Circular like-kind exchange disallowed.

• Author: Beavers, James

The Tax Court disallowed tax-free treatment for a like-kind exchange transaction in which the taxpayer exchanged properties with a related entity.

Background

Ocmulgee Fields, Inc. (OFI) is a corporation that develops, owns, and manages real estate, owned by Charles Jones, his sons Dwight and Jeff, and a partnership owned by the three men. Treaty Fields was a limited liability company in the business of real estate development owned by Dwight and Charles Jones.

In 2003, OFI entered into an agreement with an unrelated third party to sell a property known as the Wesleyan Station Shopping Center. In order to complete the sale as a like-kind exchange, OFI assigned its rights to sell Wesleyan Station to Security Bank as a qualified intermediary for OFI in the sale. Security Bank sold Wesleyan to the third party per the agreement.

After looking at several properties owned by unrelated parties, OFI decided to purchase Barnes and Noble Corner, which Treaty Fields owned, as a replacement property for Wesleyan Station and signed a sale contract with Treaty Fields. OFI had sold Barnes and Noble Corner, which was part of the Rivergate Shopping Center, to Treaty Fields in an earlier transaction. OFI continued to own the rest of the Rivergate property. OFI transferred its rights in the contract to Security Bank and received title to Barnes and Noble Corner.

Treaty Fields reported the sale of Barnes and Noble Corner as a taxable sale. OFI reported its sale of Wesleyan Station and its purchase of Barnes and Noble Corner as a like-kind exchange. The IRS issued a notice of deficiency to OFI based on the transaction, claiming that OFI had structured it in order to avoid tax by circumventing the Sec. 1031(f) prohibition on like-kind exchanges directly between related parties. OFI challenged the IRS's determination in Tax Court.

Sec. 1031

Under Sec. 1031, no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment solely for property of a like kind that is to be held either for productive use in a trade or business or for investment. Under Sec. 1031(d), the basis of property acquired in a Sec. 1031 exchange is the same as the basis of the property exchanged, decreased by any money the taxpayer receives and increased by any gain the taxpayer recognizes.

A special rule applies in the case of exchanges between related parties. If a taxpayer exchanges property with a related person and within two years...