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    TRUSTS & ESTATES, WILLS, AND TAX LAW UPDATE

    TAX: Free Like-Kind Exchanges of Property

    Posted by D. Bradley Pettit on Thu, Dec 27, 2018 @ 11:12 AM

    Brad Pettit—Senior Attorney, National Legal Research Group

                The Internal Revenue Code provides generally that "[n]o gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment," as long as the transaction does not involve an "exchange of real property held primarily for sale." 26 U.S.C. § 1031(a) (also includes Pub. L. Nos. 115-233 to 115-253, 115-255 to 115-269; Title 26 current through Pub. L No. 115-270). "As used in section 1031(a), the words 'like kind' have reference to the nature or character of the property and not to its grade or quality." 26 C.F.R. § 1.1031(a)-1(b). Thus, "[o]ne kind or class of property may not, under that section, be exchanged for property of a different kind or class." Id. For example, "[t]he fact that any real estate involved is improved or unimproved is not material, for that fact relates only to the grade or quality of the property and not to its kind or class." Id.

                Taxpayers are cautioned that a personal residence normally cannot be the subject of a tax-free like-kind exchange of real property because the use of property as a personal residence necessarily means that it is not being held for productive use in a trade or business or for investment.  United States v. Orr, 122 A.F.T.R.2d 2018-5716, 2018 WL 4134703 (W.D. Tex. Aug. 28, 2018); Yates v. Comm’r, T.C. Mem. 2013-28 (a taxpayer's use of property solely as a personal residence is inconsistent with the requirement, under 26 U.S.C. § 1031, that property must be held for investment or business purposes before it can be the subject of a tax-free like-kind exchange), aff'd, 548 F. App’x 68 (4th Cir. 2013), cert. denied, 572 U.S. 1118 (2014).  In Orr, the court ruled that even though a property owner used a parcel of real property for business activities, the realty could not be said to have been held for productive use in a trade or business or for investment because she used it primarily as her personal residence, and was not eligible to be the subject of a tax-free exchange under 26 U.S.C. § 1031:

    Even an argument that Mrs. Orr used the properties partially for business activities such that they were not used solely as personal residence would not legitimize the exchange because "[i]t is a taxpayer's primary purpose in holding the properties that counts." Moore, 2007 WL 1555852 at *10 (emphasis in original) ((citing Montgomery v. C.I.R., T.C. Memo. 1997-279, 1997 WL 337117 at *9) (rev'd on other grounds on appeal by 300 F.3d 866 (10th Cir. 1999))). And the primary purpose for which Mrs. Orr held the Hays Property and holds the Cost Property is not for business or investment, but as her personal residence. As such, the properties were ineligible for tax-deferred treatment under a § 1031 exchange.

    2018 WL 4134703, at *9 (footnote omitted).

                There are numerous technical requirements for qualifying for nonrecognition of gain or loss treatment under § 1031 of the Code.  Moreover, many types of exchanges of real or personal property, such as deferred and multi-party or multi-property exchanges, can qualify for like-kind exchange treatment.  NLRG's Senior Tax Attorneys, with combined experience of over 60 years, can help our attorney clients identify the requirements and rules that apply in a given case.

    Topics: tax, IRC, like-kind exchanges, nature or character of property, personal residence, Brad Pettit

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