The Tax Cuts and Jobs Act limited like-kind exchanges under §1031 to exchanges of real property effective January 1, 2018. The IRS has issued proposed regulations, [1] upon which taxpayers may rely,[2] to implement these revisions in §1031.

The IRS issued a private letter ruling to a taxpayer dealing with both the exclusion of gain on the sale of a residence under IRC §121 and the like-kind exchange provisions of IRC §1031 in PLR 201944006.[1]

The ruling involves a piece of property.

• One of the taxpayers had purchased the property to use as a principal residence, and when the taxpayers were married they continued to use it as their principal residence.  Eventually the taxpayers moved into a new residence.

• The property was then offered to rent.  While there was a period of time when the property was rented to full-time tenants, they also rented it for short-term rentals during other portions of this period of time.  The rental use ended when the property was destroyed in a fire.

• Following the fire the taxpayers received funds for the destroyed residence, sold the land without rebuilding the residence and acquired new property in a transaction they hoped would qualify for deferral of gain under IRC §1031.[2]

The IRS has announced that it will not acquiesce with regard to a Tax Court decision that dealt with reverse like-kind exchanges under Section 1031 in Action on Decision AOD 2017-06.

The decision in question involved the issue of whether the benefits and burdens test was appropriate to be applied to a Section 1031 exchange.  The case, Estate of George H. Bartell Jr. et al. v. Commissioner, 147 TC No. 5 was previously discussed on this site in an article dated August 11, 2016.

Benefits and Burdens Test Does Not Apply in Case of Reverse §1031 Exchange

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The taxpayer in the case of The Malulani Group, Limited and Subsidiary v. Commissioner, TC Memo 2016-209 was facing a problem with its attempted §1031 exchange—it was unable to locate properties to identify as replacement properties as the 45-day period for doing in its deferred exchange was running down.  The taxpayer decided to identify properties held by a related entity (MBL) as properties to be acquired in order to complete the transaction.

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The taxpayer in the case of Exelon Corp. et al. v. Commissioner, 147 T.C. No. 9 had a major gain that it did not want to pay current tax on—almost $1.6 billion.  The gain would occur when an acquired entity disposed of its fossil fuel power plants. 

The taxpayer was approached with a potential solution—engage in a purported §1031 exchange.  The taxpayer acquired power plants from tax exempt public utility companies as the claimed replacement property, plants which they then leased back to those entities.  Referred to as a “sale in, lease out” (SILO) transaction, it was a packaged transaction sold to the taxpayer.

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Since its original enactment, the like kind exchange provisions IRC §1031 has been allowed to apply to transactions for which there is not a direct exchange between parties of property.   Initially such transactions were expanded, first by judicial holdings and then explicitly by Congress [IRC §1031(a)(3)] to include deferred “forward” exchanges where the taxpayer does not simultaneously receive the replacement property from the party that acquires the relinquished property, but rather, with the use a qualified intermediary, acquires property from another party with the proceeds of the sale.

Later case law allowed for reverse deferred exchanges (referred to as reverse Starker exchanges in reference to a major Ninth Circuit case on the original forward exchanges) where the replacement property is acquired first and then the relinquished property is later sold.

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In Chief Counsel Advice 201605017 the IRS National Office looks at how property used both for business and personal purposes is to be treated with regard to a like kind exchange under IRC §1031.

An aircraft is held in a partnership and then leases that aircraft to a related entity for both business use and for personal use of two key officers.  Those key officers are also the owners of the partnership and hold interests in the related entity.  The entity to which the aircraft is leased includes, as required under the IRC, the appropriate portion of any personal use of the aircraft in the compensation of the key officers. 

When the partnership traded in one aircraft and acquired another, the question arose regarding whether the exchange qualified for treatment under the like kind exchange rules of IRC §1031.  Specifically, Chief Counsel Advice 201601011 looked at whether the aircraft in this situation were held for productive use in a trade or business in order to qualify for treatment under IRC §1031.