Search

Donovan’s Steakhouse

Donovans

Cover Story

Recent

Follow SD Metro Magazine

Delicious Pinterest RSS
Advertise on SD Metro Magazine

Latest Tweets

Tax Defered Exchanges – Benefit or costly mistake?

By Tim Binder

So-called 1031 exchanges are mainstays of professional real estate investors.  Named after Internal Revenue Code Section 1031, a properly structured exchange allows an investor to exchange property held in a trade or business or for investment purposes for other like kind property. In general, the taxable gain on the transaction is deferred and no federal or state income taxes are payable on the gain. However, when the exchange is not structured properly, the result is a taxable sale. A recent Ninth Circuit Court of Appeals case illustrates the point.
The case began in 1995 when two related taxpayers engaged in a series of exchanges designed to defer taxable gain for one taxpayer, and recognize taxable gain for the related taxpayer. The related taxpayer had a net operating loss carry over that the related taxpayer intended to use to offset the taxable gain so that little or no tax would be payable.
The Internal Revenue Service determined that both exchanges failed to qualify for tax deferral under Section 1031 and issued the taxpayer a tax deficiency notice of $4.1 million. The taxpayer took his case to Tax Court and lost. The taxpayer then appealed his case to the Ninth Circuit who agreed with the Tax Court.
The fatal flaw in the taxpayer’s position was a subsection of Section 1031 that deals with exchanges between related parties. This section requires that the exchange not have as one of its principal purposes the avoidance of federal income tax. In this case, the court had no problem concluding that the exchanges were structured for unwarranted tax avoidance purpose.
The taxpayer may have been able to avoid this result if there was a credible independent business purpose for structuring the exchanges as they were structured, and the related party had held its exchange property for at least two years following the exchange. However, when the related party sold its exchange property shortly after the exchange, both exchanges were no longer qualified for 1031 non-recognition treatment.
Exchanges can be complicated. If executed correctly they can be most beneficial to the taxpayer. But as this case illustrates, the IRS is more than willing to attack an exchange that fails to meet every requirement of the code. z

Tim Binder is a San Diego-based attorney concentrating on business, real estate, employment, construction and tax law.

1 Comments on “Tax Defered Exchanges – Benefit or costly mistake?

  • Tim,

    You are exactly right. In cases of obvious basis shifting to avoid tax on gain, the exchange will be disallowed and the tax will become due (plus any potential penalties or interest). I believe sage advice for any taxpayer considering a 1031 exchange is to rely on competent counsel to ensure their transaction meets all the strict guidelines of a 1031 exchange. As a Qualified Intermediary, my firm is disallowed from providing tax advice, however we regularly work with attorneys and CPAs to ensure their clients’ exchanges are structured properly.

    Jim Burnett
    Director, Business Development
    Accruit, LLC
    http://www.accruit.com

Leave a Reply

Your email address will not be published. Required fields are marked *


*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Latest Issue

Click here to view this months issue interactive online version.

Click here to view the PDF version of our magazine.

Website Design in San Diego, San Diego Web Design
Advertise on SD Metro Magazine

Voice Your Opinion


We Want Your Opinions on San Diego’s Big Issues In the coming months, Probosky Research (one of California’s leading opinion research firms) will continue its partnership with SD METRO to survey San Diego residents about topics of interest to our readers. We’d like to throw open the door for suggestions for topics. What do you want to know? What do you think you know, but aren’t sure? What are you certain you know, but want to prove it beyond doubt? Ideally, we’d like to see questions that have to do with public policy.

Some areas may include Mayor Filner’s first 100 days job performance, should the city be responsible for economic growth and the creation of new jobs, how important are infrastructure improvements to our daily lives (streets and bridges, etc.), how important is water independence, how satisfied are residents with public transit or how do city residents value Balboa Park and other open spaces? Do you believe the City Council should revive the Plaza de Panama plan for Balboa Park?

You can email Probolsky Research directly with your ideas: info@probolskyresearch.com