Harry Potter, Illusions and Section 1031 Exchanges

(The following is an excerpt from our 1031 Advisor newsletter located here )

Harry Potter learned to use the disillusionment charm to reveal and uncover hidden items and secrets.  We will uncover a few financial secrets today using a Section 1031 disillusion charm of our own.  We will reveal that Section 1031 exchanges can:

• provide a return on investments that far exceeds typical business returns
• provide more cash to invest
• result in lower debt, lower interest expense, lower income taxes and higher profits

Charming indeed!

Normally when an investment or business asset is bought, a rate of return is computed using the expected revenue earned over the life expectancy of the investment.  This includes every type of business or investment asset.  However, for today, we will use the purchase of truck used to haul business assets over long distance a.k.a. tractor trailer.

Posted by Strategic Property Exchanges on Dec 15, 2009

5 Steps to Maximize your 1031 Exchanges

(The following is an excerpt from our 1031 Advisor newsletter located here )

How can 1031 Exchange Management help your Company achieve its operational goals?  In spite of the technical nature of tax deferred exchanges, these transactions can be handled with a minimum of complexity to help your Company achieve its business goals.  Simply, the Company can reduce its income tax expense and use the monies saved to invest in more productive assets thus increasing its income, decreasing its expenses, increasing its profitability and improving its growth opportunities.

Step 1:  Define the Company’s Goals.  Whether they are to conserve cash, strengthen the balance sheet, reduce expenses, and/or invest in productive assets,  your Company can improve your business processes by capturing your existing equity and continuously reinvesting it into the business while conserving you cash.

Posted by Strategic Property Exchanges on Nov 12, 2009

IRS Reverses Position on Exchanging "Goodwill" in Intellectual Property

(The following is an excerpt from our 1031 Advisor newsletter located here )

I was speaking at a conference with an Intellectual Property (IP) attorney last week and experienced a classic misunderstanding of a single definition between two separate fields of law.

The IP Lawyer described the nature of trade names and trademarks.  In particular, he explained that trade names were inherently inseparable from the goodwill of the business.  Members of the audience questioned if trade names could be exchanged on a tax deferred basis.

In Newark Morning Ledger Co. v. U.S., the Supreme Court stated that intangible assets such as newspaper mast heads, advertiser accounts and...

Posted by Strategic Property Exchanges on Oct 08, 2009

Bahr v. Dept. of Revenue; TC-MD 080525B

Bahr v. Dep't of Revenue; TC-MD 080525B

Sep. 25, 2009

STEVEN H. BAHR AND LAUREEN R. BAHR,
Plaintiffs,

v.
DEPARTMENT OF REVENUE, STATE OF OREGON,
Defendant.

IN THE OREGON TAX COURT
MAGISTRATE DIVISION

Income Tax

TC-MD 080525B

DECISION

A trial was convened on February 12, 2009, in Salem, Oregon.  Earl A. Doman, Certified Public Accountant, represented Plaintiffs.  Laureen R. Bahr provided sworn testimony.  Bruce McDonald, Tax Auditor, represented Defendant.

At issue is whether four parcels of land qualify to Internal Revenue Code (IRC) Section 1031 deferred tax treatment for the 2005 tax year.  Defendant made its adjustments based on the conclusion that properties were held for sale and not as a mere investment.

The parties agree the sole issue is whether the $127,188 reported on Form 8824 qualifies for deferred tax treatment.

I. STATEMENT OF FACTS

The essential facts are not in dispute.  Sometime prior to 1996, Plaintiffs were in an informal partnership with Rod and Loretta Lent (Lents).  Ms. Lent is Laureen Bahr's sister.  At that time, they owned a duplex together.  In 1996, they exchanged the duplex for five acres of vacant land at 1090 Clearlake Road NE in Keizer, Oregon.  The parties agree that, at this point in time, Plaintiffs were clearly considered "investors" in the property.

