Related-party exchange chain did not prevent Section 1031 deferral

Plain-English summary

A corporation sold real property through a qualified intermediary and acquired replacement properties that had been owned by two related companies. Those companies and two additional related entities each conducted their own linked like-kind exchanges. None of the participants received cash or other non-like-kind property, the last related entity was to acquire its replacement property from unrelated sellers, and all participants represented that they would retain their replacement property for at least two years. The IRS found no cashing out of the investment and ruled that the taxpayer's use of an unrelated intermediary kept IRC § 1031(f)(1) from applying directly. It also ruled that the linked transactions were not structured to avoid the related-party rules under § 1031(f)(4). The related-party acquisitions therefore did not disqualify the taxpayer from deferring gain under § 1031.

Ruling snapshot

• Question: Did acquiring replacement property from related persons through a chain of like-kind exchanges prevent the taxpayer's gain deferral?
• Outcome: Approved, the related transactions did not disqualify the taxpayer's Section 1031 exchange
• Key authorities: IRC § 1031(a), § 1031(f); Rev. Rul. 2002-83

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202053007 Third Party Communication: None
Release Date: 12/31/2020 Date of Communication: Not Applicable
Index Number: 1031.00-00
Person To Contact:
------------------ --------------------, ID No. -----------------
------------------------------ Telephone Number:
------------------------------------------------------ --------------------
---------------------------------------- Refer Reply To:
---------------------------------------- CC:ITA:B04
PLR-110023-20
Date:
October 06, 2020

Taxpayer 1 = -----------------------------
EIN = ----------------

State 1 = -------------

Company 1 = ---------------------------------------------
EIN ----------------

Company 2 = -------------------
EIN ----------------

State 2 = ---------

Company 3 = ----------------------------
EIN ----------------

Company 4 = ------------------------------------------------------
EIN = ----------------

Property 1 = --------------------
-------------------------------

Property 2 = -----------------------------------------------------------------------
----------------------------------------

                                         --------------------

Property 3 = -----------------------------------------------------------------------
----------------------------------------
---------------------------------------------------------------------
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PLR-110023-20 2

Property 4 = -----------------------------------------------------------------------
-----------------------------------------------

Property 5 = -----------------------------------------------------------------------
--------------------------------

Date 1 = ------------------------

Qualified Intermediary = -----------------------------------------------------------

Date 2 = ------------------------

Date 3 = ----------------------

Date 4 = ------------------------

Date 5 = ----------------------

Dear ----------------:

This letter responds to your private letter ruling request, dated April 13, 2020, regarding
whether, under § 1031(f) of the Internal Revenue Code, Taxpayer is disqualified from
deferring gain on a like-kind exchange because Taxpayer acquired replacement
property from a related person.

Facts

Taxpayer is a corporation organized in State 1. Company 1 is an S corporation and
Company 4 is a limited liability company that is classified as a partnership and both are
organized in State 1. Company 2 and Company 3 are limited liability companies that
elected to be classified as a corporation and partnership, respectively, and are both
located in State 2.

Taxpayer is a related person as defined in § 1031(f)(3) (“related person”) to both
Company 1 and Company 2. Additionally, Company 2 and Company 3 are related
persons, and Company 3 and Company 4 are related persons.

On Date 1, Taxpayer entered into a deferred exchange agreement with Qualified
Intermediary to engage in a § 1031 like-kind exchange. On Date 2, a disregarded entity
of Taxpayer conveyed Property 1 as relinquished property in its exchange to an
unrelated person. As its replacement property, Taxpayer, on Date 3, acquired Property

PLR-110023-20 3

2, which was owned by Company 1 prior to the acquisition, and Property 3, which was
owned by Company 2 prior to the acquisition. Company 1 and Company 2 are related
persons to Taxpayer. Taxpayer’s replacement property also included property acquired
from unrelated persons. Taxpayer did not receive any cash or non-like kind property
(boot) in the exchange.

On Date 3, Company 1 entered into a deferred exchange agreement with Qualified
Intermediary to engage in a § 1031 like-kind exchange. Company 1 conveyed Property
2 as relinquished property in its exchange to Taxpayer and acquired replacement
properties, all of which were owned by unrelated persons prior to Company 1’s
acquisition. Company 1 did not receive any boot in the exchange.

On Date 3, Company 2 entered into a deferred exchange agreement with Qualified
Intermediary to engage in a § 1031 like-kind exchange. Company 2 conveyed Property
3 as relinquished property in its exchange to Taxpayer and acquired Property 4, which
was owned by Company 3, a related person, prior to Company 2’s acquisition.
Company 2 did not receive any boot in the exchange.

