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owner C the commercial building that taxpayer A has designated.
Buyer B then transfers title to the newly acquired commercial
building to taxpayer A, completing the tax-free like-kind exchange.
The economics of these transactions (taxes aside) are the same
as if taxpayer A had sold the apartment building to Buyer B and
used the proceeds to purchase the commercial building from owner
C. However, a transaction in which the taxpayer receives the proceeds
of the sale and subsequently purchases like-kind property would
be taxable to the taxpayer under general tax principles.
In
order for a three-way exchange to qualify for tax-free treatment,
the regulations prescribe detailed rules regarding identification
of the replacement property, rules allowing the seller to receive
security for performance by the buyer without the seller being
technically in receipt of money or other property, and rules relating
to whether a person is an agent of the taxpayer or is a qualified
intermediary whose receipt of money or other property is not attributed
to the taxpayer.
In
addition, the IRS recently released a revenue procedure (footnote
522) providing that if certain formulaic requirements
are satisfied, the IRS will not challenge deferred exchanges where
the replacement property is acquired prior to the disposition
of the relinquished property. (footnote 523)
The revenue procedure provides that the taxpayer will not
be considered the owner of the property, for purposes of determining
if the property qualifies as replacement property under section
1031, so long as the taxpayer satisfies the stated requirements
of the revenue procedure. This treatment is irrespective of whether
general tax principles would consider the taxpayer as the owner
of the property for federal income tax purposes.
The
rules prescribed in the regulations and the revenue procedure
provide safe harbors that allow taxpayers to comply with the "exchange"
requirement of present law. However, these rules are quite complicated
and the failure to comply may result in a taxable transaction.
Additionally, these rules impose compliance burdens and additional
costs to taxpayers.
Legislative
background
The
like-kind exchange provisions were originally enacted in the Revenue
Act of 1921 and have remained largely unchanged since the early
1920's. The Tax Reform Act of 1984 added the provisions regarding
deferred exchanges in response to the case of Starker v. United
States (footnote 524) that allowed
a 5-year period to acquire the replacement property. The Omnibus
Budget Reconciliation Act of 1989 added rules preventing certain
related party exchange transactions to be used to avoid gain recognition.
The definition of like-kind property has been modified legislatively
to address issues relating to targeted types of property.
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522
Rev. Proc. 2000-37, 2000-40 I.R.B. 308.
523 The preamble to the 1991 final regulations under section 1031
stated that regulations would not be applicable to exchanges where
the replacement property is acquired prior to the disposition
of the relinquished property. T.D. 8346, 1991-1 C.B. 150.
524 602 F. 2d 1341 (9 th Cir. 1979).
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