Category: Nontaxable Exchanges; Real Estate Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background Issue Discussion Rev. Rul. 76-390, 1976-2 CB 243, With the exception of Rev. Ruls. 67-254 and 64-237, all the above items involve an involuntary conversion and whether various kinds of replacement property are deemed to be "like-kind" for purposes of Section 1033(g), focusing specifically on whether replacement property consisting only of some type of land improvement constitutes a qualified replacement for converted land or land plus improvements. Because Rev. Ruls. 67-254 and 64-237 deal strictly with Section 1033(a) issues, as opposed to the broader like-kind concept of Section 1033(g), I feel these rulings are not relevant to the matter at hand. If you feel that I am missing something important from these rulings, I would appreciate your setting me straight. In addition, the trial court in Davis ruled that a transaction did not qualify under Section 1033(a) but rather did qualify under Section 1033(g). The Ninth Circuit ruled that Section 1033(a) did apply and thus did not reach the issue of the applicability of Section 1033(g). Accordingly, Davis does not provide us with the much-desired Ninth Circuit precedent that Section 1033(g) applies to this kind of fact pattern. It seems to me with respect to the items you have cited, all roads seem to lead back to Rev. Rul. 67-255: all the items cite this ruling and rely on its reasoning. The ruling considers the condemnation of land held for investment and the reinvestment of the condemnation proceeds in the construction of a building to be held for investment on land already owned by the taxpayer. The conclusion of the ruling is based on the following pronouncement for which no supporting reasoning is provided. In considering the "like kind" test, although the term "real estate" is often used to embrace land and improvements thereon, land and improvements are by nature not alike merely because one term is used to describe both. Land is not of the same nature or character as a building, or a storm drain, or a water system, or a road. As far as the IRS is concerned, reinvesting in the 1033(g) context in some kind of land improvement is not sufficient for an involuntary conversion of real property. A land improvement alone is inherently different than land plus its improvements. In addition to what you found, there are some pure 1031 cases and rulings to the same effect. See, for example, Bloomington Coca-Cola Bottling Company v. Comr., 189 F2d 14 (7th Cir., 1951) and PLR's 8701015. Based solely on the forgoing information, one could conclude that there is a considerable amount of risk in this transaction for your client. I am not satisfied with that result, however, because I believe that the present transaction is qualitatively very different from the cases and rulings cited. In the cited cases and rulings, the taxpayer received a land improvement to replace condemned real property. The cited items denied 1033(g) or 1031 treatment based on the theory that land plus its improvements are inherently not like-kind vis-a-vis land improvements alone. I do not think it necessarily follows that giving up a land improvement (i.e., a building) in exchange for land plus improvements is not a like-kind transaction. First, the 1033(g) cases and rulings involve a condemnation of property consisting of land and its improvements. In other words, the land plus its improvements were taken and a land improvement of some type was substituted. In our case, a land improvement is to be exchanged for land plus an improvement. This may be different simply because it goes in the opposite direction of the cases and rulings we have; although, that argument is clearly risky. More importantly, it seems to me that it would be impossible to find a buyer willing to take your client's hotel (or any building for that matter) without also having long-term control over the underlying land. Obviously, a building without control of the underlying land is useless. Accordingly, I think viewing the present transaction in terms of a pure, theoretical question about whether a building severed from land can be replaced by a building plus the underlying land may yield a nonsensical result: in the context of our facts, the question itself makes no sense. It seems to me that the ground lease must be taken into account in this transaction. I think the proper question is whether a building plus a ground lease for the underlying land can be exchanged for a building plus fee simple ownership of the underlying land. Here I think your client's prospects for success are vastly better. Regs. Section 1.1031(a)-1(c) says a real estate lease with 30 years or more to run is like-kind to a fee interest in real estate. I have exhausted my budget for this project, but I believe that the work set forth above has put new light on this question. I think the next step is to evaluate the taxpayer's ground lease against whatever cases and rulings exist in this area. Please call me when you have absorbed all this. I stand ready to assist you further as you desire. |
