Like-Kind Exchange Issues in a Struggling Economy

Transcription

1 Like-Kind Exchange Issues in a Struggling Economy Mary B. Foster, 1031 Services, Inc. Todd D. Keator, Thompson & Knight LLP Robert D. Schachat, Ernst & Young, LLP January 21, 2011

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3 Exchange of Underwater Real Property Can relinquished property held subject to nonrecourse debt in excess of its fair market value qualify for exchange treatment? No authority on point. Analogous authority for tax-free transfer of property without equity. Does such relinquished property qualify as property? See, e.g., 351. Clearly preferable in context of deed in lieu transfer rather than actual foreclosure transaction. Lender cooperation. Page 3

4 Exchange of Underwater Real Property: Other Issues There is no sales contract in foreclosure. Can property be deeded directly to lender? Regs permit a direct deed. But can transferor s rights be assigned to a QI? Perhaps property can be first deeded to QI. But transfer to QI may raise other issues. Bad boy loan covenants: does unauthorized transfer convert to recourse loan? Transfer taxes. Page 4

5 Exchange of Underwater Real Property: Other Issues In exchange of underwater property, the taxpayer receives no exchange proceeds to fund cash portion of purchase price of replacement property. To minimize cash portion of replacement property, taxpayer may acquire credit net lease property. Debt on replacement property should equal or exceed debt balance on relinquished property. Loan fees? Lease terms should be reviewed to confirm true ownership issue. Page 5

6 Exchange of Underwater Real Property: Timing What is the date of the transfer for federal income tax purposes? General Rule: sale occurs when benefits and burdens of ownership pass to buyer. State law redemption period for foreclosure. Is debt recourse or nonrecourse? R. Odell & Sons Co. v. Comm r, 169 F.2d 247 (3d Cir. 1948): transfer occurs upon expiration of redemption period. Form 1099-B instructions. Page 6

7 Acquisition of Underwater Real Property Can replacement property subject to nonrecourse debt in excess of property value qualify for like-kind exchange treatment? No depreciation or interest deductions allowed: Estate of Franklin v. Comm r, 544 F.2d 1045 (9 th Cir. 1976). Odend hal v. Comm r, 748 F.2d 908 (4 th Cir. 1984). Nonrecourse debt recognized as debt of the taxpayer to the extent of the fair market value of property: Pleasant Summit Land Corp. v. Comm r, 863 F.2d 263 (3d Cir. 1989). Page 7

8 Acquisition of Underwater Real Property Acquiring property out of foreclosure. Redemption period timing issue discussed above. Pleasant Summit treats liabilities in excess of value as contingent liabilities. Do contingent liabilities qualify as liabilities that reduce taxable boot from net debt relief? Page 8

9 Failure to Acquire Replacement Property Many taxpayers are unable to acquire replacement property in the current market. Acquisition of replacement property from a related seller generally flunks anti-abuse rule of 1031(f)(4). Rev. Rul , Teruya Bros., Ltd. v. Comm r, 580 F.2d 1038 (9 th Cir. 2009). Ocmulgee Fields, Inc. v. Comm r, 132 T.C. 105 (2009), aff d (11 th Cir. August 13, 2010). Possible exceptions if no basis shifting. Failure to acquire replacement property will result in taxable sale treatment. Page 9

10 Installment Sales and Busted Exchanges Taxpayer can report installment note from buyer of the relinquished property under 453 installment method. Special rule overrides general rule that installment method is allowed only for indebtedness of the buyer, which would otherwise be the QI under the fiction of the (k) regs. Reg (k)-1(j). Page 10

11 Installment Sales and Busted Exchanges If sale and receipt of cash from QI straddle two taxable years, Reg (k)-1(j) permits taxpayer to report taxable gain under 453 installment method. See Rev. Rul Assumes taxpayer transfers property through a QI and still has a bona fide intention to complete a likekind exchange at end of year one. Page 11

12 Installment Sales and Busted Exchanges Installment gain is generally taxable in year cash is received. However, gain is triggered in year one to extent of: Liabilities in excess of basis. Depreciation recapture under 1245, 1250 and 291(a)(1). Interest charge under 453A(c). Applies at partner level. Announcement Page 12

13 Loss Disallowed in Section 1031 Exchanges Taxable loss is disallowed in a 1031 exchange. Section 1031 is not elective. Regardless of presence or absence of boot. Redwing Carriers, Inc. v. Tomlinson, 399 F.2d 652 (5 th Cir. 1968). Taxpayer sought to recognize gain to obtain basis step-up at capital gain rates for gain before enactment of Page 13

14 Loss Disallowed in Section 1031 Exchanges To avoid loss disallowance under 1031: Use different taxpayers to transfer and receive property. Did not work in Redwing Carriers. Separate agreements. No cross default provisions. Better yet, no cross references. Separate closing dates. Page 14