Opinion ID: 447571
Heading Depth: 1
Heading Rank: 1

Heading: THE HOLDING REQUIREMENT OF SECTION 1031(a)

Text: 9 The Commissioner argues that the exchange of the Iowa Street Property for the Plaza Property cannot qualify for nonrecognition under section 1031(a) because the Magnesons did not hold the Plaza Property for investment. The Magnesons contend that holding the property to contribute to a partnership is holding the property for investment. The court found for the Magnesons. The majority concluded that the contribution of the Plaza Property to U.S. Trust was a continuation of the Magnesons' investment unliquidated but in a modified form, and that therefore the Magnesons did hold the Plaza Property for investment. 81 T.C. at 771-72. We review the Tax Court's conclusions of law de novo, noting however that its opinions are entitled to respect because of its special expertise in the field. California Federal Life Insurance Co. v. Commissioner, 680 F.2d 85, 87 (9th Cir.1982). 10 To qualify for nonrecognition treatment under section 1031(a), the taxpayer must, at the time the exchange is consummated, intend to hold the property acquired for investment. Regals Realty Co. v. Commissioner, 127 F.2d 931, 934 (2d Cir.1942); see Margolis v. Commissioner, 337 F.2d 1001, 1003-05 (9th Cir.1964). Numerous cases have held that the taxpayers' intent at the time of the exchange to liquidate their interest in the property acquired disqualifies the exchange from nonrecognition under section 1031(a). See, e.g., Regals Realty, 127 F.2d at 933-34 (intent to sell); Click v. Commissioner, 78 T.C. 225, 233-34 (1982) (intent to give as gift); Lindsley v. Commissioner, T.C.M. (P-H) 1983-729, at 3047-48 (intent to give to charity); Land Dynamics v. Commissioner, T.C.M. (P-H) 1978-259, at 1107-08 (intent to sell). But see Wagensen v. Commissioner, 74 T.C. 653, 658-59 (1980) (intent at time of exchange to hold for productive use not negated by desire to give eventually to children). It is stipulated that the Magnesons intended at the time of the exchange to hold the property for contribution to U.S. Trust. Therefore, the Magnesons' exchange can only qualify under section 1031(a) if contributing property to a partnership in return for an interest in the partnership is holding the property for investment within the meaning of section 1031(a). 11 We have found no precedent on point at either the Tax Court or the circuit court level. Revenue Ruling 75-292, 1975-2 C.B. 333, relied on by the Commissioner, addresses a related question: whether a like-kind exchange followed by a transfer for stock under section 351 2 to a controlled corporation qualifies for nonrecognition under section 1031(a). The Service ruled that the property transferred to the corporation was no longer held by the taxpayer, and gain was recognized on the exchange. Id. at 334. Revenue rulings, however, are not binding on this court. Ricards v. United States, 683 F.2d 1219, 1224 & n. 12 (9th Cir.1981) (rulings not dispositive although entitled to consideration as body of experience and informed judgment). More significantly, transfer to a corporation in exchange for shares is distinguishable from transfer to a partnership for a general partnership interest in several important ways. 12 First, a corporation is a distinct entity, apart from its shareholders, whereas a partnership is an association of its partner-investors. Shareholders have no ownership interest in the assets of a corporation; partners own the assets of a partnership. Shareholders have no participation in daily management of corporate assets and very little participation in long-term management; general partners are the managers of the partnership. Thus when the owner of property transfers it to a corporation in exchange for shares, he relinquishes ownership and control of the property. In contrast, he retains both in a transfer to a partnership for a general partnership interest. 13 Second, a like-kind exchange followed by a section 351 transfer, viewed as a whole, results in the exchange of property for stock. The parenthetical clause of section 1031(a) expressly excludes stock as property eligible for exchange, but there is no such prohibition on exchange of partnership interests. Long v. Commissioner, 77 T.C. 1045, 1066-68 (1981) (rejecting Commissioner's argument that partnership interests fit within exclusionary clause as choses in action or evidences of interests). Revenue Ruling 75-292 is therefore inapplicable to this case. 14 The central purpose of both sections 721 and 1031(a), as stated by the Treasury Regulations, is to provide for nonrecognition of gain on a transfer of property in which the differences between the property parted with and the property acquired are more formal than substantial, and the new property is substantially a continuation of the old investment still unliquidated. Treas.Reg. 1.1002-1(c), T.D. 6500, 25 Fed.Reg. 11910 (1960). 