prior to transfer of such
property to Affiliate, Related Party will enter into a deferred exchange agreement with a
QI providing for the Related Party’s exchange of Affiliate RP that it transfers to Affiliate.
Thus the Affiliate RP to be transferred by Related Party will be Related Party’s
relinquished property (Related Party RQ).

Before the expiration of the statutory identification period, Related Party will identify
potential replacement properties (Related Party RP). All potential Related Party RP will
be owned by parties unrelated to PT, Affiliate and Related Party. Related Party will
acquire ownership of some or all of the potential Related Party RP within the
replacement period provided in § 1031(a)(3)(B).

If Related Party acquires Related Party RP through a QI at a cost that is less than the
amount realized on the disposition of Related Party RQ, the difference will result in
Related Party recognizing gain equal to the difference. However, Related Party
represents that the amount of gain Related Party will have to recognize will not exceed
5 percent of the gain realized by Related Party on its disposition of the Related Party
RQ.
PLR-134451-11 4

PT, Affiliate and Related Party receiving replacement properties from related parties in
the series of exchanges described in this letter will hold their replacement properties for
at least two years following the date of the acquisition of the last property acquired by
any of the parties in these described transactions.

APPLICABLE LAW & ANALYSIS:

Application of § 1031(f)

Section 1031(a)(1) of the Code provides that no gain or loss is recognized on the
exchange of property held for productive use in a trade or business or for investment if
the property is exchanged solely for property of like kind to be held either for productive
use in a trade or business or for investment.

Section 1031(f)(1) provides that if--(A) a taxpayer exchanges property with a related
person, (B) there is nonrecognition of gain or loss to the taxpayer under § 1031 on the
exchange of such property (determined without regard to § 1031(f)), and (C) before the
date 2 years after the date of the last transfer that was part of the exchange—
(i) the related person disposes of the property, or
(ii) the taxpayer disposes of the property received in the exchange from the related
person that was of like kind to the property transferred by the taxpayer,
there is no nonrecognition of gain or loss under § 1031 to the taxpayer on the
exchange. Any gain or loss recognized by the taxpayer by reason of §1031(f) must be
taken into account as of the date on which the disposition referred to in (C) occurs.

Section 1031(f)(2)(C) provides that, for purposes of the application of § 1031(f)(1)(C), a
disposition is not taken into account if it is established to the satisfaction of the
Secretary that neither the exchange nor the disposition had as one of its principal
purposes the avoidance of federal income tax.

Section 1031(f)(4) provides that § 1031 does not apply to any exchange that is part of a
transaction (or series of transactions) structured to avoid the purposes of § 1031(f).

Section 1031(f)(1) is not applicable to PT’s exchange of RQ for RP because PT is
exchanging property with QI, who is not a related person to PT. The same is true of the
separate exchanges of Affiliate and Related Party. However, under § 1031(f)(4), if PT
(or Affiliate or Related Party) is using a QI or EAT to structure its transactions with tax
avoidance as one of its principal purposes, § 1031 will not apply to the exchange. See,
e.g., Teruya Brothers Ltd. v. Commissioner, 580 F.3d 1038 (9th Cir. 2009); Ocmulgee
Fields v. Commissioner, 613 F.3d1360 (11th Cir. 2010); and Rev. Rul. 2002-83, 2002-2
C.B. 927.
PLR-134451-11 5

Both the House Ways and Means Committee and the Senate Finance Committee
disclosed the policy concern that led to the enactment of § 1031(f):

   Because a like-kind exchange results in the substitution of the basis of the
   exchanged property for the property received, related parties have
   engaged in like-kind exchanges of high basis property for low basis
   property 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 property, 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 (1989).

The Senate Finance Committee Print, however, also gives three examples of fact
situations for which it is deemed established for purposes of § 1031(f)(2(C) that neither
the exchange nor such disposition had as one of its principal purposes the avoidance of
federal income tax. One of the three involves “. . . dispositions of property in
nonrecognition transactions.” S. Print. No. 56, 152.

