In Action on Decision 2017-6, the IRS announced that it will not acquiesce to the 2016 Tax Court decision in Estate of George H. Bartell, Jr. v. Commissioner, but it will recognize the precedential impact of the ruling within the 9th Circuit. This announcement creates uncertainty for taxpayers looking to enter into reverse like-kind exchanges.
In Bartell, the taxpayer identified replacement property it wished to acquire and develop into a drug store. The taxpayer did not purchase the replacement property directly. Instead, the taxpayer used an exchange facilitator to acquire the replacement property and, over a period of 17 months, constructed a drug store on the replacement property. Following completion of construction, the taxpayer leased the replacement property from the exchange facilitator until the taxpayer, through a qualified intermediary, was able to sell relinquished property to a third party and use the proceeds to acquire the replacement property.
The Tax Court held that the transaction qualified as a like-kind exchange. In its Action on Decision, the IRS indicated it did not agree with the conclusion in Bartell because, in its view, the taxpayer had the benefits and burdens of ownership of the replacement drug store during the 17-month construction period and subsequent lease. The IRS did not, however, appeal the Bartell decision, so it will recognize the precedential nature of the case in the 9th Circuit, which is where the taxpayer is located.
In a reverse like-kind exchange, a taxpayer, via an intermediary, purchases replacement property prior to the sale of property to be relinquished. The IRS provided a safe harbor for reverse like-kind exchanges in Revenue Procedure 2000-37, which later was modified by Revenue Procedure 2004-51. The safe harbor provides that an exchange is treated as a like-kind exchange qualifying for tax deferral under IRC Section 1031 if all of the following apply:
- The replacement property is held by the qualified intermediary pursuant to a qualified exchange accommodation arrangement (QEAA).
- The taxpayer does not take title to the replacement property before it is held in the QEAA.
- The relinquished property is identified on or before 45 days after the QEAA takes ownership of the replacement property.
- The replacement property is received by the taxpayer on or before 180 days after the date on which the QEAA takes ownership of the replacement property.
The safe harbor does not address situations in which a reverse exchange similar to the one in Bartell would be allowed.
Taxpayers looking to achieve a result similar to Bartell should take caution, as it is unclear whether the Action on Decision is in response to specific facts within Bartell or to deferred reverse like-kind exchanges in general. For example, although the exchange agent held the land while the drug store was being built, the taxpayer managed the construction process.