Source: https://www.bna.com/no-constructive-receipt-n17179877470/
Timestamp: 2017-01-21 19:30:47
Document Index: 385686931

Matched Legal Cases: ['§1031', '§1031', '§1031', '§1031', '§1', '§1', '§1', '§1', '§1', '§1', '§1', '§1', '§1', '§1031', '§1', '§1', '§1', '§1', '§1031', '§1031']

No Constructive Receipt of Proceeds Where QI Uses Proceeds to Pay Down Taxpayer Debt | Bloomberg BNA
No Constructive Receipt of Proceeds Where QI Uses Proceeds to Pay Down Taxpayer Debt
By David I. Kempler, Esq., Elizabeth CarrottMinnigh, Esq. and Christine Bowers, Esq.
In CCA 201325011, the Chief Counsel's Office advised that ataxpayer did not have actual or constructive receipt ofrelinquished property (RQ) sale proceeds for purposes of §1031 ofthe Internal Revenue Code (the "Code"), where the RQ secured thetaxpayer's lines of credit used both to purchase the RQ and forgeneral business operations and the taxpayer's qualifiedintermediary (QI) was required to use the proceeds to pay down theamounts owed under the lines of credit. In this CCA, ChiefCounsel's Office concluded that the exchange is tax-free under§1031 of the Code even though funds received from sellingrelinquished property were used for the taxpayer's benefit.
As a general rule, under §1031, a taxpayer may exchange propertythat has been used productively in a trade or business or held forinvestment for other like-kind property used in a trade or businessor held for investment without recognizing the taxable gain on thesale of the property. Under §1031(a)(3), these like-kind exchangeprovisions extend to deferred transactions if the replacementproperty is received within 180 days of the date the relinquishedproperty is transferred. In a deferred exchange, Regs.§1.1031(k)-1(f) provides that a taxpayer is prohibited fromactually or constructively receiving any portion of the saleproceeds until the exchange has been completed. However, underRegs.§1.1031(k)-1(g)(4), QI is permitted to hold the sale proceedsfor the benefit of the taxpayer during the exchange process, todisburse funds for the purchase of replacement property and returnany unused portion of the funds to the taxpayer at the end of theexchange. Under Regs. §1.1031(k)-1(g)(4)(iii), a "qualifiedintermediary" is a person who (i) is not the taxpayer or adisqualified person with respect to the taxpayer underRegs.§1.1031(k)-1(k), and (ii) enters into a written exchangeagreement with the taxpayer and, in accordance with that agreement,acquires the relinquished property from the taxpayer, transfers therelinquished property, acquires the replacement property andtransfers the replacement property to the taxpayer.
Taxpayer rented equipment to customers for use in farming,construction, manufacturing and warehousing. In 2003, Taxpayerimplemented a like-kind exchange program in order to defer therecognition of gain from the sale of its rental equipment. Taxpayermaintained lines of credit with two creditors, which were used topurchase replacement properties under the like-kind exchangeprogram and also for general business purposes. Under the creditagreements, all rental properties, including propertiesrelinquished and acquired in the like-kind exchange program,secured the outstanding balances on the lines of credit. Theoutstanding balances on the lines of credit were also secured byTaxpayer's accounts receivable and equipment held by Taxpayer forsale in the ordinary course of business. All properties wereseparately listed as collateral for one or the other, but not both,of the lines of credit.
As part of its like-kind exchange program, Taxpayer entered intoa master exchange agreement (MEA) with a QI to engage in theseexchanges. Under the MEA, Taxpayer did not have the right toreceive, pledge, borrow or otherwise obtain the benefits of moneyor other property held by QI. The MEA also provided that QI mustuse the proceeds from the sale of the relinquished property, butnot proceeds from its accounts receivable and new equipment sales,to pay down Taxpayer's outstanding balances on the lines ofcredit. Consequently, the proceeds from the disposition ofrelinquished property as part of any exchange under the MEA weredeposited directly into a joint QI-Taxpayer account and thenimmediately disbursed by QI to satisfy Taxpayer's obligation on oneor the other line of credit.
Under Regs. §1.1031(k)-1(g)(4)(ii), the agreement between ataxpayer and a QI must expressly limit the taxpayer's rights toreceive, pledge, borrow, or otherwise obtain the benefits of moneyor other property held by the qualified intermediary. In addition,Regs. §1.1031(k)-1(g)(6), requires that the exchange agreementbetween a taxpayer and the QI provide that the taxpayer have noright to receive, pledge, borrow, or otherwise obtain the benefitsof money or other property held by the qualified intermediarybefore the end of the exchange period, other than those provided inRegs. §1.1031(k)-1(g)(6)(ii) and (iii).
