Background
In Ocmulgee Fields, the taxpayer used a §1031 Intermediary to sell a parcel of taxpayer's real estate to an unrelated third-party. The taxpayer then used the proceeds from the first sale to purchase §1031 replacement property from a relative, who is a related party as defined under §1031(f). The IRS determined a deficiency because the taxpayer failed to establish that it met all of the requirements for the non-recognition of gain under Section 1031(f), which provides special rules for like-kind exchanges with related persons.
Like-kind exchange transactions
According to §1031(a)(1), generally no gain or loss is recognized on the exchange of property used in a trade or business, or for investment, for another like kind property. Under Section 1031(f)(1), gain or loss on an exchange between related persons is generally not recognized if the property exchanged is not disposed within two years from the date of the exchange. However, under Section 1031(f)(2)(C), the taxpayer must establish to the IRS’s satisfaction that neither the original transaction nor the later disposition had the avoidance of Federal income tax as one of its principal purpose. Further, under Section 1031(f)(4), the non-recognition treatment of a like-kind exchange doesn’t apply to a transaction or series of transactions structured to avoid the purposes of the related party exchange rules.
In Ocmulgee Fields, the Tax Court relied on its earlier decision in Teruya Brothers, Ltd. & Subsidiaries, 124 TC 45 (2005), which also dealt with a like-kind exchange between related parties effected through a qualified intermediary. In that case, the Tax Court held that the transactions involved were economically equivalent to direct exchanges of properties between related parties, followed by the sale of property by one of the related parties to unrelated third parties. The interposition of a qualified intermediary did not obscure the end result. The Tax Court found that the transactions were set up to avoid Federal income taxes under Section 1031(f)(4).
In essence this kind of related party transaction is scrutinized by the IRS as though the cash realized on the first sale and ultimately transferred to the relative (i.e., when the second piece of real estate is purchased from that relative to close the loop on the §1031 Like-Kind Exchange) is funneled back to the taxpayer in a tax avoidance scheme covered by §1031(f)(4).
Tax Court rejected the taxpayer’s claim that it had no tax avoidance purpose and concluded that the substance of the transaction was as if the taxpayer had made an exchange directly with the related person.
The Tax Court stated that it was not prepared to hold, as a matter of law, that a finding of basis shifting precludes the possibility of having a non-tax avoidance principal purpose. However, it found that in Ocmulgee Fields, the immediate tax consequences resulting from the taxpayer’s deemed exchange with a related party included approximately $1.8 million reduction in taxable gain and the substitution of a 15-percent tax rate for a 34-percent tax rate. The Court found that the tax savings were significant and that the taxpayer’s counter arguments were unconvincing or speculative, and thus did not persuade the Court that the principal purpose was something other than to avoid Federal income taxes.
Accuracy-related penalty
The Tax Court found that although the taxpayer’s understatement was substantial under Section 6662(d), the taxpayer showed reasonable cause and good faith for its position. The taxpayer relied on a CPA, who was a member of the largest accounting firm in the taxpayer’s area and had significant experience in the real estate business. The CPA provided tax advice to the taxpayer for many years and was aware of all the facts with respect to the like-kind exchange. In addition, the Tax Court had not yet decided the Teruya Brothers case when the return was prepared. Although the IRS had issued Revenue Ruling 2002-83, the Tax Court found that the Revenue Ruling did not leave the result free from doubt and that the CPA did not make any unreasonable assumptions. Therefore, the Tax Court ruled that the taxpayer was not liable for an accuracy-related penalty.
For More Information Contact The Atlanta, Georgia Law Offices Of AttorneyBritt:
AttorneyBritt
Gary L. Britt, CPA, J.D.
1200 Abernathy Road, Suite 1700
Atlanta, Georgia 30328
404-567-6445
“Lawyer's That Mean Business”
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
0 comments:
Post a Comment