A. Introduction
Determining whether exchange property is of “like kind” necessitates a review of IRS pronouncements, decisional case law, and the Regulations. Regs. § 1.1031(a)-1(b) provides that the words “like kind”
[h]ave reference to the nature or character of the property and not to its grade or quality. one kind or class of property may not be exchanged for property of a different kind or class. [however,] whether 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. (emphasis added).
As the Regs state, exchanges involving real estate enjoy rarefied status. Regs. §1.1031(a)-1(c) further provides that the exchange of a fee interest with a 30 year lease, or the swap of city real estate for a ranch or farm, are exchanges of “like kind” property. The exchange of a fee interest for coop shares would also appear to qualify under Section 1031. See also PLR 943125, stating that a lot held for investment is of like kind with a townhouse to be used as rental property.
Rev. Rul. 67-255 stated that a building is not of like kind to a building and land. It may therefore be difficult to strip a building from the underlying land and engage in an exchange. However, if the building includes an easement or lease, the building and lease might together qualify as real property for purposes of a like kind exchange.
IRC §1031(h)(1) provides that “[r]eal property located in the United States and real property located outside the United States are not property of a like kind.” Although nonresidents may engage in like kind exchanges, Section 1031 applies only to exchanges of United States property interests for interests in property the sale of which would be subject to United States income tax. IRC §897 provides for the treatment of gain or loss realized by a nonresident individual or foreign corporation who disposes of a United States real property interest. IRC §1445 (subject to some exemptions) requires withholding of 10 percent of the amount realized in a transaction subject to IRC § 897.
Rev. Rul. 2004-86 expanded the scope of “like kind” real property by finding that real property, and interests in a Delaware Statutory Trust which itself owns real property, are of like kind. This result occurs because the owner of an interest in a Delaware Statutory Trust (DST), which is a grantor trust under IRC §671 et seq, is treated as owning assets which are owned by the trust. Therefore, such an exchange actually consists of the exchange of real property interests, rather than the exchange of a real property interest for a certificate of trust, which would be barred under IRC §1031(a)(2)(E).
The IRS blessed the exchange of cooperative shares in PLR 20063112. While acknowledging that “New York case law might suggest that there are conflicts concerning whether a cooperative interest in real property is real property [citations omitted],” the ruling remarked that “various New York statutes treat an interest in a cooperative as equivalent to an interest in real property.” Accordingly, the ruling held that interests in cooperative apartments in New York are of like kind to improved and unimproved realty.
B. Tangible Personal Property
In contrast to exchanges involving real property, exchanges of tangible personal property will qualify under Section 1031 only if the properties bear a strong resemblance to one another. In making this determination, the “similar or related in service or use” test of IRC §1033(a)(1), rather than the rules developed for determining whether real estate is of like kind, appears to be the standard called for in the Regulations. Rev. Rul. 82-166 states that gold bullion and silver bullion are not of like kind since “silver and gold are intrinsically different metals . . . used in different ways.” Regs. § 1.1031(a)-2 provides that depreciable tangible personal property qualifies for exchange treatment if the properties are of “like kind” or “like class.” Properties are of “like class” if on the exchange date they are of the same (i) “General Asset Class” or (ii) “Product Class.”
Regs. § 1.1031(a)-2(b)(2) provide a list of thirteen General Asset Classes. Under Regs § 1.1031(a)(2)(b)(2), a light general purpose truck is not of the same General Asset Class as a heavy general purpose truck. Nor is a computer of the same General Asset Class as office furniture (or equipment). However, an automobile and a taxi are of the same General Asset Class, as are noncommercial airplanes (airframes and engines) and “all helicopters.” The origin of the regulations appears to be Rev. Proc. 87-56, which lists asset classes for purposes of depreciation.
Product Class was formerly determined by reference to the 4-digit Standard Industrial Classification (SIC) codes published in the Office of Management and Budget’s SIC Manual, modified every five years. The SIC codes for Product Classes have been replaced by the North American Industrial Classification System (NAICS) (and Manual) with respect to exchanges after August 13, 2004. Regs. §1.1031(a)-2(b)(3) (superseded). Under the new regime, the NAICS Manual provides that depreciable tangible property is listed within a 6-digit product class. Categories contained in the NAICS Manual are narrower than in the SIC Manual formerly used.
