Federal Taxation - Augustus N. Makris

• Publication year: 2011

Federal Taxation

by Augustus N. Makris*

I. Introduction

This Article¹ surveys certain federal tax cases decided by courts in the Eleventh Circuit in 2010. There were no significant decisions.² The case of Ocmulgee Fields, Inc. v. Commissioner³ addressed the applicability of section 1031(f)(4) of the Internal Revenue Code (I.R.C.)⁴ to like-kind exchanges.⁵ The case of United States v. Fort⁶ involved a partner who, in exchange for his interest in an acquired partnership, received shares of the acquiring corporation subject to certain restrictions.⁷ The issue was whether the restrictions permitted the partner to exclude the

* Associate in the firm of King & Spalding LLP, Atlanta, Georgia. University of Michigan (B.A., 2003); University of Chicago (J.D., 2006). Member, State Bar of Georgia.

1. For an analysis of federal tax cases decided the prior survey period, see Dustin M. Covello & Augustus N. Makris, Federal Taxation, 2009 Eleventh Circuit Survey, 61 MERCER L. REV. 1133 (2010).

2. The year 2010 saw a number of "tax-protestor" cases in courts in the Eleventh Circuit. See, e.g., Martins v. United States, No. 10-12086, 2010 WL 4721610 (11th Cir. Nov. 23, 2010). Perhaps the most colorful of these cases involved movie actor Wesley Snipes, who appealed his criminal convictions for willfully failing to file federal income tax returns. See United States v. Snipes, 611 F.3d 855, 859 (11th Cir. 2010). Snipes made

several arguments justifying his failure to file his personal tax returns, including that he was a non-resident alien to the United States, that earned income must come from sources wholly outside the United States, that a taxpayer is defined by law as one who operates a distilled spirit Plant, that the Internal Revenue Code's taxing authority is limited to the District of Columbia and insular possessions of the United States, exclusive of the 50 States of the Union, [and] that as a fiduciary of God, who is a nontaxpayer, he was a foreign diplomat who was not obliged to pay taxes. Id. at 860 (internal quotation marks omitted).

3. 613 F.3d 1360 (11th Cir. 2010).

4. I.R.C. § 1031(f)(4) (2006).

5. Ocmulgee Fields, 613 F.3d at 1361.

6. 105 A.F.T.R.2d (RIA) 2559 (N.D. Ga. 2010).

7. Id. at 2560.

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shares from gross income when received.⁸ The case of Southern Family Insurance Co. v. United States⁹ addressed whether "takeout bonuses" paid by a state to an insurance company were included in gross income or excluded from gross income as nonshareholder contributions to

capital.¹⁰

II. Ocmulgee Fields, Inc. v. Commissioner

"When a taxpayer exchanges one property for another, the exchange is typically treated for tax purposes as a sale of the relinquished property followed by a purchase of the received property."¹¹ Under I.R.C. § 1001(c),¹² the taxpayer must immediately recognize the gains or losses realized.¹³ Under I.R.C. § 1031(a),¹⁴ however, gain or loss is not recognized on exchanges of certain business or investment property "solely for [other] property of like kind."¹⁵ The long-standing concept underlying I.R.C. § 1031¹⁶ is that when a taxpayer exchanges one property (the "relinquished property") for a replacement property oflike-kind (the "replacement property"), the taxpayer is continuing an ongoing investment, rather than disposing of one property to obtain another.¹⁷ Accordingly, gain or loss is not recognized, and under I.R.C. § 1031(d) the taxpayer's basis in the relinquished property carries over to the replacement property.¹⁸

The transfer of the relinquished property in exchange for the replacement property need not be simultaneous. I.R.C. § 1031(a)(3) can apply to a "deferred exchange," defined by the regulations "as an exchange in which, pursuant to an agreement, the taxpayer transfers [the relinquished] property . . . and subsequently receives [the replacement] property."¹⁹ Generally, the replacement property must be identified within 45 days and received within 180 days of the transfer of the relinquished property.²⁰

8. See id. at 2560-61.

9. 106 A.F.T.R.2d (RIA) 7200 (M.D. Fla. 2010).

10. Id. at 7200.

11. Ocmulgee Fields, Inc. v. Comm'r, 613 F.3d 1360, 1364 (11th Cir. 2010).

12. I.R.C. § 1001(c) (2006).

13. Id.

14. I.R.C. § 1031(a) (2006).

15. Id.

16. I.R.C. § 1031 (2006).

17. Ocmulgee Fields, 613 F.3d at 1364.

18. I.R.C. § 1031(d).

19. Treas. Reg. § 1.1031(k)-1(a) (as amended in 2008).

20. Treas. Reg. § 1.1031(k)-1(b) (as amended in 2008).

2011] FEDERAL TAXATION 1189

I.R.C. § 1031(a)(3), however, does not alter the rule that I.R.C. § 1031 applies only to exchanges of property and not cash sales, which can make deferred exchanges difficult to execute.²¹ For example, if a taxpayer sells the relinquished property for cash and then uses the cash to purchase replacement property, gain or loss is recognized on the sale even if the transaction falls within the 45-day and 180-day windows.

The regulations provide various rules designed to mitigate this and other problems presented by deferred exchanges. Under one such rule, if a taxpayer transfers the relinquished property to a "qualified intermediary," and the qualified intermediary sells the relinquished property for cash proceeds, then, generally, the proceeds held by the qualified intermediary are not considered to be received by the taxpayer.²² This rule permits a qualified intermediary to effect a deferred exchange by collecting cash proceeds from the sale of the taxpayer's relinquished property without the recognition of gain, using the cash proceeds to purchase the replacement property and transferring the replacement property to the taxpayer.²³

Prior to the enactment of I.R.C. § 1031(f) in 1989,²⁴ related taxpayers acted in concert to exploit the nonrecognition treatment and carry-over basis provisions of I.R.C. § 1031.²⁵ According to the House Ways and Means Committee,

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. . . . 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.²⁶

I.R.C. § 1031(f)(1) provides that when a taxpayer exchanges property with a "related person" (as defined in I.R.C. § 1031(f)(3)), gain or loss that would otherwise escape recognition is recognized by the taxpayer if

21. See Treas. Reg. § 1.1031(k)-1(f)(1) (as amended in 2008).

22. See Treas. Reg. § 1.1031(k)-1(g)(4) (as amended in 2008).

23. See id.

24. See Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101-239, 103 Stat. 2106 (codified as amended in scattered sections of the U.S.C. (2006)).

25. Ocmulgee Fields, 613 F.3d at 1366.

26. H.R. REP. NO. 101-247, at 1340 (1989), reprinted in 1989 U.S.C.C.A.N. 1906, 2810.

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the taxpayer or the related person...