IRS Disagrees with Tax Court in Bartell Case Ruling on Reverse Like-Kind Exchange
The IRS recently disagreed with a 2016 Tax Court decision that allowed tax-free like-kind exchange treatment for a “reverse exchange.”
The case, Estate of George H. Bartell, Jr. v. Commissioner, involves a taxpayer that had used an exchange accommodation titleholder (EAT) to facilitate a transaction with the belief that the transaction would qualify as a tax-free like-kind exchange under §1031. The taxpayer completed a “reverse exchange” where the replacement property was purchased first by the EAT. The taxpayer then performed substantial construction on the replacement property over the next year. After the construction was completed, the taxpayer agreed to sell the relinquished property through the EAT. The taxpayer completed the sales transaction 17 months after the EAT had initially purchased the replacement property.
The IRS’s position before the Tax Court was that the taxpayer, not the EAT, was the true owner of the replacement property during the time of the construction. It argued that the taxpayer had engaged in a self-exchange that did not qualify as a tax-free like-kind exchange.
The Tax Court ruled in favor of the taxpayer. However, it cited 9th Circuit Court cases that held the EAT does not need to assume the benefits and burdens of ownership to satisfy the §1031 requirements. In other words, the Court stated that, "… where a Code Sec. 1031 exchange is contemplated from the outset, and a third-party exchange facilitator rather than the taxpayer takes title to the replacement property before the exchange, the exchange facilitator need not assume the benefits and burdens of ownership of the replacement property in order to be treated as its owner for Code Sec. 1031 purposes before the exchange."
The IRS published information on the case in its AOD 2017-06 to notify the public that it does not agree with the Bartell decision. The IRS stated that the cases cited in Bartell were decided before the deferred exchange regulations under §1031 and Rev. Proc. 2000-37. The AOD stated the IRS will not follow the Court’s decision that an EAT may be treated as the owner of the replacement property if it doesn’t have the benefits and burdens of ownership.
What does CohnReznick think?
The IRS does allow reverse exchanges under Rev. Proc. 2000-37 regardless of who has the benefits and burdens of ownership. Rev. Proc. 2000-37 allows the EAT to be treated as the owner of the replacement property as long as the like-kind exchange deal is completed up to 180 days after acquisition of the replacement property. Outside of this procedure, the IRS will probably challenge the tax-free like-kind exchange treatment. However, taxpayers in the 9th Circuit (including CA, OR, WA, and other Western states) can use the reasoning and cases cited in the Bartell decision to argue that the EAT can be the owner of the property before the exchange, even if the taxpayer has the benefits and burdens of ownership.
For more information, please Contact Richard Shevak, Principal National Tax Services, at Richard.Shevak@CohnReznick.com or 862-245-5029 or Selvan Boominathan, Manager, at Selvan.Boominathan@CohnReznick.com or 301-280-6455.
This has been prepared for informational purposes, is general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without first obtaining professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.