IRC §1031(h)(2) provides that personal property used predominantly in the United States is not of like kind to personal property used predominantly outside of the United States. Predominant use is based on the 2-year period preceding the exchange, with respect to relinquished property, and the 2-year period following the exchange, with respect to replacement property. IRC § 1031(h)(2)(C).
C. Mixed Property Exchanges
Some exchange property may itself be comprised of both real and personal property. For example, an exchange may involve an apartment building or restaurant that contains furniture, fixtures, equipment or other assets. Since real property cannot be exchanged for personal property, the IRS views such transactions as exchanges of multiple assets rather than exchanges of one economic unit. The properties transferred and properties received must be separated into “exchange groups” by matching properties of like kind or like class to the extent possible. After the matching process is completed, if non-like kind assets remain, gain recognition may be required with respect to those assets. Regs. § 1.1031(j)-1.
At times, it may be difficult to determine whether exchange property is real property or personal property. This determination is not one of federal tax law: it is based on the law of the state in which the property is located. Aquilino v. U.S., 363 U.S. 509 (1960); Coupe v. Com’r., 52 T.C. 394 (1969). A dispute involving a similar issue of characterization of exchange property arose in Peabody v. Com’r, 126 T.C. No. 14 (2006). There, the IRS argued that a coal supply contract itself, and not the mine supplying the coal, possessed most of the value of property being exchanged. Accordingly, the IRS urged that upon the receipt of replacement property consisting of a gold mine, a good exchange occurred, but that since the supply contract was not of like kind to the gold mine, the taxpayer received boot. However, the Tax Court held the right to mine coal and sell coal is inherent in the fee ownership, and the two cannot be separated. Thus, the exchange was held not to produce boot.
D. Intangible Property
Although like kind exchanges are most often associated with real property or tangible personal property (e.g., an airplane), exchanges involving intangible personal property, consisting of customer lists, going concern value, assembled work force, and good will may also occur. An exchange of business assets requires the transaction to be separated into exchanges of its component parts. Rev. Rul. 57-365, 1957-2. Unlike the case involving exchanges of real property or tangible personal property, no regulatory guidance is provided for exchanges of intangible property. Whether such an exchange qualifies under Section 1031 is therefore reduced to an inquiry as to whether the exchanged properties are of “like kind” under the words of the statute itself. In published rulings, the IRS has imported concepts from the regulations dealing with real property exchanges. As might be surmised, exchanges of intangible personal property are at times problematic.
Regs. §1.1031(a)-2(c) provides that whether intangible personal properties are of like kind depends on the nature and character of (i) the rights involved and (ii) the underlying property to which the intangible personal property relates. The Regs take the position that the goodwill or going concern value of one business can never be of like kind to the goodwill or going concern value of another business. Therefore, such exchanges would always produce boot. The Regs state that a copyright on a novel is of like kind to a copyright on another novel. However, a copyright on a song is not of like kind to a copyright on a novel since, although the rights are identical, the nature of the underlying property is substantially different. The objective in an exchange of businesses will therefore be first to demonstrate that the intangible assets being swapped do not consist of goodwill. The taxpayer must then demonstrate that both the rights and the underlying properties involved are also of like kind.
TAM 2000035055 stated that the exchange of a radio license for a television license qualified for exchange treatment. The rights involved, and the property to which the rights related, involved differences only in “grade or quality,” rather than in their “nature or character.” Both licenses enabled the licensee to broadcast programming over the electromagnetic spectrum, making the rights “essentially the same.” The underlying property related to the use of the radio transmitting apparatus rather than the apparatus itself. The ruling concluded that although the bandwidth of radio and television broadcasts are different, those differences constituted differences only in grade or quality, rather than differences with respect to nature or character.
Recently issued TAM 200602034 takes a more restrictive view of exchanges involving intangible personal property, stating that the rule for intangibles is “still more rigorous” than for tangible personal property. The rationale for this conclusion appears questionable.