In 2001 and 2002, the Lents built a personal residence at the back of the property.  In March of 2004, the partnership submitted an application to the City of Keizer seeking permission to subdivide the property into 27 individual lots.  At that time, Plaintiffs agreed "at the beginning that 22 lots were to be sold to Darrell Beam Construction."  (Def's Position Paper at 1.)  The application was approved and the subdivision site work was done later in 2004.  That development work included placing roads, underground utilities, excavation, engineering, permits and other indirect costs.  (Id.)  The total spent on development was $524,038.  (Id.)  Following those improvements to the land, the first lots were sold on January 7, 2005.  (Id.)

Laureen R. Bahr testified at the trial.  She stated that Darrell Beam Construction initially offered $60,000 per acre for the raw land in its entirety.  He also offered to pay $58,000 per developed lot if  it were instead divided by the partnership.  That computed to a net gain of over $700,000 after the development costs were deducted.  Plaintiffs were not actively involved in the development efforts.  Ms. Bahr testified she was busy during this period attending nursing school; she testified she never viewed or inspected the project.  Any business coordination was primarily handled by the Lents.  She stated the land was improved "to increase the sale price of our investment."  Plaintiffs, she said, "intended to make an investment for our retirement."

Defendant admits the initial land holding was for investment purposes.  The auditor maintains this intent changed after receiving the Beam offer and then subdividing into individual lots.  That, he concluded, converted the investment aim to a business venture with a clear intent to liquidate the business holdings at a profit.

(The rest of the file can be viewed by clicking on the link at the top of this page.)

Posted by Strategic Property Exchanges on Oct 08, 2009

Like-Kind Exchanges Require Additional Oversight to Ensure Taxpayer Compliance

(The following is a another take on a Like-Exchange ruling which was first discussed on our October 2007 newsletter based on the Special Feature under 1031 Newsletters located here which contains the full report)

Highlights of Report Number: 2007-30-172 to the Internal Revenue Service Commissioners for the Small Business/Self-Employed and Wage and Investment Divisions.

IMPACT ON TAXPAYERS

The practice of deferring capital gains tax through like-kind exchanges is increasing in popularity.  However, if taxpayers do not specifically follow the rules for like-kind exchanges, they could be held liable for taxes, penalties, and interest on their transaction.  Therefore, its is important for the Internal Revenue Service (IRS) to provide specific and consistent guidance to taxpayers on this provision of the tax law.

WHY TIGTA DID THE AUDIT

This audit was initiated to evalute the IRS' oversight of the deferment of capital gains tax through like-kind exchanges.  TIGTA also determined whether taxpayers' use of this investment strategy is growing and whether this poses any specific problems for the IRS.

Under normal circumstances, when a taxpayer sells a business or investment property, tax must be paid on the gain.  A like-lind exchange allows an exception to payment of the capital gains tax.  When taxpayers sell businesses or investment real estate and replace them with different businesses or investment properties using an exchange, they can defer payment of the capital gains tax normally required on these sales.  As long as a property used for business or investment is replaced with similar property, no gain or loss is recognized at that time; rather, it is deferred until the eventual sale of the replacement property.

A taxpayer must report an exchange to the IRS on Like-Kind Exchanges (Form 8824), which is filed with his or her tax return for the year during which the exchange took place.  The IRS Office of Research, Analysis, and Statistics reported that in Tax Year 2004 taxpayers filed more than 338,500 Forms 8824 claiming deferred gains (or losses) of more than $73.6 billion.  While this represents a doubling of the number of like-kind exchanges reported in 1998, the total dollar amounts deferred more than tripled.

WHAT TIGTA FOUND

Like-kind exchanges require more IRS oversight to ensure taxpayers comply with tax law.  Some IRS guidance needs revision to provide more consistent and complete information regarding like-kind exchange filing requirements.  In addition, the IRS regulations for like-kind exchanges of second and vacation homes are complex and may be unclear to taxpayers, and little informaiton exists with respect to a published position by the IRS on like-kind exchanges involving such properties.  The absence of clarification leaves unrebutted the sales pitch of like-kind exchange promoters who may encourage taxpayers to improperty claim deferral to capital gains through "tax-free" exchanges.

