Question

George, age 68, decides to retire from farming and is considering selling his farm. The farm has a $100,000 basis and a $400,000 FMV. George’s two sons are not interested in farming. Both sons have large families and would like to own houses suitable for their needs. The Iowa Corporation is willing to purchase George’s farm. George’s tax advisor suggests that Iowa Corporation should buy the two houses the sons want to own for $400,000 and then exchange the houses for George’s farm. After the exchange, George could make a gift of the houses to the sons. George is concerned that this transaction does not qualify as a like-kind exchange. George wants the exchange to qualify as a like-kind exchange and still help his sons obtain the houses. What advice do you have for him? Prepare a memo to send to him and reference sources.

Answer 1

Technical Advice Memorandum No. 2000-39005 (TAM 200039005)

Internal Revenue Service (I.R.S.)

Technical Advice Memorandum (TAM)

Issue Date: 28^th April 2018

Section 1031 — Exchange of Property Held for Productive Use (Farming) for Two Houses.

ISSUE:

Under the facts of this case, does the transaction constitute to qualify for recognition as a like kind exchange.

FACTS:

Mr.George wants to sell his farm having $400000 FMV to lowa corporation in exchange of two houses costing $400000 and thereby houses will be gifted to his sons.

LAW AND ANALYSIS:

A like-kind exchange under United States tax law, also known as a 1031exchange, is a transaction or series of transactions that allows for the disposal of an asset and the acquisition of another replacement asset without generating a current tax liability from the sale of the first asset.

Section 1031(a) provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment (not including stocks, bonds, notes, choses of action, certificates of trust or beneficial interest and certain other types of property not here pertinent) if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment.

Section 1.1031(a)-1(b) defines the words “like kind” as having reference to the nature or character of the property and not to its grade or quality. Further, the regulations provide that one kind or class of property may not, under the nonrecognition provisions of § 1031(a), be exchanged for property of a different kind or class. Thus, the fact that any real estate involved is improved or unimproved is not material, for that fact relates only to the grade or quality of the property and not to its kind or class.

Several requirements must be met in a like-kind exchange to ensure that tax liability is not created upon the sale of the first asset:

1. The property or asset being sold ("old property") must be held for investment or use in a trade or business, and cannot be a personal residence.
2. The property or asset being purchased with the proceeds ("new property") must be "like-kind" to the old property.
3. The proceeds from the sale must be used to purchase the new property within 180 days of the sale of old property, although the new property must be identified within 45 days of the sale.
4. The investor cannot be in "constructive receipt" of the money from the sale of the old property.

In determining the proper classification of property as real or personal for purposes of § 1031 and the like-kind exchange rules, it is well settled that state law must be considered. For example, in Rev. Rul. 55-749, 1955-2 C.B. 295, the Service held that where, under applicable state law, water rights are considered real property rights, the exchange of perpetual water rights for a fee interest in land constitutes a non-taxable exchange of like-kind property under § 1031(a). Similarly, in Oregon Lumber v. Commissioner, 20 T.C. 192 (1953), a taxpayer exchanged a fee simple interest in real property for a limited right to cut and remove standing timber. The court found that the cutting rights were personal property under Oregon law and held that "[a]n exchange of realty for personalty is not an exchange of property for property of like kind." 20 T.C. at 196. See also Morgan v. Commissioner, 309 U.S. 78, 82 (1940), providing that "[i]n the application of a federal revenue act, state law controls in determining the nature of the legal interest which the taxpayers had in the property or income sought to be reached by the statute." Once it is determined that property is personal property, the rules in § 1.1031(a)-2 must be used to determine if the “like-kind” requirements of § 1031 have been satisfied. Under § 1.1031(a)-2(b)(1), if depreciable tangible personal property is exchanged for other property, the properties are of like-kind within the meaning of § 1031 if they are either of a like kind or a like class. For this purpose, depreciable tangible personal property is of a like class to other depreciable tangible personal property if the exchanged properties are either within the same General Asset Class or within the same Product Class. A single property may not be classified within more than one General Asset Class or within more than one Product Class. In addition, property classified within any General Asset Class may not be classified within a Product Class. A property’s class is determined as of the date of the exchange. Section 1.1031(a)-2(b)(2) sets forth the rules relating to General Asset Classes. The rules relating to whether exchanged properties are within the same Product Class are in § 1.1031(a)-2(b)(3).

CONCLUSION & ADVICE:

In the present case, it can be seen that the exchange of properties does not arise any profit or loss to George & or lowa Corporation. George is receiving the houses and then gifting the same to his sons for the FMV. So proceed for the transaction as it qualifies to be a like kind exchange of transaction.

If you have any questions regarding this memorandum, please contact Attorney.

Deborah Gregory at (202) 874-1407.

Carol E. Schultze Associate Area Counsel (Large & Mid-Size Business)