In the present case, the only acquisitions of replacement property from related entities
will be as part of subsequent like-kind exchanges by these related entities, which will
substantially constitute nonrecognition transactions. Affiliate will be relinquishing
property to PT as part of its own like-kind exchange with Related Party and Related
Party will relinquish property to Affiliate as part of its separate like-kind exchange for
replacement property from one or more unrelated parties. Since both Affiliate and
Related Party are also structuring their respective dispositions of property as exchanges
for like-kind replacement property, neither § 1031(f)(1) nor (f)(4) will apply to trigger gain
recognition in PT’s exchanges or to disqualify the application of § 1031 to any exchange
in this series of transactions.

Furthermore, there is no material cashing out by any of the related parties within 2 years
of the last transfer in the series of transactions because neither Taxpayer, Affiliate nor
Related Party will receive non-like-kind replacement property greater than 5 percent of
the gain realized on disposition of relinquished property. Upon completion of the series
of transactions, all related parties will own the properties received in these exchanges
that are of like kind to the properties exchanged for at least two years after the date of
the last transfer in the series.

Application of the identification and replacement period rules
PLR-134451-11 6

Section 1031(a)(3) provides that for purposes of § 1031(a), any property received by the
taxpayer is treated as not like-kind property if—

(A) the property is not identified as property to be received in the exchange on or
before the day which is 45 days after the date on which the taxpayer transfers the
property relinquished in the exchange, or

(B) the property is received after the earlier of—
    (i) the day which is 180 days after the date on which the taxpayer transfers the

property relinquished in the exchange, or
(ii) the due date (determined with regard to extension) for the transferor’s return of
the tax imposed by this chapter for the taxable year in which the transfer of the
relinquished property occurs.

Section 1.1031(k)-1(c)(4) provides rules limiting the number and the fair market value of
potential replacement properties that exchanging taxpayers may identify prior to their
receipt of replacement property.

In the present case, PT, Affiliate and Related Party represent that they are separate
taxpayers that will separately report the results of any exchange, including the
realization and recognition of gain or loss on the dispositions. Thus, each must be
regarded as undertaking its own exchange transaction with an identification and
replacement period that would apply separately to that party’s exchange. Thus, for
example, Date 1 would be the day on which PT’s 45-day identification period would
begin, whereas Affiliate’s identification period would begin when Affiliate transfers its
RQ and Related Party’s identification period begins when Related Party transfers its
RQ. Similarly, each party would separately apply the limits on identification of multiple
or alternative properties under §1.1031(k)-1(c)(4).

RULINGS:

1. Section 1031(f)(1) and (f)(4) of the Code do not apply to disqualify PT from the
   benefits of § 1031(a) in its exchanges with related parties provided that (A) each
   related party transferring replacement property into the exchanges described in this
   letter is also engaging in its own like-kind exchange and (B) PT, Affiliate and Related
   Party hold their replacement properties for at least two years after the date of the
   last transfer of property in the exchanges.

2. Receipt by Affiliate or Related Party of non-like-kind property equal to no more
   than 5 percent of the gain realized by Affiliate or Related Party, respectively, in its
   exchange will not result in the application of § 1031(f) to PT in its exchange.

3. Each transfer of relinquished property by PT, Affiliate or Related Party in its
   separate exchange will result in a separate identification period and replacement
   PLR-134451-11 7

   period provided in § 1031(a)(3) commencing on the date of the respective party’s
   initial transfer of relinquished property.

   4. Each transfer of relinquished property by PT, Affiliate or Related Party in its
      separate exchange will result in a separate application of the limits on identification
      of multiple or alternative replacement properties provided in §1.1031(k)-1(c)(4).

CAVEATS:

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 taxpayers requesting it. Section 6110(k)(3)
of the Code provides that it may not be used or cited as precedent.

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 provides the date and control number of the
letter ruling.

The ruling contained in this letter is based upon information and representations
submitted by PT, Affiliate and Related Party and accompanied by a penalty of perjury
statement executed by an appropriate party. This ruling is also based upon the
representation that PT, Affiliate and Related Party receiving replacement properties
from related parties in the series of exchanges described in this letter will hold their
replacement properties for at least two years following the date of the acquisition of the
last property acquired by any of the parties in these described transactions.

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.

                                     Sincerely,

                                     Michael J. Montemurro
                                     Chief, Branch 4
                                     (Income Tax & Accounting)

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