WHAT TIGTA RECOMMENDED

TIGTA recommended the Director, Research, Small Business/Self-Emplyed Division, conduct a study of issue-related returns selected by the National Research Program.  At the conclusion of the study, the Research function would recommend to the Small Business/Self-Employed Division Examination function what particular data should be captured in future National Research Programs in order to ensure appropriate IRS oversight of taxpayer compliance with tax laws pertaining to like-kind exchanges.  TIGTA also recommended the Commisioner Wage and Investment Division update some current guidance regarding Form 8824 and provide additional guidance to taxpayers regarding rules and regulations governing like-kind exchanges of second and vacation homes that were not used exclusively by owners.  In their response to the report, IRS officials agreed with all of the recommendations.  The IRS plans to conduct a research study of reporting and compliance issues associated with like-kind exchanges and share the results with the appropriate function.  In addition, the IRS agreed to revise instructions for certain tax forms; update the information available on IRS.gov; and provide additional guidance on like-kind exchanges to taxpayers.

The original text of the above-listed summary can be found on the TIGTA website using the following link http://www.treas.gov/tigta/auditreports/2007reports/200730172_oa_highlights.pdf

Posted by Strategic Property Exchanges on Sep 24, 2009

Teruya Bros. vs. Commissioner, 9th Cir (9/8/2009)

TERUYA BROTHERS LTD. V. COMMISSIONER, 9TH Cir. No. 05-73779 (Sept. 8, 2009)

The 9th Circuit Court of appeals affirmed the 2005 Tax Court decision (Teruya Bros., Ltd & Subsidiaries v Comm'r of Internal Revenue, 124 T.C. 45 (2005)), holding the exchanges in question were structured to avoid pursposes of the related party provisions of § 1031(f), and thus violated § 1031(f)(4).

In 1995, Teruya Brothers, Ltd. ("Teruya"), a Hawaii corporation, disposed of two of its properties, the Ocean Vista condominium complex ("Ocean Vista"), and the Royal Towers APartment building ("Royal Towers").  The dispostions were structured as tax deferred exchanges using a QI.  The replacement properties were acquired from a related party to Teruya, Times Super Market, Ltd. ("Times").  Teruya owned 62.5% of the common shares of Times.

Ocean Vista Exchange.  Ocean Vista was sold to a third party buyer, using a QI, for $1,468,500.  On the same day, the QI used the sale proceeds along with an additional $1,366,056 from Teruya to purchase the Kupuohi II property from Times for $2,828,000.  Teruyas' basis in Ocean Vista was $93,270, and its deferred gain from the exchange was $1,345,169.  Times had a basis in Kupuohi II of $1,475,361, and recognized a $1,353,639 gain from the sale.  Importantly, Times paid no tax on this gain because it had a large net operatin loss (NOL).

Royal towers Exchange.  Royal towers was sold, using the QI for $11,932,000.  On the same day, the QI used the sale proceeds alongwith $724,554 in additional funds from Teruya to puchase the Kupuohi I and Kaahumany properties from Times for $8,900,000 and $3,730,000, respectively.  Teruya's basis in Royal Towers was $670,506, and its deferred gain from the exchange was $10,700,878.  Timas had a basis in Kaahumanu of $1,502,960, and realized and recognized a $2,227,040 gain on the property's sale.  However, as with Kupuohi II, Timeas paid no tax on this gain because of its NOL.  Times had a basis in Kupuohi I of $15,602,152, and reliazed a capital loss of $6,453,372 on its sale.  (Timas did not regnize this loss, however, because IRC § 267 prohibits the recognition of losses from sales and exchange of property related parties.

