Trust termination did not defeat beneficiary's Section 1031 holding purpose

Plain-English summary

A testamentary trust held real property for investment and began negotiating its disposition before the death that required the trust to terminate. Under a proposed court-approved termination plan, the trustees would distribute an undivided tenancy-in-common interest, subject to the sales contract, to a disregarded single-member LLC owned by a beneficiary. The LLC would dispose of the interest and pursue a separate like-kind exchange for replacement property to be held for investment. The IRS ruled that the involuntary termination and distribution would not prevent the interest from satisfying Section 1031's productive-use-or-investment holding requirement. The termination plan would proceed independently of whether the beneficiary completed the exchange, distinguishing voluntary prearranged transfers in Revenue Rulings 75-292 and 77-337. The ruling did not decide whether the transaction otherwise qualified for gain deferral under Section 1031 or whether the trust remained in existence for federal tax purposes.

Ruling snapshot

• Question: Does the trust's involuntary termination and distribution of a sale-contracted tenancy-in-common interest prevent the beneficiary from holding that interest for Section 1031 purposes?
• Outcome: approved
• Key authorities: IRC § 1031(a); Treas. Reg. §§ 1.1031(a)-1(b), 1.641(b)-3(b), 301.7701-2(c)(2), 301.7701-3(b)(1)(ii); Rev. Ruls. 75-292 and 77-337

Full text (IRS public release)

 Internal Revenue Service                                  Department of the Treasury
                                                           Washington, DC 20224

 Number: 202416012                                         Third Party Communication: None
 Release Date: 4/19/2024                                   Date of Communication: Not Applicable
 Index Number: 1031.00-00, 1031.01-00
                                                           Person To Contact:
 --------------------------------                          ---------------------, ID No. ------------------
 ---------------------                                     Telephone Number:
 -----------------------------                             --------------------
                                                           Refer Reply To:
 In Re:                                                    CC:ITA:B04
          --------------------------                       PLR-114894-23
          -------------------------                        Date:
                                                           January 22, 2024




                                                LEGEND

 Taxpayer   = ---------------------------------------------------------------------------------------------
              --------------------------
 Property   = -------------------------------------------
 Trust      = ---------------------------------------------------------------------------------------------
              -------------------------
 Will       = ---------------------------------------------------------------------------------------------
              ---------------------------------------------------------------------------------------------
              -------------------------
 Decedent = -------------------
 State Z    = ---------
 Date 1     = ----------------
 Date 2     = -------------------
 Date 3     = -------
 Date 4     = -------
 Date 5     = -------------------------
 Date 6     = ------------------
 Individual = -------------------
 X          = --------------
 Y          = -------
 Daughters = ---------------------------------------------------------------------------------------------
              ------------
 Trustees   = ---------------------------------------------------------------------------------------------
              ----------------

Dear --------------:

This is in response to your request for a private letter ruling, dated Date 6, as to the
application of 1031(a) of the Internal Revenue Code (“Code”) to the proposed
PLR-114894-23                                2

transaction. Specifically, you have requested a ruling that the distribution from Trust to
be made to Taxpayer of an undivided tenancy-in-common (“TIC”) interest in Property,
subject to a binding contract for its disposition, as result of Trust’s involuntary
termination, will not preclude such interest from being held for investment or for the
productive use in a trade or business within the meaning of § 1031(a) of the Code.

                                         FACTS

Taxpayer is one of X beneficiaries of Trust, a testamentary trust whose terms were
established by Decedent’s Will, dated Date 1, for the benefit of her Daughters and their
descendants. Trust, created on Date 2, holds Property, real property located in State Z.
Decedent’s Will provided for the Trust to cease upon the death of the last surviving child
of Daughters who was living upon the death of Decedent (“Terminating Event”) and
directed Trustees to distribute the Trust corpus to the beneficiaries in due course.
Decedent’s Will granted Trustees broad powers to determine the nature of property and
cash proceeds includible in any distributions and made those determinations binding on
the beneficiaries. In addition, it did not provide the beneficiaries with the right to
alienate his or her interest in the Trust.

During the period between Date 3 and Date 4, Trustees took no significant actions to
dispose of the Property. After Date 4, Trustees, in their fiduciary duty to preserve the
Trust corpus, determined that it would be in the best interests of the beneficiaries to
engage in a like-kind exchange, under § 1031 of the Code, of the Property for other real
properties and began negotiations with a potential buyer for its disposition. On Date 5,
during the negotiations with the potential buyer, the Terminating Event occurred upon
the death of Individual. After Date 5, Trustees completed negotiations and entered into
a sales contract, subject to a due diligence clause, with the buyer to dispose of the
Property (“Sales Contract”). At that time, Trustees also determined that it was no longer
feasible for the Trust to consummate a § 1031 like-kind exchange of Property for other
real properties because of the Terminating Event.