On Date 4, Company 3 entered into a deferred exchange agreement with Qualified
Intermediary to engage in a § 1031 like-kind exchange. Company 3 conveyed Property
4 as relinquished property in its exchange to Company 2 and, on Date 5, acquired an
interest in Property 5, which was owned by Company 4, a related person, prior to
Company 3’s acquisition. Company 3 did not receive any boot in the exchange.

On Date 5, Company 4 entered into a deferred exchange agreement with Qualified
Intermediary to engage in a § 1031 like-kind exchange with respect to Company 4’s
relinquished property, Property 5. Company 4 will acquire replacement property owned
by persons unrelated to Taxpayer, Company 1, Company 2, Company 3, and Company

4. Company 4 will receive no boot in its exchange.

Applicable Law

Section 1031(a)(1) provides that no gain or loss is recognized on the exchange of real
property held for productive use in a trade or business or for investment if such real
property is exchanged solely for real property of a like kind that is to be held either for
productive use in a trade or business or for investment.

Section 1031(f)(1) provides that if a taxpayer exchanges property with a related person,
the taxpayer is precluded from the nonrecognition of gain or loss under § 1031 on the
exchange of such property if, before the date 2 years after the date of the last transfer
that was part of the exchange1, the related person disposes of the property, or the
taxpayer disposes of the property received in the exchange from the related person that
was of like kind to the property transferred by the taxpayer (referred to as “the

1 See § 1031(f)(2) for certain dispositions that are not taken into account under § 1031(f)(1).

PLR-110023-20 4

subsequent disposition by the related person or the taxpayer”). Any gain or loss
recognized by the taxpayer by reason of § 1031(f) must be taken into account as of the
date on which the subsequent disposition by the related person or the taxpayer occurs.

Section 1031(f)(2)(C) provides that a subsequent disposition by the taxpayer or a
related person is not taken into account if it is established to the satisfaction of the
Secretary that neither the taxpayer’s exchange nor the subsequent disposition by the
related person or the taxpayer had as one of its principal purposes the avoidance of
federal income tax.

Under § 1031(f)(4), § 1031 does not apply to an exchange that is part of a transaction
(or series of transactions) structured to avoid the purposes of § 1031(f).

Both the House Ways and Means Committee Report and the Senate Finance
Committee Print describe the policy concern that led to enactment of § 1031(f):

   Because a like-kind exchange results in the substitution of the basis of the
   exchanged property for the property received, related parties have engaged in
   like-kind exchanges of high basis property for low basis property in anticipation of
   the sale of the low basis property in order to reduce or avoid the recognition of
   gain on the subsequent sale. Basis shifting also can be used to accelerate a loss
   on the retained property. The committee believes that if a related party
   exchange is followed shortly thereafter by a disposition of the property, the
   related parties have, in effect, ‘cashed out’ of the investment, and the original
   exchange should not be accorded nonrecognition treatment. See H.R. Rep. No.
   247, 101st Cong. 1st Sess. 1340 (1989); S. Print. No. 56, at 151.

The committee reports also contain the following example of when § 1031(f)(4) applies:

   If a taxpayer, pursuant to a pre-arranged plan, transfers property to an unrelated
   party who then exchanges the property with a party related to the taxpayer within
   2 years of the previous transfer in a transaction otherwise qualifying under
   section 1031, the related party will not be entitled to nonrecognition treatment
   under section 1031. See H.R. Rep. No. 247, at 1341; S. Print. No. 56, at 152.

The Senate Finance Committee also gave three examples of its intent with respect to
the non-tax avoidance exception in § 1031(f)(2)(C):

   It is intended that the non-tax avoidance exception generally will apply to (i) a
   transaction involving an exchange of undivided interests in different properties
   that results in each taxpayer holding either the entire interest in a single property
   or a larger undivided interest in any of such properties; (ii) dispositions of
   property in nonrecognition transactions; and (iii) transactions that do not involve
   the shifting of basis between properties. See S. Print. No. 56, at 152.

