PLRs provide insight into “held for” requirement in a like-kind exchange transaction involving property distributed to trust beneficiaries

In brief

What happened?

In private letter rulings 202449007 and 202450005 through 202450009 (PLRs), the IRS issued rulings to beneficiaries (taxpayers) of a testamentary trust (trust) who intended to engage in a like-kind exchange under Section 1031.

The PLRs addressed the “held for productive use in a trade or business or for investment” requirement under Section 1031. The IRS held that the distributions of tenancy-in-common (TIC) interests in real property, which were subject to sales contracts due to the trusts’ involuntary termination, did not preclude the interests from being “held for productive use in a trade or business or for investment.

Why is it relevant?

The IRS’s rulings in the PLRs are consistent with previous PLRs on the treatment of involuntary transfers of real property to beneficiaries of a trust. The rulings provide insight into the IRS’s stance on similar transactions, potentially offering guidance to other entities, such as partnerships or limited liability companies (LLCs), that are contemplating like-kind exchange transactions. The rulings underscore the possibility that such entities could maintain compliance with the holding requirements of Section 1031, even when faced with involuntary terminations and subsequent property distributions. 

Action items to consider

Although the PLRs apply specifically to the taxpayers to whom they were issued, taxpayers considering like-kind exchange transactions should evaluate whether voluntary or involuntary distributions of TIC interests from entities such as trusts, LLCs, or partnerships might meet the “held for productive use in a trade or business or held for investment” requirement. Taxpayers should consult with tax professionals to assess the applicability of the rulings to their specific circumstances.

Like-kind exchange

In each PLR, the trust’s terms were established by the decedent’s will, and the trust was set to terminate upon the death of the last surviving child of the decedent's daughters who was alive at the time of the decedent's death (terminating event). Upon the terminating event, the trustees were directed to distribute the trust’s assets to the beneficiaries.  

Prior to the terminating event, the trustees intended for the trust to engage in a like-kind exchange transaction for each property and each property was held for investment purposes throughout each trust’s existence. During negotiations with potential buyers of each of the properties, the terminating event occurred. The trustees had finalized the sales contracts with the potential buyers. However, due to the terminating event, the trustees determined that it was no longer feasible for the trusts to consummate the sales as like-kind exchange transactions. The trustees informed the beneficiaries of their intention to request the probate court (court) to approve the disposition of each of the properties as part of the overall approval of the termination plan for the trusts (termination plans). Under the termination plans, the trustees finalized the sales contracts to dispose each of the properties and agreed to accommodate any beneficiaries interested in completing their own like-kind exchanges transactions similar to what was initially contemplated for the trusts prior to the terminating event.  

Disregarded entities were formed and owned separately by each beneficiary that intended to effectuate their own like-kind exchanges (exchanging beneficiaries), which included the taxpayers. Following the creation of the disregarded entities, the trustees planned to distribute undivided tenancy-in-common (TIC) interests in each of the properties, subject to the sales contracts, to the exchanging beneficiaries’ disregarded entities. Subsequently, the trustees planned to dispose of the TIC interests, and each exchanging beneficiary planned to engage in a separate like-kind exchange transaction of their own.

The taxpayer in each PLR made certain representations, including, among others, the following:

• The property had been held by the trusts for investment purposes throughout the trust’s existence, 
• Any replacement properties acquired by the taxpayer through the taxpayer’s LLC would be held for investment purposes, 
• The disposition of the taxpayer’s TIC interest and the acquisition of replacement properties through the taxpayer’s LLC would be accomplished in a manner that in all respects, aside from the issue raised in the ruling, qualified the transactions as a like-kind exchange eligible for nonrecognition treatment under Section 1031, and 
• The trust’s winding-up period had not been unduly postponed.  

The IRS held that the distributions of the TIC interests in each of the properties, subject to sales contracts, as a result of the trusts’ involuntary termination, would not preclude the interests from being “held for the productive use in a trade or business or held for investment.” In other words, the IRS viewed the properties as satisfying the “held for the productive use in a trade or business or held for investment” requirement in the hands of the taxpayers as they were in the hands of the trusts. The IRS compared the facts in the PLRs to older revenue rulings, Rev. Rul. 75-292 and Rev. Rul. 77-337, where the exchanges did not qualify for nonrecognition treatment.   

In Rev. Rul. 75-292, an individual taxpayer, as part of a prearranged plan, exchanged real property used in the taxpayer’s trade or business with real property held by an unrelated corporation. The replacement real property was received and immediately thereafter contributed to a new corporation in a Section 351 transaction. The IRS concluded that nonrecognition treatment was not allowed because the taxpayer did not hold the replacement real property for use in a trade or business or for investment; rather, the taxpayer acquired the replacement property for the purpose of transferring it to a new corporation.    

Using a similar attribution analysis, in Rev. Rul. 77-337, an individual taxpayer, as part of a prearranged plan, liquidated all of the stock of a corporation, resulting in the taxpayer’s acquisition of the property held by corporation, followed by an immediate transfer of the corporation’s real property asset to a third party in exchange for like-kind property. The IRS concluded that the corporation’s previous trade or business could not be attributed to its sole shareholder and therefore the relinquished property was not “held for productive use in a trade or business or for investment” by the individual taxpayer and thus ineligible for like-kind exchange.   

The IRS noted in its analysis that the “held for” requirement was designed, in part, to postpone the recognition of gain or loss when property used in a trade or business or held for investment is exchanged for other property in the course of the continuing operation of that trade or business, or in the course of investment.   

The IRS noted that the termination events occurred after the trusts had held each of the properties for many years, and the termination events were fixed and could not be modified or changed. The IRS further noted that the termination plans were anticipated to be approved by the court without regard to whether the taxpayers’ exchange of the TIC interests for replacement properties would be completed. The IRS distinguished the facts of the PLRs from the revenue rulings because those rulings involved prearranged plans that were voluntary transfers of property. Whereas, in the PLRs, the distributions of the TIC interests were involuntary, they were the result of the termination event, and were wholly independent of the taxpayers’ proposed like-kind exchange.   

Observation: The IRS’s analysis in the PLRs is consistent with the IRS’s holdings in earlier PLRs (PLRs 200521002, 200651030, and 202416012) that involved involuntary transfers of property in trusts, where the IRS ruled that the “held for productive use in a trade or business or held for investment” requirement was not violated.   

Observation: The rulings distinguish the facts of the PLRs from those in revenue rulings involving voluntary transfers of properties under prearranged plans. The PLRs suggest that involuntary transfers of property, such as those from a trust to its beneficiaries, might not prevent taxpayers from being considered as holding the property for productive use in a trade or business or for investment purposes. The IRS’s reasoning in the PLRs emphasizes the involuntary nature of the trust's termination, implying that a voluntary termination could have resulted in a different tax outcome.