Parent’s Exchange with Subsidiary Not Qualified for Nonrecognition Treatment (The Malulani Group, Limited, TCM)

CCH Tax Day Report

A real estate leasing company was not entitled to defer recognition of the gain it realized on an exchange of property with its subsidiary. The transaction was structured to avoid the purposes of Code Sec. 1031(f).

The taxpayer’s argument that the exchange was not structured to avoid the related-person rules was rejected. The taxpayer’s investment in the property was cashed out with a related person retaining the cash proceeds and the interposition of a qualified intermediary could not obscure that result.

The taxpayer’s contention that it had no prearranged plan because it first diligently sought a replacement property held by an unrelated party and only turned to its subsidiary when the deadline to complete the deferred exchange was imminent did not change the result. Further, the taxpayer’s decision to acquire the replacement property from a related person only after it had already engaged a qualified intermediary, did not distinguish the transaction sufficiently from cases in which the taxpayers decided to acquire replacement properties from related persons before hiring qualified intermediaries.

Moreover, the taxpayer failed to demonstrate that avoidance of federal income tax was not one of the principal purposes of the exchange. The aggregate tax liability of the taxpayer and the related person arising from the like-kind exchange and sale transaction was significantly less than the hypothetical tax that would have arisen from the taxpayer’s direct sale of the relinquished property. The substantial economic benefits to the taxpayer and its subsidiary as a result of structuring the transaction as a deferred exchange were clear; the taxpayer and its subsidiary were able to cash out of the investment in the property almost tax free because the subsidiary was able to offset the gain recognized with its net operating losses (NOLs) resulting in a net tax savings to the taxpayer and its subsidiary as an economic unit. The net tax savings achieved through use of the related party’s NOLs demonstrated the presence of a tax-avoidance purpose notwithstanding a lack of basis shifting. Therefore, the taxpayer structured the transaction with a tax avoidance purpose.

Ocmulgee Fields, Inc., CA-11, 2010-2 ustc ¶50,565, and Teruya Brothers, Ltd., CA-9, 2009-2 ustc ¶50,624, followed.

The Malulani Group, Limited and Subsidiary, TC Memo. 2016-209, Dec. 60,737(M)

Other References:

Code Sec. 1031

CCH Reference – 2016FED ¶29,608.2493

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CCH Reference – TRC SALES: 30,206

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