PLR-110023-20 5

In Rev. Rul. 2002-83, 2002-2 C.B. 927, a taxpayer transferred low-basis property to an
unrelated buyer through a qualified intermediary (QI) and acquired high-basis
replacement property from a related person, through the QI, with the proceeds of the
sale of the relinquished property. The taxpayer and the related person structured the
transaction to cash out of their investment in the low-basis relinquished property without
recognizing gain. The related person had $0 of realized gain on its sale of the high-
basis replacement property and the taxpayer used § 1031 to defer the realized gain on
the disposition of the low-basis property. In analyzing these facts under § 1031(f)(4),
the Service quoted the above legislative history for the proposition that § 1031(f)(4) is
intended to apply to situations in which an unrelated person, such as a QI, is used to
effectuate a like-kind exchange between related parties of high-basis property for low
basis property in anticipation of the sale of the low-basis property. In these situations,
had the taxpayer engaged in a direct exchange with the related person, without the use
of an unrelated person such as QI, followed by an immediate sale by the related person
of the property formerly owned by the taxpayer, § 1031(f)(1) would apply and gain
recognition would be triggered in the year of the subsequent disposition by the related
person. The Service concluded that the transaction described in the revenue ruling was
structured to avoid the purposes of § 1031(f) and, therefore, the taxpayer must
recognize the gain realized on its transfer of the relinquished property.

Analysis

In the present case, Taxpayer exchanged Property 1 for Property 2 and Property 3, both
of which were owned by a related person, using Qualified Intermediary to facilitate the
exchange. Consequently, § 1031(f)(1) does not apply because Qualified Intermediary is
not a related person to the Taxpayer. However, under § 1031(f)(4), § 1031 does not
apply to Taxpayer’s exchange if the exchange is part of a transaction (or series of
transactions) structured to avoid the purposes of § 1031(f).

Here, Taxpayer contends that § 1031(f)(2)(C) applies. Company 1 and Company 2, the
related persons that owned Property 2 and Property 3, respectively, prior to Taxpayer’s
acquisition of those properties, transferred the properties as part of their own like-kind
exchanges that Taxpayer represents were nonrecognition transactions in which no boot
was received by Company 1 or Company 2. Company 1 transferred as relinquished
property Property 2 to Taxpayer as part of a like-kind exchange in which all Company
1’s replacement property was formerly owned by an unrelated person. Company 2
transferred as relinquished property Property 3 to Taxpayer as part of a like-kind
exchange in which some of Company 2’s replacement property was formerly owned by
Company 3, a related person to Company 2, and some was formerly owned by an
unrelated person. Likewise, Company 3 transferred as relinquished property Property 4
to Company 2 as part of its own like-kind exchange in which all of Company 3’s
replacement property was owned by Company 4, a related person to Company 3.
Finally, Taxpayer also represents that Company 4’s transfer of property to Company 3
will be part of its own like-kind exchange in which all of its replacement property will be
acquired from unrelated persons. Taxpayer represents that all of the entities will

PLR-110023-20 6

continue to own the property received in its exchanges for at least two years after the
date of the last transfer in the series.

Taxpayer asserts that there is no cashing out by Taxpayer or any of the related
persons. That is because Taxpayer, Company 1, Company 2, Company 3, and
Company 4 did not or will not receive cash or any non-like-kind property in the
exchanges, and upon completion of the series of transactions, all related persons will
own property that is of like kind to the property the respective entity transferred in its
exchange.

Based on the facts and representations submitted by the Taxpayer, we rule as follows:

   Section 1031(f)(1) does not apply to Taxpayer’s exchange of Property 1 for
   Property 2 and Property 3, and the other transactions described in this ruling are
   not, as described in section 1031(f)(4), part of a transaction (or series of
   transactions) structured to avoid § 1031(f) from applying to Taxpayer’s exchange
   of Property 1 for Property 2 and Property 3. Consequently, the transactions
   described in this ruling involving Company 1, Company 2, Company 3, and
   Company 4 do not disqualify Taxpayer from deferring gain under § 1031 for
   Taxpayer’s exchange of Property 1 for Property 2 and Property 3.

Pursuant to section 7.06 of Rev. Proc. 2020-1, 2020-1 I.R.B. 1, Taxpayer must attach a
copy of this letter ruling to any Federal income tax return to which it is relevant. If
Taxpayer files its returns electronically, it may satisfy this requirement by attaching a
statement to the return that provides the date and control number of this letter ruling.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

The ruling contained in this letter is based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
an appropriate party. However, this office has not verified any of the material submitted
in support of the request for this ruling, and therefore it is subject to verification on
examination.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

Pursuant to the provisions of a power of attorney currently on file, we are sending a
copy of this letter ruling to Taxpayers’ authorized representatives, -----------------------------
and ----------------------------.

PLR-110023-20 7

If you have any questions concerning this matter, please contact ------------------------ at --
------------------------.

                                    Sincerely,

                                    SJT

                                    Stephen J. Toomey
                                    Senior Counsel
                                    (Income Tax & Accounting)

cc: