IRS analysis
The IRS compared the facts in the PLR to older revenue rulings where the exchanges did not qualify for nonrecognition treatment.
In Revenue Ruling 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 Revenue Ruling 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 event occurred after the trust had held the property for many years, and the termination event was fixed and could not be modified or changed. The IRS further noted that the termination plan was anticipated to be approved by the court without regard to whether the taxpayer’s exchange of the TIC interest for replacement property would be completed. The IRS distinguished the facts of the PLR from the revenue rulings because those rulings involved prearranged plans that were voluntary transfers of property. Whereas, in this PLR, the distribution of the TIC interest was involuntary, it was the result of the termination event, and it was wholly independent of the taxpayer’s proposed like-kind exchange.
Therefore, the IRS held that the distribution of the TIC interests in the property, subject to a sale contract, as a result of the trust's 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 property as satisfying the “held for the productive use in a trade or business or held for investment” requirement in the hands of the taxpayer as it was in the hands of the trust.
Observation: The IRS’s analysis in this PLR is consistent with the IRS’s holdings in two earlier PLRs 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 holding in the PLR is noteworthy because the IRS distinguished the facts of the PLR from those in the revenue rulings, which involved voluntary transfers of properties under prearranged plans. The PLR suggests that involuntary transfers of property, from a trust to its beneficiaries, might not preclude those taxpayers from being viewed as holding the property for the productive use in a trade or business or for investment purposes. The IRS’s analysis in the PLR appears to have placed a significant emphasis on the involuntary termination of the trust, suggesting that a voluntary termination could have had a different tax result. Although this PLR related specifically to a trust, the analysis as it relates to the “held for the productive use in a trade or business or held for investment” requirement potentially could be relevant to other entities (e.g., partnerships, LLCs) that may engage in similar like-kind exchange transactions.