Related Party Ruling

March 2007

In this ruling, the Taxpayer and Related Party are related persons within the meaning of §1031 (f)(3). Related Party wished to acquire Relinquished Property from Taxpayer but did not own like-kind assets that Taxpayer wished to acquire. Taxpayer entered into an agreement with an unrelated third party that required the closing of the acquisition of Replacement Property to occur before Taxpayer transferred Relinquished Property to Related Party. Accordingly, Taxpayer structured the transaction as a "reverse" like-kind exchange under the provisions of Rev. Proc. 2000-37.

Taxpayer entered into a qualified exchange accommodation arrangement with an EAT. The EAT was a single-owner limited liability company, wholly owned by EAT Parent, a corporation unrelated to the Taxpayer. On the same day, Taxpayer loaned the EAT the purchase price of Replacement Property, and the EAT Parent granted Taxpayer a security interest in 100-percent of the membership interest in the EAT as collateral for Taxpayer's loan to the EAT. The EAT then purchased the Replacement Property. The purchase price of the Replacement Property exceeded the value of Relinquished Property, so the Taxpayer was trading up in value.

Subsequently, the Taxpayer entered into an agreement with the Related Party to transfer the Relinquished Property to the Related Party's wholly owned subsidiary. The Related Party intended to dispose Relinquished Property within two years of its receipt.

The exchange was structured as follows: Taxpayer and QI, an affiliate of the EAT, entered into an exchange agreement and the Taxpayer assigned the rights to receive the sale proceeds from the Relinquished Property to QI. Taxpayer transferred the Relinquished Property to Related Party, who paid the purchase price to QI. To complete the exchange, QI purchased 100-percent of the membership interest in the EAT, subject to the EAT's obligation under the loan. At QI's direction, Parent EAT transferred EAT's membership interest to Taxpayer and also transferred the purchase price of the Relinquished Property to Taxpayer to pay down the loan. The Replacement Property value exceeded the Relinquished Property value and the outstanding balance of the loan attributable to this excess value was cancelled because Taxpayer in effect became both the debtor and the creditor with respect to such balance.

This ruling presents the same issues as the recent PLR 200709036, but in a reverse exchange context. The ruling analyzes whether §1031 (f)(1) or (4) applies where (1) Taxpayer purchases like-kind Replacement Property from an unrelated third party via the EAT, (2) Taxpayer sells Relinquished Property to Related Party for cash consideration received by a QI, and (3) Related Party disposes of Relinquished Property within two years of the acquisition. First, the ruling concludes that §1031 (f)(1) does not apply because the Taxpayer and Related Party did not engage in a like-kind exchange. Instead, the Taxpayer exchanged with the QI, who is not related to Taxpayer. Second, the ruling concludes that §1031(f)(4) does not apply because the Taxpayer did not transfer Relinquished Property to Related Party as part of a transaction or series of transactions, structured to avoid the purposes of §1031(f)(1) because: (1) The related parties did not exchange high basis property for low basis property in anticipation of the sale of the low basis property; (2) Only Taxpayer held property before the reverse like-kind exchange and continued to hold like-kind property after the exchange, while Related Party did not hold property before the exchange; and (3) Related Party's disposal of Relinquished Property within two years of acquisition does not result in a "cashing out" of an investment or shifting of basis between Taxpayer and Related Party.

Comment: The ruling does not state why the Related Party wanted the Relinquished Property or why it would dispose of the Relinquished Property within two years of acquisition. There is no representation of business purpose. The only explanation is simply that "Related Party wished to acquire Relinquished Property from Taxpayer". Related Party apparently was not a taxable REIT subsidiary, like the Related Party in PLR 200709036. Perhaps the parties wanted to perform dealer activities on the Relinquished Property and they decided to transfer it to the Related Party so the Taxpayer could do an exchange and avoid ordinary income. Or perhaps they wanted extra time to find a buyer for the Relinquished Property and were trying to avoid the 180 day limitations of Rev. Proc. 2000-37.

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