3 The regulations reflect the legislative history of the predecessor of section 1031(a). See H.R.Rep. No. 704, 73d Cong., 2d Sess. 12, reprinted in 1939-1 C.B. (pt. 2) 554, 564; Starker v. United States, 602 F.2d 1341, 1352 (9th Cir.1979) (section 1031 designed to avoid the imposition of a tax on those who do not 'cash in' their investments in trade or business property). Furthermore, as the Tax Court noted, the regulations unequivocally describe section 721 as representing a continuation, not a liquidation, of the old investment. The case law, the regulations, and the legislative history are thus all in agreement that the basic reason for nonrecognition of gain or loss on transfers of property under sections 1031 and 721 is that the taxpayer's economic situation after the transfer is fundamentally the same as it was before the transfer: his money is still tied up in investment in the same kind of property. Koch v. Commissioner, 71 T.C. 54, 63-64 (1978); see Starker, 602 F.2d at 1352; Biggs v. Commissioner, 69 T.C. 905, 913-14 (1978), aff'd, 632 F.2d 1171 (5th Cir.1980). This principle exactly describes the Magnesons' situation. Before the two transactions, their investment was a fee interest in income-producing real estate. They exchanged this property for other income-producing real estate, which they held as tenants in common with NER. The Magnesons and NER then changed the form of their ownership of that real estate from tenancy in common to partnership. They still own the income-producing real estate, and they have taken no cash or non-like-kind property out of the transaction. The Magnesons' transactions therefore fit squarely within the central purpose of section 1031. They exchanged their investment property for like-kind investment property which they continue to hold for investment, albeit in a different form of ownership. 15 The Commissioner, and the dissenting Tax Court judges, argue that the differences between ownership as tenants in common and ownership as a partnership are so substantial that the Magnesons cannot be regarded as having continued to hold the property for investment under section 1031(a) after the partnership contribution. Previous like-kind exchange cases have indeed looked to the nature of the taxpayer's ownership interest as well as to the nature of the property owned to determine if the section 1031(a) requirements are met. See Estate of Meyer v. Commissioner, 503 F.2d 556, 557-58 (9th Cir.1974) (per curiam) (general partnership and limited partnership interests not like-kind property); Pappas v. Commissioner, 78 T.C. 1078, 1086-87 (1982) (general partnership for general partnership qualifies as like-kind); Long, 77 T.C. at 1064-66 (joint venture for general partnership qualifies as like-kind); Gulfstream Land & Development Corp. v. Commissioner, 71 T.C. 587, 595 (1979) (joint venture for joint venture qualifies as like-kind); cf. M.H.S. Co. v. Commissioner, 575 F.2d 1177, 1178 (6th Cir.1978) (section 1033 condemnation and reinvestment; real property proceeds put into joint venture owning real property; not like-kind because state law converted all joint venture property into personal property of investors so exchange was real for personal and not like-kind); Koch, 71 T.C. at 64-65 (unencumbered fee for fee subject to 99-year leasehold interest qualifies as like-kind). 16 In application of federal tax statutes, state law controls in determining the nature of the legal interest the taxpayer holds in the property sought to be taxed. Federal law does not create or define property rights; it merely attaches tax consequences to the interests created by state law. Aquilino v. United States, 363 U.S. 509, 512-13, 80 S.Ct. 1277, 1279-80, 4 L.Ed.2d 1365 (1960). The dissent and the majority therefore correctly looked to California law to determine and compare the nature of tenancy in common and partnership ownership. 17 In California, a tenant in common owns an undivided interest in and is entitled to possession and enjoyment of the entire property. Dimmick v. Dimmick, 58 Cal.2d 417, 422, 374 P.2d 824, 826, 24 Cal.Rptr. 856, 858 (1962). Title to his interest is vested in him, he may encumber it or sell it independently of his co-tenants, Meyer v. Wall, 270 Cal.App.2d 24, 30, 75 Cal.Rptr. 236, 240 (1969), and the interest is devisable and descendible, see Wilkerson v. Thomas, 121 Cal.App.2d 479, 482, 263 P.2d 678, 680 (1953). Similarly, a partner is co-owner with his partners, as a tenant in partnership, of specific partnership property. Cal.Corp.Code Sec. 15025(1) (West Supp.1984). A general partner has the right to possess partnership property for the purposes of the partnership, although title is not vested in him. Cal.Corp.Code Sec. 15025(2)(a) (West Supp.1984). However, a partner's interest in specific partnership property is not assignable without concurrent assignment by all other partners, Cal.Corp.Code Sec. 15025(2)(b) (West Supp.1984), nor subject to attachment except for partnership debt, Cal.Corp.Code Sec. 15025(2)(c) (West Supp.1984), nor subject to marital property rights, Cal.Corp.Code Sec. 15025(2)(e) (West Supp.1984). On the death of a partner, his interest in specific partnership property vests in the surviving partners, not in the deceased partner's devisees or heirs. Cal.Corp.Code Sec. 15025(2)(d) (West Supp.1984). 18 The Tax Court minority concluded from these differences that the transformation of the Magnesons' tenancy in common into a partnership interest so changed their legal relationship to that property as to disqualify the exchange from section 1031(a) treatment. We disagree. While there are significant distinctions, we do not believe that they are controlling in determining the holding for investment issue. First, we note that the crucial question in a section 1031(a) analysis is continuity of investment in like-kind property. Therefore, the critical attributes in the taxpayer's relationship to the property are those relevant to holding the property for investment. As both tenants in common and as general partners, the Magnesons owned an interest in the Plaza Property. As both tenants in common and as general partners, the Magnesons had the right to possess and control the property. While it is true that section 15025(2)(a) limits their possession and control to partnership purposes, the partnership purpose was to hold for investment. Under these circumstances their control as general partners is of the same nature as their control as tenants in common, in each case holding the property for investment. 19 The significant differences between the tenancy in common and the partnership interests lie in the voluntary and involuntary alienability of the property. Basically, the tenancy in common interest is freely alienable, but specific partnership property is not. Because the whole premise of section 1031(a) is that the taxpayer's intent is not to alienate the property, we believe that alienability distinctions are not dispositive. If at the time of the exchange, as here, the taxpayer intends to contribute the property to a partnership for a general partnership interest, and the partnership's purpose is to hold the property for investment, the holding requirement of section 1031(a) is satisfied despite the limited alienability of specific partnership property. 20 The Commissioner contends that the Tax Court majority, in focusing exclusively on the continuity of investment principle underlying section 1031(a), ignored the equally important technical requirements of the section itself. Treasury Regulation 1.1002-1(b) provides: 21 The exceptions from the general rule requiring the recognition of all gains and losses ... are strictly construed and do not extend either beyond the words or the underlying assumptions and purposes of the exception. Nonrecognition is accorded by the Code only if the exchange is one which satisfies both (1) the specific description in the Code of an excepted exchange, and (2) the underlying purpose for which such exchange is excepted from the general rule. 22 The Commissioner contends that this double test applies, and that even if this transaction satisfies the underlying purpose prong of the test, it still fails to qualify under the specific description prong because technically the partnership and not the taxpayers holds the acquired property. This circuit, however, rejected an analogous argument in Starker, 602 F.2d at 1352-53, refusing to give such a narrow construction. The Commissioner argued in Starker that the language of the regulation quoted above, as applied to section 1031(a), required simultaneous transfer for section 1031(a) nonrecognition. After analyzing the legislative history of section 1031(a) and concluding that it did not support the Commissioner's position, the court stated: 23 [T]here is a second sound reason to question the applicability of Treas.Reg. Sec. 1.1002-1: the long line of cases liberally construing section 1031. If the regulation purports to read into section 1031 a complex web of formal and substantive requirements, precedent indicates decisively that the regulation has been rejected. 24 Starker, 602 F.2d at 1352; see, e.g., Coastal Terminals, Inc. v. United States, 320 F.2d 333, 336-39 (4th Cir.1963) (cash option did not preclude section 1031(a) nonrecognition because taxpayer intended to take cash only if no property available); Alderson v. Commissioner, 317 F.2d 790, 793 (9th Cir.1963) (three-corner exchange); Biggs, 69 T.C. at 913-14 (four-corner exchange); 124 Front Street, Inc. v. Commissioner, 65 T.C. 6, 17-18 (1975) (taxpayer can advance money toward purchase price of property to be acquired); Coupe v. Commissioner, 52 T.C. 394, 405-09 (1969) (taxpayer can locate and negotiate for the property to be acquired); J.H. Baird Publishing Co. v. Commissioner, 39 T.C. 608, 611 (1962) (taxpayer can oversee improvements on the land to be acquired). Applying the Starker manner of construing the section, we decline to read into section 1031(a) the requirement that the taxpayer continue to hold the acquired property by the exact form of ownership in which it was acquired. So long as, as in this case, the taxpayers continue to own the property and to hold it for investment, a change in the mechanism of ownership which does not significantly affect the amount of control or the nature of the underlying investment does not preclude nonrecognition under section 1031(a).