The Chief Counsel's Office concluded that the facts of the casewere similar to the situation described in Example 5 of Regs.§1.1031(k)-1(j)(3), wherein B, the transferor of RQ in a deferredexchange, transferred property that was encumbered with a $30,000mortgage to C on May 17, 1991. C assumed the mortgage on that date.On July 15, 1991, B received the replacement property and assumed a$20,000 mortgage encumbering the replacement property. Under theboot netting rules of Regs. §1.1031(b)-1(c), the gain required tobe recognized by the taxpayer in Example 5 was the excess of thedebt relieved on the transfer of the RQ and the debt incurred onthe acquisition of RP. Thus, the consideration received by B in theform of the liability assumed by C ($30,000) was offset by theconsideration given by B in the form of the liability assumed by B($20,000), and the excess of the liability assumed by C over theliability assumed by B, $10,000, was treated as "money or otherproperty." As a result, B recognized gain in the amount of $10,000in accordance with §1031(b). In the example, the taxpayer wasrelieved of debt on the transfer of RQ and incurred debt on theacquisition of RP. The example concluded that the taxpayer had notactually or constructively received all or a portion of theproceeds of the RQ, but rather that the boot received in the formof debt relief was offset by the debt assumed.
In relying on this example, the Chief Counsel's Officerecognized that there were two important differences between thefacts in Example 5 and those in the present case: (1) that the debtthat was secured by the RQ was incurred not only to purchase RQ butalso for general business operations, whereas Example 5 providedonly that the RQ was "encumbered by a mortgage of $30,000" and didnot discuss when or why the property was encumbered, and (2) thetransferee of the RQ in Example 5 assumed the RQ debt whereas, inthe present case, the QI used the RQ proceeds to pay down the RQdebt. The Chief Counsel's Office concluded, nonetheless, that thesedifferences did not result in Taxpayer having actual orconstructive receipt of the RQ proceeds for purposes of Regs.§1.1031(k)-1. In reaching this conclusion, the Chief Counsel's Officeexplained that the result in Example 5 should not change if thedebt was incurred as a result of refinancing the RQ and using theproceeds for general business operations, and that it was not awareof any authority for making a distinction along the lines of thepurpose of the encumbrance or whether the taxpayer used theproceeds for more than the purchase of RQ. To that effect, theChief Counsel's Office stated that the fact that the debt in thepresent case was incurred for more than the acquisition of the RQshould not result in actual or constructive receipt of the RQproceeds when QI pays off the RQ debt.
In addition, in reaching its conclusion, the Chief Counsel'sOffice relied on Barker v. Commissioner,1 inwhich the Tax Court held that proceeds from the disposition of RQcan be used to pay off debt on the RQ without triggering gain if ataxpayer incurs or assumes a liability on the purchase of RP thatequals or exceeds the debt on the RQ. In Barker, which wasdecided before the issuance of deferred exchange regulations ofRegs. §1.1031(k)-1, the taxpayer received cash in the exchange butwas contractually obligated by the transferee of the RQ to use thecash to pay off the RQ debt. The Tax Court held in Barkerthat the boot netting principle in Regs. §1.1031(b)-1(c) covers notjust assumptions of debt but also situations in which the proceedsof the RQ are used to pay off RQ debt.
Accordingly, the Chief Counsel's Office concluded that, eventhough the RQ debt was used not only to purchase RQ but also forgeneral business operations and the QI used the RQ proceeds to paydown Taxpayer's lines of credit, the payments did not result inTaxpayer being in actual or constructive receipt of the RQ proceedsfor purposes of Regs. §1.1031(k)-1. Accordingly, the ChiefCounsel's office advised that Taxpayer's exchanges would qualify asa §1031 like-kind exchanges if Taxpayer met the other requirementsof §1031 of the Code and the regulations thereunder.
This commentary also appears in the October 2013 issue ofthe Real Estate Journal.For more information in theTax Management Portfolios, see Levine, 567 T.M., TaxfreeExchanges Under Section 1031, and in Tax Practice Series, see¶1510, Like-Kind Exchanges.
1 74 T.C. 555 (1980).