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Determining Whether Exchange Property is of “Like Kind”
A. Introduction
Determining whether exchange property is of “like kind” necessitates a review of IRS pronouncements, decisional case law, and the Regulations. Regs. § 1.1031(a)-1(b) provides that the words “like kind”
[h]ave reference to the nature or character of the property and not to its grade or quality. one kind or class of property may not be exchanged for property of a different kind or class. [however,] whether 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. (emphasis added).
As the Regs state, exchanges involving real estate enjoy rarefied status. Regs. §1.1031(a)-1(c) further provides that the exchange of a fee interest with a 30 year lease, or the swap of city real estate for a ranch or farm, are exchanges of “like kind” property. The exchange of a fee interest for coop shares would also appear to qualify under Section 1031. See also PLR 943125, stating that a lot held for investment is of like kind with a townhouse to be used as rental property.
Rev. Rul. 67-255 stated that a building is not of like kind to a building and land. It may therefore be difficult to strip a building from the underlying land and engage in an exchange. However, if the building includes an easement or lease, the building and lease might together qualify as real property for purposes of a like kind exchange.
IRC §1031(h)(1) provides that “[r]eal property located in the United States and real property located outside the United States are not property of a like kind.” Although nonresidents may engage in like kind exchanges, Section 1031 applies only to exchanges of United States property interests for interests in property the sale of which would be subject to United States income tax. IRC §897 provides for the treatment of gain or loss realized by a nonresident individual or foreign corporation who disposes of a United States real property interest. IRC §1445 (subject to some exemptions) requires withholding of 10 percent of the amount realized in a transaction subject to IRC § 897.
Rev. Rul. 2004-86 expanded the scope of “like kind” real property by finding that real property, and interests in a Delaware Statutory Trust which itself owns real property, are of like kind. This result occurs because the owner of an interest in a Delaware Statutory Trust (DST), which is a grantor trust under IRC §671 et seq, is treated as owning assets which are owned by the trust. Therefore, such an exchange actually consists of the exchange of real property interests, rather than the exchange of a real property interest for a certificate of trust, which would be barred under IRC §1031(a)(2)(E).
The IRS blessed the exchange of cooperative shares in PLR 20063112. While acknowledging that “New York case law might suggest that there are conflicts concerning whether a cooperative interest in real property is real property [citations omitted],” the ruling remarked that “various New York statutes treat an interest in a cooperative as equivalent to an interest in real property.” Accordingly, the ruling held that interests in cooperative apartments in New York are of like kind to improved and unimproved realty.
B. Tangible Personal Property
In contrast to exchanges involving real property, exchanges of tangible personal property will qualify under Section 1031 only if the properties bear a strong resemblance to one another. In making this determination, the “similar or related in service or use” test of IRC §1033(a)(1), rather than the rules developed for determining whether real estate is of like kind, appears to be the standard called for in the Regulations. Rev. Rul. 82-166 states that gold bullion and silver bullion are not of like kind since “silver and gold are intrinsically different metals . . . used in different ways.” Regs. § 1.1031(a)-2 provides that depreciable tangible personal property qualifies for exchange treatment if the properties are of “like kind” or “like class.” Properties are of “like class” if on the exchange date they are of the same (i) “General Asset Class” or (ii) “Product Class.”
Regs. § 1.1031(a)-2(b)(2) provide a list of thirteen General Asset Classes. Under Regs § 1.1031(a)(2)(b)(2), a light general purpose truck is not of the same General Asset Class as a heavy general purpose truck. Nor is a computer of the same General Asset Class as office furniture (or equipment). However, an automobile and a taxi are of the same General Asset Class, as are noncommercial airplanes (airframes and engines) and “all helicopters.” The origin of the regulations appears to be Rev. Proc. 87-56, which lists asset classes for purposes of depreciation.
Product Class was formerly determined by reference to the 4-digit Standard Industrial Classification (SIC) codes published in the Office of Management and Budget’s SIC Manual, modified every five years. The SIC codes for Product Classes have been replaced by the North American Industrial Classification System (NAICS) (and Manual) with respect to exchanges after August 13, 2004. Regs. §1.1031(a)-2(b)(3) (superseded). Under the new regime, the NAICS Manual provides that depreciable tangible property is listed within a 6-digit product class. Categories contained in the NAICS Manual are narrower than in the SIC Manual formerly used.