Opinion.  The Court of Appeals found that the Tax Court was correct in determining that the transaction were structured to avoid the purposes of § 1031(f)(4).  The related parties cashed out of investments of approximately $13.4 million but avoided gain recognition by using basis-shifting provisions of § 1031.

The Court also examined if either exchange did not violate § 1031(f)(4) because under § 1031(f)(2), the taxpayer can establish "to the satisfaction of the Secretary" that the transaction did not have "as one of its principal purposes the avoidance of Federal income tax."  The court concluded that the record supported the Tax Court's determination that the impoper avoidance of federal income tax was one of the principal purposes behind these exchanges.  Times recognized only $2.2 million in gain on the Royal towers transaction, far less than the nearly $11 million gain that Teruya would have faced from the direct sale of Royal Towers.  Moreover, Times paid no tax on even this smaller gain due to its NOLs.  Thus, the Court concluded, Teruya/times economic unit achieved far more advantageous tax consequences through the exchanges than it would have had Teruya simply sold its properties to the third-party buyers.

 The Court stated, in a footnote, that the tax price paid by Times from reducing its NOLs may have theoretically equaled or even exceeded the amount of the tax deferred by Teruya, particularly in the Ocean Vista transaction.  It cited "Kelly Alton et al., Related-Party Like-Kind Exchanges," 115 TAX NOTES 467, at *26-27 (2007).  The Court did not address this argument, however, because Teruya did not argue it on appeal.

To read the whole case click here.

Posted by Strategic Property Exchanges on Sep 22, 2009

Managing Your Cash to Grow in a Recession: A Tale of Two Companies

(The following is an excerpt from our 1031 Advisor newsletter located here )

Two companies, Company A and Company B, were competitors.  In the past, Company A borrowed heavily to expand.  Company B kept its debt at a minimum.  When the economy slid into recession, customers disappeared and profit margins were squeezed,  reducing profits.  

Company A initially cut costs as far as it could, sometimes making repeated cuts thus sending shock waves through its workforce.  Company A then turned to reducing working capital and inventory to conserve its cash.  Company B’s low overhead enabled it to survive without such drastic reductions.

Facing default on its loans with its Bank, Company A offered to sell its business to Company B.

The offer was a tremendous opportunity to acquire distressed assets at a fraction of the cost compared to a couple years ago.  Company B weighs its options:

Posted by Strategic Property Exchanges on Sep 09, 2009

Reduce Costs by Exchanging Strategic Assets

Reduce Costs by Exchanging Strategic Assets- August 2009- (The following is an excerpt from our 1031 Advisor newsletter located here )

Companies regularly face a certain dilemma—retain their current assets or make investments in new strategic assets and dispose of less profitable assets.  A  range of attractive (even once-in-a-lifetime) acquisitions and other investment opportunities seem hard to pass up, including some that weren’t possible just a few years ago.

Expense Reduction.  One factor in the overall success of the disposition and acquisition of strategic assets is the overall effect of expense reduction in the transaction.  The Companies that succeed with reducing the overall costs associated with the disposition and acquisition of strategic assets will have a decisive competitive advantage.

Posted by Christa Hyson on Aug 18, 2009

Related Party Exchanges Continue to Generate Controversy

(The following is an excerpt from our 1031 Advisor newsletter located here )

Related Party Exchanges continue to generate controversy,  in part,  because there are no tax regulations to provide guidance.   There are very few cases to refer to and the rulings provide inconsistent results.   Join us for our 1031 Exchange Planning Topics discussion forum during the month of July, 2009 for strategies in effecting related Party Exchanges at http://www.linkedin.com/in/steverobisontaxman.

Posted by Strategic Property Exchanges on Jul 09, 2009

Exchanging Partnership Assets in Section 1031 Exchanges

(The following is an excerpt from our 1031 Advisor newsletter located here )

Problem: A Partnership currently owns property to be sold. Some of the partners wish to treat the sale as a tax deferred exchange and to re-invest the proceeds into a like-kind property. Some of the other partners wish to cash out of their investment and not acquire additional property or, in the alternative, simply part company and/or invest the proceeds on their own. The Partners come to you and ask for your advice.