Trustees informed the beneficiaries of their intention to request for the State Z Probate
Court (“Court”) to approve the disposition of Property as part of the overall approval of
the termination plan for the Trust (“Termination Plan”).

Upon the Court’s approval, the Termination Plan will include the transactions described,
in part, below. Trustees will finalize the Sales Contract to dispose of the Property with
the buyer or another buyer in the unlikely event that the existing buyer terminates the
Sales Contract after the due diligence period.

As part of the Termination Plan, Trustees agreed to accommodate any beneficiaries
interested in completing exchanges in a manner like that which the Trustees initially
contemplated prior to the Terminating Event. Y beneficiaries, including Taxpayer,
informed Trustees of their desire to complete such an exchange (“Exchanging
Beneficiary”).
PLR-114894-23                                 3


Limited liability companies (hereinafter referred to as “LLC” or collectively as “LLCs”) will
be formed and owned separately by each Exchanging Beneficiary, including Taxpayer.
Each LLC will be disregarded as an entity separate from its sole member, within the
meaning of § 301.7701-2(c)(2) and § 301.7701-3(b)(1)(ii) of the Procedure and
Administration Regulations and will be managed initially by Trustees.

Following the creation of the LLCs, Trustees will make distributions of the appropriate
undivided TIC interests in the Property, subject to the Sales Contract, to each
Exchanging Beneficiary’s LLC. Shortly after the distributions, Trustees will cause the
disposition of the TIC Interests. Each Exchanging Beneficiary, through his or her
respective LLC, will engage in a separate exchange transaction.

Taxpayer also makes the following additional representations:

1. The Property has been held by the Trust for investment purposes throughout the
   Trust’s existence.
2. Any replacement properties acquired by Taxpayer through her LLC will be held for
   investment purposes.
3. The disposition of Taxpayer’s TIC Interest and the acquisition of replacement
   properties by Taxpayer through her respective LLC will be accomplished in a
   manner that in all respects, aside from the issue raised in this ruling, qualifies the
   transactions as a like-kind exchange eligible for nonrecognition treatment under §
   1031 of the Code and the Income Tax Regulations thereunder.
4. Trust’s winding-up period, within the meaning of § 1.641(b)-3(b) of the Income Tax
   Regulations, has not been unduly postponed.

                                   LAW AND ANALYSIS

Section 1031(a)(1) of the Code provides 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
the property is exchanged solely for property of a like kind which is held either for
productive use in a trade or business or for investment.

Section 1.1031(a)-1(b) of the Income Tax Regulations defines “like kind” as referring to
the nature or character of the property and not to its grade or condition. The fact that
the real estate involved in the exchange is improved or unimproved is not material, for
that fact relates only to the grade or the quality of the property and not to its kind or
class.

Section 1.641(b)-3(b) of the Income Tax Regulations generally provides that the
determination of whether a trust has terminated depends upon whether the property
held in trust has been distributed to the persons entitled to succeed to the property upon
termination of the trust rather than upon the technicality of whether or not the trustee
has rendered its final accounting. A trust does not automatically terminate upon the
PLR-114894-23                                4

happening of the event by which the duration of the trust is measured. A reasonable
time is permitted after such event for the trustee to perform the duties necessary to
complete the administration of the trust. However, the trust’s winding-up period cannot
be unduly postponed and if the distribution of the trust corpus is unreasonably delayed,
the trust will be considered as terminated for federal income tax purposes after the
expiration of a reasonable period for the trustee to complete the administration of the
trust.

Under § 301.7701-3(b)(1)(ii) of the Procedure and Administration Regulations, a
domestic eligible entity is generally (with exceptions noted) disregarded as an entity
separate from its owner if it has a single owner.

Section 301.7701-2(c)(2) of the Procedure and Administration Regulations, provides
that, in general, a business entity that has a single owner and is not a corporation (as
defined in § 301.7701-2(b)) is disregarded as an entity separate from its owner for
federal tax purposes.

In Rev. Rul. 75-292, 1975-2 C.B. 333, an individual taxpayer, in a prearranged
transaction, transferred land and buildings used in the taxpayer’s trade or business to
an unrelated corporation in exchange for land and an office building owned by the
corporation and used in its trade or business. Immediately following the exchange, the
individual taxpayer transferred the newly acquired land and office building to the
individual’s newly created corporation in exchange for stock in the same corporation in a
transaction that qualified for nonrecognition of gain under § 351. The revenue ruling
concluded that the individual taxpayer did not exchange the real estate for other real
estate to be held either for productive use in a trade or business or for investment by
that taxpayer but that the taxpayer acquired the replacement property for the purpose of
transferring it to the new corporation. As a result, the exchange did not qualify for
nonrecognition under § 1031.

