Transfer of Relinquished Property to Related Person Gets Favorable Like-Kind Treatment

The Service recently ruled (PLR 200728008) that Section 1031(f) will not trigger gain recognition in an otherwise qualifying like-kind exchange when the taxpayer transfers relinquished property (through a qualified intermediary (QI)) to a related person and acquires replacement property (through a QI) from an unrelated person, even if the related person disposes of the relinquished property within two years of its acquisition of such property.

This is the third time the Service has issued a letter ruling that addressed whether Section 1031(f)(4) applies when a taxpayer transfers relinquished property (through a QI) to a related person and the related person disposes of the relinquished property within two years. (See PLR. 200709036 and PLR 200712013). These three letter rulings may encouragte taxpayers looking to structure transactions with similar facts.

Taxpayers should remain cautious, however, in considering whether a related party's participation in a like-kind exchange will implicate Section 1031(f). The related party's purpose for acquiring the property may  determine whether the transaction qualifies for tax deferal. That is, if the related party acquired the property to subdivide it or construct improvements before selling (to preserve nondealer status for the exchanging taxpayer), or to list the property for sale immediately (seeking to extend the 180-day parking period permitted under Rev. Proc. 2000-37), the Service might not reach a similar conclusion.

Taxpayers should also be aware that this PLR should not be confused with the fact situation of earlier unfavorable rulings where the taxpayer acquired replacement property (through a QI) from a related person. Specifically, in Rev. Rul. 2002-83, 2002-2 CB 927, the Service concluded that a taxpayer transferring relinquished property (through a QI) to an unrelated person in exchange for replacement property (through a QI) owned by a related person must recognize gain if the related person receives cash or non-like-kind property. The Tax Court reached a similar conclusion in Teruya Brothers Ltd., 124 TC 45 (2005).