1031 Exchange Services

Non-Docket Service Advice Review (NSAR 19935222)

Internal Revenue Service (I.R.S.)

Non-Docketed Service Review (NSAR)

Issue: October 20, 1993

Section 1031 — Exchange of Property Held for Productive Use or Investment

This refers to your request for advice dated September 7, 1993 regarding the above taxpayer. You requested an opinion as to whether or not certain transactions qualify as a like-kind exchange under I.R.C. Section 1031(a)(3) and Treas. Reg. Section 1.1031-(k).

Statement of Facts

*** ("***" or "***") is the parent company and *** ("***" or "***") is its ***% owned subsidiary. Both *** and *** are calendar year taxpayers. In ***, *** had approximately *** subsidiaries; *** and *** were part of a consolidated return filed by ***. *** highlighters, sticktube glue, accounting paper, notebooks and stationery products.

During early ***, *** owned land with improvements in ***, ***, and *** owned land with improvements in ***, ***. *** desired to exchange both the *** and the *** property for certain property in ***, *** owned by ***, plus a building to be constructed thereon by a contractor, ***. The *** parcel which *** wished to acquire was described as Lots *** through ***, ***, and ***, but was later renumbered as Lots *** through ***. *** already owned a parcel in *** [Lot ***] adjacent to the *** land. The president of both *** and *** was ***, a developer in the *** area.

The value of the *** property was $ *** [Final Exchange Settlement Statement, ***], and the value of the *** property was $ *** [although the Purchase Agreement lists the price of the *** property as $ ***, the property actually sold for $ ***.] The total value of the properties to be relinquished in the exchange was $ ***, approximately *** percent being attributable to property owned by *** and *** percent to property owned by ***. By agreement, the total value of the *** property and building to be constructed thereon was not to exceed $ ***. According to the construction contract, work on the building was required to commence within thirty days of the issuance of a building permit, and the contractor was required to deliver $ *** of the project's value on or before ***.

The parties entered into a series of complex agreements in order to effectuate the transactions. On ***, a Real Estate Exchange Agreement was signed by ***, ***, ***, and ***. Under the terms of this agreement,

(1) *** and *** would convey the *** and *** properties, respectively, to ***;

(2) *** would give a mortgage to *** and *** for the *** and *** properties;

(3) *** would sell the *** and *** properties to third parties designated by *** and ***;

(4) the third parties would deposit the proceeds directly into a Collateral [Escrow] Account;

(5) *** would grant a first priority security interest to *** and *** in the Collateral Account;

(6) *** and *** would enter into a construction contract whereby *** would construct an office building, parking lot, and related work areas, on the *** land and adjacent land already owned by ***;

(7) *** would pay *** for the work with disbursements from the Collateral Account; and

(8) upon completion of the specified improvements, *** would convey the *** land and improvements to *** and *** as tenants in common, the interests of each to be "pro-rated in accordance with percentages of the proceeds" from the sales of the *** and *** properties, respectively.

The conveyance by *** of the *** property was required to occur by the earlier of (1) the disbursement of all the proceeds from the Collateral Account, or (2) the ***h day after the conveyance by *** to *** of the ***, *** property.

The ***, *** property was conveyed by *** to *** on ***, and was sold the same day by *** to ***, a California partnership. The *** property was conveyed by *** to *** on *** and was sold the same day by *** to ***. The *** land, including the partially constructed office building, was conveyed by *** to *** and *** on ***, with *** owning ***% and Stationery owning ***%. Construction of the office building was not completed until ***. However, proceeds in the amount of $ *** were in fact expended from the Collateral Account by ***, $ *** of which was for construction.

In the "Second Amendment to Real Estate Exchange Agreement" dated ***, ***, ***, ***, and *** agreed that in addition to the *** property which *** would convey to *** and *** as tenants in common, *** would also convey "adjacent property" in ***, known as Lots *** and ***, solely to ***. Lots *** and *** had been owned by *** until ***, when they were sold, subject to a $ *** mortgage in favor of ***, to ***. Pursuant to the Second Amendment, *** conveyed this adjacent property [Lots *** and ***] to *** subject to the mortgage owed to ***, on ***, and *** conveyed it solely to *** on ***. *** caused the Escrow Agent to disburse to *** funds in the amount of the *** mortgage plus two other small notes, for a total of $ ***.