IRC §1031(h)(2) provides that personal property used predominantly in the United States is not of like kind to personal property used predominantly outside of the United States. Predominant use is based on the 2-year period preceding the exchange, with respect to relinquished property, and the 2-year period following the exchange, with respect to replacement property. IRC § 1031(h)(2)(C).
C. Mixed Property Exchanges
Some exchange property may itself be comprised of both real and personal property. For example, an exchange may involve an apartment building or restaurant that contains furniture, fixtures, equipment or other assets. Since real property cannot be exchanged for personal property, the IRS views such transactions as exchanges of multiple assets rather than exchanges of one economic unit. The properties transferred and properties received must be separated into “exchange groups” by matching properties of like kind or like class to the extent possible. After the matching process is completed, if non-like kind assets remain, gain recognition may be required with respect to those assets. Regs. § 1.1031(j)-1.
At times, it may be difficult to determine whether exchange property is real property or personal property. This determination is not one of federal tax law: it is based on the law of the state in which the property is located. Aquilino v. U.S., 363 U.S. 509 (1960); Coupe v. Com’r., 52 T.C. 394 (1969). A dispute involving a similar issue of characterization of exchange property arose in Peabody v. Com’r, 126 T.C. No. 14 (2006). There, the IRS argued that a coal supply contract itself, and not the mine supplying the coal, possessed most of the value of property being exchanged. Accordingly, the IRS urged that upon the receipt of replacement property consisting of a gold mine, a good exchange occurred, but that since the supply contract was not of like kind to the gold mine, the taxpayer received boot. However, the Tax Court held the right to mine coal and sell coal is inherent in the fee ownership, and the two cannot be separated. Thus, the exchange was held not to produce boot.
D. Intangible Property
Although like kind exchanges are most often associated with real property or tangible personal property (e.g., an airplane), exchanges involving intangible personal property, consisting of customer lists, going concern value, assembled work force, and good will may also occur. An exchange of business assets requires the transaction to be separated into exchanges of its component parts. Rev. Rul. 57-365, 1957-2. Unlike the case involving exchanges of real property or tangible personal property, no regulatory guidance is provided for exchanges of intangible property. Whether such an exchange qualifies under Section 1031 is therefore reduced to an inquiry as to whether the exchanged properties are of “like kind” under the words of the statute itself. In published rulings, the IRS has imported concepts from the regulations dealing with real property exchanges. As might be surmised, exchanges of intangible personal property are at times problematic.
Regs. §1.1031(a)-2(c) provides that whether intangible personal properties are of like kind depends on the nature and character of (i) the rights involved and (ii) the underlying property to which the intangible personal property relates. The Regs take the position that the goodwill or going concern value of one business can never be of like kind to the goodwill or going concern value of another business. Therefore, such exchanges would always produce boot. The Regs state that a copyright on a novel is of like kind to a copyright on another novel. However, a copyright on a song is not of like kind to a copyright on a novel since, although the rights are identical, the nature of the underlying property is substantially different. The objective in an exchange of businesses will therefore be first to demonstrate that the intangible assets being swapped do not consist of goodwill. The taxpayer must then demonstrate that both the rights and the underlying properties involved are also of like kind.
TAM 2000035055 stated that the exchange of a radio license for a television license qualified for exchange treatment. The rights involved, and the property to which the rights related, involved differences only in “grade or quality,” rather than in their “nature or character.” Both licenses enabled the licensee to broadcast programming over the electromagnetic spectrum, making the rights “essentially the same.” The underlying property related to the use of the radio transmitting apparatus rather than the apparatus itself. The ruling concluded that although the bandwidth of radio and television broadcasts are different, those differences constituted differences only in grade or quality, rather than differences with respect to nature or character.
Recently issued TAM 200602034 takes a more restrictive view of exchanges involving intangible personal property, stating that the rule for intangibles is “still more rigorous” than for tangible personal property. The rationale for this conclusion appears questionable.
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