Rulings relax related-party exchange rules.

• Author: Cohen, Gabriel

Recently released IRS Letter Rulings 200709036 and 200706001 suggest a liberal trend regarding related-party exchanges under Sec. 1031(f).The rulings may indicate a more favorable Service attitude toward exchanges in which the related parties have not cashed out of their original investments through "abusive" basis-shifting.

Background

Sec. 1031(a) allows a taxpayer to defer gain or loss recognition if property held for productive use in a trade or business or investment is exchanged solely for property of like-kind also held for a qualified use. In a deferred like-kind exchange, a taxpayer is bound by certain time limits in which to complete an exchange, including the requirement that the replacement property generally must be received within 180 days of the disposition of the relinquished property or, in the case of a reverse exchange, the "parked" property must be transferred to the taxpayer as replacement property within 180 days after the accommodation party acquires title of the parked property; see Sec. 1031(a)(3) and Rev. Proc. 2000-37.

Related parties: Sec. 1031(f) limits exchanges of property between related parties. Enacted by Congress in 1989, it is intended to prevent abusive scenarios in which a taxpayer uses a like-kind exchange to swap high-tax-basis property for low-tax-basis property with related parties in anticipation of selling the low-basis property; the taxpayer would effectively "cash out" of the original investment in the low-basis property, by selling it shortly after the exchange, with little or no gain recognition.

In general, Sec. 1031(f)(1) provides that a taxpayer exchanging like-kind property with a related person may not use Sec. 1031 if, within two years of the date of the last transfer, either the related person disposes of the relinquished property or the taxpayer disposes of the replacement property. In addition, pursuant to the anti-abuse rule of Sec. 1031 (f) (4), if an unrelated third party is used to circumvent the purposes of the related-party rule in Sec. 1031(f), the nonrecognition treatment under Sec. 1031(a) does not apply to the transaction. However, in situations that do not involve abusive basis-shifting, Sec. 1031 (f) (2) (C) provides a nontax-avoidance exception to the related-party rules.

In recent years, both the IRS and the Tax Court have invoked the Sec. 1031(f)(4) anti-abuse rule to disallow an indirect exchange between related parties, in which a third-party qualified intermediary...