As a result of all of the above-described transactions, *** relinquished property valued at $ *** and received property valued at $ *** [***% of $ ***]. *** relinquished property valued at $ *** and received property valued at $ *** [***% of $ ***, or $ ***, plus $ ***].

You have not questioned the exchange of the *** and *** properties for the *** property, but have questioned the transfer of the adjacent property to ***.

Issue on which Advice is Requested

Whether the conveyance by *** of the adjacent *** property [Lots *** and ***] to Stationery should be disallowed as a like-kind exchange under Treas. Reg. Section 1.1031(k), since the property was not identified within forty-five days after the conveyance of the *** property to *** on ***.


I.R.C. Section 1031(a) provides, in general, that no gain or loss shall be recognized on the exchange of property which is held for productive use in a trade or business or for investment, for property of a like kind which is also held for use in trade or business or for investment. The applicable regulations state that "like-kind" refers to the "nature or character of the property and not to its grade or quality;" Treas. Reg. Section 1.1031(a)-1(b). Unimproved property may be exchanged for improved real property, provided both properties are for business use or investment, because improvements relate only to the grade or quality of the property and not to its kind or character. If a property is exchanged for like-kind property plus other property, such as cash ("boot"), any gain on the exchange will be recognized, I.R.C. Section 1031(b), but any loss will not be recognized, I.R.C. Section 1031(c).

An exchange must be a reciprocal transfer of properties, not the transfer of property for money. Spalding v. Commissioner, 7 B.T.A. 588 (1927). However, reciprocal sales of property have been held to constitute like-kind exchanges. Allegheny County Auto Mart, 12 T.C.M. 427 (1933), aff'd per curiam, 208 F.2d 693 (3rd Cir. 1953). If a taxpayer sells a property for cash and later repurchases another property, this will not qualify as a like-kind exchange; Rogers v. Commissioner, 377 F.2d 534 (9th Cir. 1967); Carlton v. Commissioner, 385 F.2d 238 (5th Cir. 1967); Wheeler v. Commissioner, 58 T.C. 459 (1972). The presence of multiple parties and transfers of property will not necessarily disqualify the transactions, Brauer v. Commissioner, 74 T.C. 1134, 1141 (1980); Barker v. Commissioner, 74 T.C. 555 (1980). Three and four party exchanges have been held to qualify as like-kind exchanges if the parties manifested an intent to exchange properties and the exchanges actually occurred, Alderson v. Commissioner, 317 F.2d 790 (9th Cir. 1963), and if the property transfers are "interdependent parts of an overall plan," Biggs v. Commissioner, 69 T.C. 905 (1978).

Deferred, or non-simultaneous, exchanges are permitted as like-kind exchanges if they meet specific timetables set forth in the Code and Regulations, and if they otherwise qualify in substance. Under I.R.C. Section 1031(a)(3), property received by the taxpayer will be treated as property which is not like-kind, if "[it] is not identified as property to be received in the exchange on or before [the 45th day] after the date on which the taxpayer transfers the property relinquished in the exchange," or, if such property is received "after...180 days after the date on which the taxpayer transfers the property relinquished in the exchange..." Treas. Reg. Section 1.1031(k)-1(b)(2)(iii) provides that "If, as part of the same deferred exchange, the taxpayer transfers more than one relinquished property and the relinquished properties are transferred on different dates, the identification period and the exchange period are determined by reference to the earliest date on which any of the properties are transferred."

In this case, the *** property was relinquished by *** on ***. The replacement property to be received by *** - its pro rata portion of the *** land as tenant in common - was identified on ***, prior to the date of the conveyance of the *** property, and thus meets the identification period requirement. The replacement property was received by *** on ***, *** days after the date of the transfer of the relinquished property (***), so the exchange period requirement of 180 days is also met.

