Source: https://nytaxattorney.com/2010/03/15/recent-rulings-expand-scope-of-like-kind-exchanges/
Timestamp: 2019-04-22 12:46:16+00:00

Document:
Owners of real estate requiring active management may seek to acquire property requiring no active management in a like-kind exchange. However, triple net leased properties – ideal vehicles — generally cost more than $1 million. Rev. Proc. 2002-22 allows a group of small investors to acquire tenancy in common interests (TICs) in a single large replacement property and still qualify under §1031. However, management activities must be kept to a minimum, or owners of TIC interests will be deemed to comprise a de facto partnership. This would render the exchange a taxable sale since §1031 cannot accommodate the exchange of partnership interests.
Thus, co-owners may not file a partnership return or hold themselves out as being a partnership. Nor are any restrictions on alienability that might typically be found in a partnership agreement permissible. Business activities among co-owners must be limited to those customarily performed in connection with the “maintenance and repair” of rental real estate. The guidance provides the basis for a private letter ruling; it is not a substantive rule of law nor does it provide a “safe harbor”.
Until recently, the IRS had issued little guidance with respect to satisfying these requirements. After relinquishing property, the taxpayer has only 45 days to identify a replacement property. As a practical matter, the taxpayer has had to rely on tax opinions of counsel. However, Private Letter Ruling (PLR) 200513010, involving a multi-tenant net leased property with a blanket mortgage owned by 35 co-owners, shed light on the issue.
PLR 200513010 states that (i) the IRS will not view the multi-tenant aspect of the building as creating a partnership; (ii) a blanket mortgage will not violate Rev. Proc. 2002-22; (iii) the Manager’s discretion to lease without obtaining the consent of the co-owners will not cause the TICs to be ineligible replacement property; and (iv) a sponsor may himself own a TIC interest for up to 6 months without causing his sale activities to be attributed to the other co-owners.
Another recent ruling, Rev. Rul. 2004-86, expanded the scope of like-kind replacement property to interests, represented by certificates, in a Delaware Statutory Trust (DST) owning real estate. The ruling is based on the fact that since the DST is a grantor trust, the certificate holders are deemed to own that portion of the real estate attributable to their certificates. Accordingly, §1031(a)(2)(E), which excludes “certificates of trust” from exchange treatment, is inapplicable.
In the facts of the Ruling, A purchases Blackacre and enters into a 10-year net lease with tenant. A then contributes Blackacre to a newly formed DST, which assumes A’s obligations under the lease. B and C, who seek like-kind exchange treatment, then exchange Greenacre and Whiteacre for all of A’s interest in the DST through a qualified intermediary. Whiteacre and Greenacre are of like-kind to Blackacre.
A DST is an unincorporated association recognized as an entity separate from its owners. Beneficial owners of a DST are entitled to the same limitation on personal liability that is extended to stockholders of a Delaware corporation. The DST agreement provides that interests in the DST are freely transferable, but are not publicly traded.
The trustee’s activities are limited to the collection and distribution of income. The trustee may not exchange real estate or purchase assets (other than short-term investments), and is required to distribute all available cash (less reserves) quarterly to each beneficial owner in proportion to his respective interest in the DST.
The Ruling notes that since the trustee’s activities and the trust’s investments are circumscribed, the DST is not a business trust created to carry on a profit, and is not subject to reclassification under Regs. § 301.7701-4(c)(1). Accordingly, the DST is entitled to be classified as a trust for federal income tax purposes. Since it is a trust, it is subject to the grantor trust rules.
Under §677(a), the grantor is treated as owner of any portion of a trust whose income is or may be distributed or held for future distribution to the grantor or the grantor’s spouse. Regs. § 1.671-2(e)(1) provides that a person who is considered as the owner of an undivided fractional interest (UFI) of a trust is considered to own trust assets attributable to that UFI for income tax purposes. Therefore, each certificate holder is considered to own an undivided fractional interest in the DST and each is considered to own the trust assets attributable to that UFI. Here, the trust assets consist of Blackacre.
Since each certificate holder is considered to own an undivided fractional interest in Blackacre for federal income tax purposes, the Ruling concludes that the exchange of real property for an interest in a DST through a qualified intermediary constitutes the exchange of real property for Blackacre rather than the exchange of real property for a mere certificate of trust. Accordingly, the exchange will qualify under § 1031.

References: §1031
 §1031
 §1031
 § 301
 §677
 § 1
 § 1031