In Uncategorized on 06/24/2013 at 17:50

Advice to real estate operators who want to swap a leasehold for fee title in a Section 1031 like-kind exchange, a darling of the real estate operators. Thus Judge Marvel opines in VIP’S Industries Inc. & Subsidiaries, 2013 T. C. Memo. 157, filed 6/24/13.

VIP’s had a 21-year leasehold of some land where they built a motel. They tried to swap it for fee interests.

Quick refresher: “Generally, gain or loss realized from the sale or exchange of property is recognized. Sec. 1001(c). Section 1031 provides, however, 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 a like kind that is to be held either for productive use in a trade or business or for investment. Sec. 1031(a)(1). When money or unqualified property is received in an otherwise qualifying like-kind exchange, a taxpayer’s realized gain is recognized to the extent of the sum of such money and the fair market value of such unqualified property. Sec. 1031(b); sec. 1.1031(a)-1(a)(2), Income Tax Regs. The rationale for nonrecognition of gain or loss on the exchange of like-kind property is that the taxpayer’s economic situation after the exchange is fundamentally the same as it was before the transaction occurred. See Jordan Marsh Co. v. Commissioner, 269 F.2d 453, 455-456 (2d Cir. 1959), rev’g T.C. Memo. 1957-237; Koch v. Commissioner, 71 T.C. 54, 63-64 (1978). As a House report explained: ‘[I]f the taxpayer’s money is still tied up in the same kind of property as that in which it was originally invested, he is not allowed to compute and deduct his theoretical loss on the exchange, nor is he charged with a tax upon his theoretical profit.’ H.R. Rept. No. 73-704 (1934), 1939-1 C.B. (Part 2) 554, 564.” 2013 T. C. Memo. 157, at pp. 7-8.

But like-kind means like kind, and while a thirty-year or more leasehold term is like-kind for fee title purposes per Reg. section 1.1031(a)-1(c), 21 years is too short. And State law has nothing to do with it.

Even though VIP’s owned the improvements, which had a far greater value than the raw land on which they stood, the lease said that the improvements belonged to the landlord on expiry or sooner termination.

No nonrecognition, and tax due. Go long for a leasehold 1031.

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