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We are a qualified 1031 exchange company
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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. |
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