Question

“The Tax Court erred in Crandall v. Commissioner. The “substance-over-form” doctrine, not the constructive receipt principle, should have controlled. The cash proceeds from the sale of their Arizona property that were placed into escrow ($66,000) in fact were never received by Mr. & Mrs. Crandall, even momentarily. That fact should have resulted in a decision that they correctly reported the sale and follow-on acquisition of the California property as a good § 1031 LKE.”

Discuss.

Answer 1

CRANDALL VS COMMISSIONER CASE:-

• Petitioners owned an undeveloped parcel of property in Lake Havasu City, Arizona (Arizona Property).
• Petitioners held the property for investment. They desired to own investment property closer to their residence in California.
• After Receiving some limited advice concerning a tax-free exchange of properties, petitioners took step to sell the Arizona property and purchase a new property with the intention of executing a tax free exchange.
• On 04-Mar-2005 , Petitioners sold the Arizona property for $ 76000.
• The Buyer of the property paid petitioners $10,000 & the remaining $66,000 was placed in an escrow account with Capital Title Agency Inc.
• At petitioners discretion $ 61743.25 was held in escrow account.Capital Title initially released $ 4256.75 to petitioners.Petitioners basis in Arizona property was $8500.
• In furtherance of the purchase, petitioners made payments to Chicago Title Co.& placed in an escrow account as deposit.
• The Capital Title & Chicago Title escrow agreements did not reference a like-kind exchange under Sec 1031, nor did they expressly limit petitioners right to receive, pledge, borrow, or otherwise obtain the benefits of the funds.
• The General rule regarding recognition of gain or loss on sale or exchange of property is that the entire amount of gain or loss is recognised. But an exception to general rule is found in Sec-1031.
• Sec-1031 provides that no gain or loss is recognised when business or investment property is exchanged solely for other business or investment property of like kind.
• To avoid being in constructive receipt of money or property, a taxpayer may use a qualified escrow account.
• The Arizona Property & California Property are like-kind properties. Issue is whether there was an exchange within the meaning of the statute & the regulations.
• The underlying purpose of section 1031 is to permit a taxpayer to defer gain with respect to an "ongoing investment", rather than ridding himself of one investment to obtain another. ( Teruya Bros Ltd. Vs Commissioner).
• Although petitioners used the funds in the Capital Title Escrow account to purchase the California Property , the lack of express Limitations in the escrow agreement results in petitioners being treated as having constructively received the proceeds.

Conclusion:- The disposition of Arizona Property was sale and funds deposited in Capital Title Escrow Account represent the receipt of proceeds. Consequently this transaction doesnot qualify for Section 1031 nonrecognition & therefore the petitioners must recognise the gain for year 2005 ( Year Of Sale)