In Uncategorized on 11/16/2016 at 17:07

A colleague’s firm may have been tangentially involved in this one, so although the colleague just e-mailed an argument why Section 1031 wasn’t just a dodge for billionaires, this one turns out to be a dodge for non-billionaires.

At least Judge Gale says so, in The Malulani Group, Limited and Subsidiary, 2016 T. C. Memo. 209, filed 11/16/16.

The Malus owned real estate in Hawaii and Maryland. They had a couple subsidiaries (hi, Judge Holmes), but a hostile stockholder got a 30% stake in one of them out of bankruptcy court, so they set up separate boards, and The Malus made loans to the subs as they saw fit.

An unrelated entity offered to buy a Maryland parcel from a Malu sub for heavy cash, fifty percent above basis.

The Malus go for a 1031, get the appropriate QI, and gear up for the 45-180 day squaredance. That means find replacement property, identify same within 45 days of closing sale of relinquished, and close within 180 days (or end of tax year, as extended, whichever shorter).

Relinquished property closes, but no replacement on horizon except a Hawaiian parcel owned by related sub, which has a heavy-duty NOL. Related sub exchanges its parcel, and sells off acquired parcel, burying much gain with its NOL.

QI buys replacement as ordered. I am sure QI didn’t give the Malus, or anyone else, tax advice.

IRS blows up deal.

While 1031(f)((1) only bars non-recognition of direct transfers between related entities, and this wasn’t direct as the Malus used a third-party independent QI, 1031(f)(4) bars deals structured to avoid tax.

But there’s an exception (why not?). 1031(f)(2)(C) requires a look-see if there’s any non-tax avoidance part of the deal.

The Malus claim there was no tax avoidance, as they tried to find a replacement, but all they came up with was what their sub had. And IRS’ lead case involved structuring in advance, whereas The Malus only did the deal when they were running out of 45-day runway; no advance planning.

No good. “…the presence or absence of a prearranged plan to use property from a related person to complete a like-kind exchange is not dispositive of a violation of section 1031(f)(4).” 2016 T. C. Memo. 209, at p. 12.

“Instead, the inquiry into whether a transaction has been structured to avoid the purposes of section 1031(f) has focused on the actual tax consequences of the transaction to the taxpayer and the related party, considered in the aggregate, as compared to the hypothetical tax consequences of a direct sale of the relinquished property by the taxpayer.  Those actual consequences form the basis for an inference concerning whether the transaction was structured in violation of section 1031(f)(4).” 2016 T. C. Memo. 209, at pp. 12-13.

At close of play, it’s all about the numbers.

“Petitioner would have had to recognize a $1,888,040 gain had [relinquishing sub] directly sold the Maryland property to an unrelated third party.  Although petitioner’s NOLs would have offset a portion of this gain, it would have paid an additional $387,494 in tax for 2007 as a result of the direct sale.  Petitioner would have also owed an additional $264,171 of tax… because of the loss of that NOL carryback.  However, because the transaction was structured as a like-kind exchange, only [acquiring sub] was required to recognize gain–and that $3,127,004 of gain was almost entirely offset by its NOLs.  The substantial economic benefits to petitioner and [relinquishing sub] as a result of structuring the transaction as a deferred exchange are thus clear:  Malulani Group and [relinquishing sub] were able to cash out of the investment in the Maryland property almost tax free.  We thus infer that [relinquishing sub] structured the transaction with a tax-avoidance purpose.” 2016 T. C. Memo. 209, at pp. 14-15. (Footnotes omitted, but read them; though The Malus’ CEO claimed he didn’t know what was going on, he was on the committee that oversaw intercompany loans and got all the data).

And while there was no basis-shifting (swapping high-basis property for low-basis property between related entities), because the acquiring sub had more tax to pay when it unloaded the acquired parcel, acquiring sub had NOLs, and no evidence that using them would have unsheltered income for carryback years.

The idea behind 1031 is that the relinquisher is carrying on the investment program via the acquired like-kind property. Here, the relinquisher cashed out, and the acquirer enabled the deal by ducking behind its NOLs.

I give The Malus a Taishoff “good try, second class.”


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