In Rev. Rul. 77-337, 1977-2 C.B. 305, an individual taxpayer, in a prearranged plan,
liquidated all the stock of a corporation and transferred the corporation’s sole asset, a
shopping center, to a third party in exchange for like-kind property. Rev. Rul. 77-337
noted that under Rev. Rul. 75-292, a newly created corporation’s eventual productive
use of property in its trade or business is not attributable to its sole shareholder.
Consequently, the individual taxpayer did not hold the shopping center for use in a
trade or business or for investment, because the corporation’s previous trade or
business use could not be attributed to its sole shareholder. Thus, the exchange did not
qualify for nonrecognition of gain or loss under § 1031.

Section 1031 of the Code includes a “holding” requirement that requires both the
relinquished property and the replacement property to be held for productive use in a
trade or business or held for investment. This provision was designed, in part, to
postpone the recognition of gain or loss when property used in a trade or business or
held for investment is exchanged for other property in the course of the continuing
PLR-114894-23                                 5

operation of that trade or business, or in the course of investment. Under these
circumstances, a taxpayer is not considered to have received a gain nor suffered a loss
in a general and economic sense, nor has the exchange of property resulted in the
termination of one venture and an assumption of a new venture. The business venture
operated before the exchange continues after the exchange without any real economic
change or alteration, and without the realization of any cash or readily liquefiable
assets. See Carlton v. United States, 385 F.2d 238 (5 th Cir. 1967); Jordan Marsh Co. v.
Comm’r, 269 F.2d 453 (2 nd Cir. 1959); cf. Portland Oil Co. v. Comm’r, 109 F.2d 479 (1st
Cir. 1940). See generally § 1.1002-1(c) (“[t]he underlying assumption of these
exceptions [e.g., § 1031] is that the new property is substantially a continuation of the
old investment still unliquidated”).

In this case, the Terminating Event, as defined by the terms of Trust’s governing
instrument, occurred after many years of the Trust’s existence. Because the Trust was
a testamentary trust, the Terminating Event was fixed by the Decedent and could not be
modified or changed.

Based on the representation that Taxpayer’s LLC will be disregarded as an entity
separate from Taxpayer, the distribution of the TIC Interest by Trust to the LLC will be
considered, for federal income tax purposes, as a distribution of the TIC interest to
Taxpayer. The Termination Plan is anticipated to be approved by the State Z Probate
Court and implemented as described above without regard to whether the exchange of
Taxpayer’s TIC Interest for eligible like-kind replacement property is consummated
(“Proposed Exchange”). Accordingly, Trust’s distribution of Taxpayer’s TIC Interest,
pursuant to the Termination Plan, will be wholly independent of Taxpayer’s Proposed
Exchange. The facts herein are distinguishable from those in Rev. Rul. 75-292 and
Rev. Rul. 77-337, which involve voluntary transfers of properties pursuant to
prearranged plans.

Based on the authorities discussed above and the facts and representations submitted
by Taxpayer, we rule that the distribution from Trust to be made to Taxpayer of the TIC
Interest, subject to the Sales Contract, as result of Trust’s involuntary termination, will
not preclude such Interest from being held for investment or for the productive use in a
trade or business within the meaning of § 1031(a) of the Code.

This ruling is based upon facts and representations submitted by Taxpayer and
accompanied by a penalty-of-perjury statement executed by an appropriate party. This
office has not verified any of the material submitted in support of the request for a ruling.
However, as part of an examination process, the Service may verify the factual
information, representations, and other data submitted. No determination is made by
this ruling letter as to whether the described transaction otherwise qualifies for deferral
of gain realized under § 1031 of the Code. We have no opinion, express nor implied,
except as specifically ruled above, as to the federal income tax treatment of the
transaction under any other provisions of the Code and regulations that may be
applicable or under any other general principles of federal income taxation. Nor is any
PLR-114894-23                                  6

opinion expressed as to the tax treatment of any conditions existing at the time of, or
effects resulting from, the transaction(s) that are not specifically covered by the above
ruling. Further, no determination is made by this ruling letter as to whether the Trust
remains in existence within the meaning of § 1.641(b)-3(b) of the Income Tax
Regulations.

A copy of this ruling letter should be attached to any income tax return to which it is
relevant.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the
Code provides that this ruling may not be used or cited as precedent.

This letter ruling is being issued electronically in accordance with Rev. Proc. 2023-1,
2023-1 I.R.B. 1. A paper copy will not be mailed to Taxpayer.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to Taxpayer’s authorized representatives.


                                                   Sincerely,




                                                   Alexa T. Dubert
                                                   Senior Technician Reviewer
                                                   Branch 4
                                                   Office of Associate Chief Counsel
                                                   (Income Tax & Accounting)




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