With respect to ***, the original agreement of the parties dated ***, identified the pro rata portion of the *** property, but not the adjacent land, as replacement property. The *** property was not relinquished by *** until ***. The additional replacement property - the adjacent property [Lots *** and ***] - was not identified until ***. However, *** received both its portion of the *** property plus the adjacent property by ***, so that all of the transactions occurred within the exchange period of 180 days.

If the transactions are treated as interdependent parts of one overall plan for a deferred exchange, then the regulations state that the identification period and the exchange period are determined by reference to the earliest date that any of the properties are transferred; Treas. Reg. Section 1.1031(k)- 1(b)(2)(iii). Thus, the *** date would trigger the identification period requirement and the adjacent property would not qualify as property of a like kind. This is the position which you have taken. The taxpayer, on the other hand, maintains that there were two separate like-kind exchanges, the first involving *** and ***, and the second involving *** and ***. The taxpayer argues that the 45 day identification period for the second transaction was not triggered until ***, and that since the adjacent property was identified by the ***th day (***), the requirements were in fact met.

We have carefully considered all of the documents and information which you have furnished. After informal consultation with our National Office, we believe that the exchange of the *** property for ***% of the *** property plus the adjacent property does qualify as a like-kind exchange. The Real Estate Exchange Agreement indicates that the parties intended to make one overall exchange of two parcels for a parcel and a building to be constructed. However, it is apparent that the parent and the subsidiary would relinquish separate properties and would receive separate interests in the replacement property. The parties also intended that the replacement properties would be substantially equivalent in value to their respective relinquished properties. The analysis of the values of the relinquished and replacement properties indicates that there were reciprocal exchanges between *** and ***. Therefore, the taxpayer would probably be successful arguing in Court that there was a separate agreement between *** and ***, under which the *** property was relinquished on ***, the replacement properties were identified by *** days thereafter, on ***, and the replacement properties were received by *** days thereafter, on ***.

Even if the Second Amendment did not trigger a second *** day identification period, and all of the dates had to be measured from the first transfer by *** on ***, the taxpayer might also be successful in arguing that all portions of the transaction qualify as like-kind exchanges. The regulations provide certain exceptions from the identification requirements which the taxpayer would probably invoke. The taxpayer could argue that the adjacent property was "incidental" to a larger item of property (the *** property) and should therefore be disregarded, as permitted under Treas. Reg. Section 1.1031(k)- 1(c)(5)(i). To qualify as "incidental" property, the taxpayer would have to show that "(A) In standard commercial transactions, the property is typically transferred together with the larger item of property, and (B) The aggregate fair market value of all of the incidental property does not exceed 15 percent of the aggregate fair market value of the larger item of property." The adjacent property includes separate undeveloped lots, but you have also indicated that it includes one of the access roads. The taxpayer would meet the fair market value test, assuming the value of the adjacent property was approximately the same as the mortgage of $ ***. As of the ***th day after the transfer of the *** property by ***, the value of the larger property transferred by *** [the *** land and partially constructed building] was $ ***, *** percent of which is $ ***.

The taxpayer might also argue under Treas. Reg. Section 1.1031(k)-1(d)(i) and  (ii) that the replacement property was received before the end of the exchange period and that it is "substantially the same property as identified." All of the replacement property was received before the end of the exchange period, and the additional two undeveloped lots do not change the basic nature or character of the property which Stationery received as a whole. Treas. Reg. Sec. 1.1031(k)-1(d)(2), ex. 4. Rather, it appears that the additional two lots may have been added to the replacement property in order to even out the exchange.

This is a fact-intensive issue, and the facts are subject to different interpretations. However, on balance, it appears that the taxpayer would be successful defending this transaction as a like-kind exchange, and it would be difficult for the Service to prevail in Court on this issue if the exchange were disallowed.

Gerald J. O'Toole

District Counsel


David N. Brodsky

Assistant District Counsel


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