Solutions: Which of the following solutions will be treated as a valid Section 1031 Exchange?

Posted by Strategic Property Exchanges on Jun 05, 2009

Second Case Issued on Related Party Exchanges

(The following is an excerpt from our 1031 Advisor newsletter located here )

In Ocmulgee Fields, Inc. vs. IRS, 132 TC 6 (March 31, 2009), the Tax Court (properly) disallowed a like-kind exchange under Section 1031(f)(4) because the exchange was part of a transaction structured to avoid the purposes of Section 1031(f), governing exchanges between related persons. This case reiterates the existing holding in Revenue Ruling 2002-83 and Teruya Brothers.¹

Posted by Strategic Property Exchanges on May 18, 2009

IRS Reverses Position on Certain Intangible Assets

(The following is an excerpt from our 1031 Advisor newsletter located here )

Intangible Property (I.P.), a.k.a. Intellectual Property, assets are one of the  most  important  assets  in  commerce today.  Between sixty to eighty percent of the assets of U.S. Corporations are classified as Intellectual Property assets.  Furthermore, investment in Intellectual Property and the resulting innovation is the primary engine for growth in the U.S. economy.  It is important for companies to be able to determine which assets to invest in, to acquire, or dispose of with the least possible tax cost as possible.

U.S. tax policy has gradually recognized the value of these assets.  First, by piecemeal changes to the existing law.  Second, by enacting Section 197, permitting the amortization of numerous classes of intellectual property, including goodwill.  In the area of Section 1031 exchanges, the IRS continues to expand and liberalize the interpretation of what is like-kind and what assets are exchangeable.  The Office of the Associate Chief Counsel (Income Tax and Accounting) just released TAM 200911006 which changes the previously issued TAM and FAA regulations regarding intangibles.

Posted by Strategic Property Exchanges on Apr 24, 2009

Intangible Asset Exchanges Lead to Innovation and Growth

(The following is an excerpt from our 1031 Advisor newsletter located here )

As we have discussed in the past, intangible assets can be exchanged for like-kind intangible assets.  The key, of course, is planning in advance to separate the assets to be sold and acquired to maximize the benefits of the Exchange.

Innovation.  If history is any guide, the period during the Great Depression, from 1931 to 1938, was a period of tremendous innovation by US Companies.  U.S. Companies expanded the size and number of laboratories to find new and innovative products to bring to the market.  These products, such as nylon and Teflon, led the way to greater prosperity for the innovators and the country as a whole.

Posted by Strategic Property Exchanges on Mar 23, 2009

Impact of Sales Tax on Business Asset Exchnages, Including Aircraft

(The following is an excerpt from our 1031 Advisor newsletter located here )

Most practitioners are aware that income taxes on a Section 1031 Exchange of business assets can be deferred.   However, in the arcane world of sales and use taxes, the states generally seek to impose sales taxes in full on the purchase and sale of (taxable) business assets rather than permitting a credit for the prior tax paid on the replacement property.

In the case of aircraft exchanges, these transactions are highly visible because they are reported to the states by the Federal Aviation Administration.  Given the stark shortfall in tax collections, we have seen a marked increase in sales and use tax collection activity throughout the Midwest.

Posted by Strategic Property Exchanges on Feb 11, 2009

Expanding Your Professional Practice Is Just a Phone Call Away

(The following is an excerpt from our 1031 Advisor newsletter located here )

When professional advisors are asked, “What is a Section 1031 Exchange?”, the vast majority instinctively visualize a real estate transaction—not a sale of business assets, nor collectibles or other investments, and not intangible assets.

Posted by Strategic Property Exchanges on Jan 15, 2009