Opinion ID: 153022
Heading Depth: 3
Heading Rank: 2

Heading: Purpose for the exchange15

Text: Ocmulgee Fields claims that even though it cashed in on its low-basis property as part of the exchange, it should receive nonrecognition treatment because unwarranted tax-avoidance was not a principal purpose of the exchange. But we find adequate evidence in the record to conclude the tax court did not commit clear error in rejecting that argument. The combination of several factors, some of which we have already discussed, support the tax court’s finding of a taxavoidance purpose: (1) Ocmulgee Fields and Treaty Fields cashed in on their low- 15 The analysis of this section involves the recognition of tax consequences when the exchange or disposition “had as one of its principal purposes the avoidance of Federal income tax,” § 1031(f)(2)(C), as § 1031(f)(2)(C) is necessarily encompassed by the restriction in § 1031(f)(4) that “[t]his section [§ 1031] shall not apply to any exchange which is part of transaction (or series of transactions) structured to avoid the purposes of this subsection [§ 1031(f)].” See Teruya Bros., 580 F.3d at 1047. 23 basis property but paid taxes as if they had cashed in on their high-basis property; (2) Ocmulgee Fields and Treaty Fields significantly reduced their immediate taxes by engaging in the exchange; and (3) Ocmulgee Fields and Treaty Fields enhanced these immediate tax savings by shifting nearly the entire burden of taxation to the party with the lowest tax rate, Treaty Fields.16 And to rebut the negative inference drawn from these factors, Ocmulgee Fields offers only unpersuasive evidence of adverse future tax consequences and purported business reasons for the exchange. i. Cashing-in on the low-basis property but paying taxes only on the disposition of the high-basis property The transaction structure allowed Ocmulgee Fields and Treaty Fields, as a unit, to cash in on their low-basis property (Wesleyan Station), but pay taxes as calculated on the sale of their high-basis property (the Barnes & Noble Corner). Because both properties had sold for a similar amount but one had a higher basis, Ocmulgee Fields and Treaty Fields reduced their tax burden by creating a transaction structure that made it seem as if they had disposed of their high-basis property (the Barnes & Noble Corner property) when, in fact, they had cashed in on their low-basis property (Wesleyan Station). This type of basis-shifting that allows a taxpayer to cash in on the low-basis property but pay taxes as if it were 16 For purposes of our analysis, we consider Ocmulgee Fields and Treaty Fields, including its partners, as an economic unit. See Teruya Bros., 580 F.3d at 1047. 24 cashing in on the high-basis property is precisely what Congress designed § 1031(f) to prevent when the transaction involves related parties and a quick sale. See H. R. Rep. No. 101-247, at 1340 (discussing the problem of taxpayers using basis-shifting and nonrecognition treatment to minimize the amount of immediately recognized gains and accelerate losses while cashing in on their lowbasis investment property).17 In this regard, the tax court used a helpful comparative analysis. The tax court recast the actual exchange that occurred as a direct exchange between Ocmulgee Fields and Treaty Fields followed by Treaty Fields’ sale of Wesleyan Station to the McEachern Family Trust. See Ocmulgee Fields, 132 T.C. at 118-19. It then considered whether, under those circumstances, a tax court would infer that tax-avoidance was a principal purpose of the exchange or subsequent disposition of Wesleyan Station. See id. at 119. As the tax court pointed out, and as we discussed earlier, a direct exchange would have involved the exchange of a lowbasis property (Wesleyan Station) for a high-basis property (the Barnes & Noble Corner) in anticipation of the immediate disposition of the low-basis property (Wesleyan Station) once it took on the higher basis of the other property (the 17 As discussed previously, the means of achieving this result are slightly different in the context of a direct exchange between a related party and a taxpayer and the context of an exchange, such as here, where a taxpayer has interposed a qualified intermediary between himself and the related party. 25 Barnes & Noble Corner), thereby reducing the overall tax burden incurred by Ocmulgee Fields and Treaty Fields—in this case, by approximately $2 million. See id. at 118. And, as the tax court noted in its opinion, see id., it is this type of tax manipulation that Congress designed § 1031(f) to prevent. Cf. H. R. Rep. No. 101-386, at 614 (Cont. Rep.) (explaining that a taxpayer is more likely to establish that tax-avoidance was not a principal purpose where the exchange does not involve this type of basis-shifting). We think the tax court’s approach to the issue sheds light on Ocmulgee Fields’ purpose: if a taxpayer structures its exchange in a manner that avoids the rules on direct exchanges between related parties, we think a tax court can draw inferences against the taxpayer. ii. Immediate tax savings Ocmulgee Fields and Treaty Fields netted immediate tax savings by engaging in the exchange. Through the exchange, Ocmulgee Fields avoided immediate recognition of $6 million in gains from its disposition of Wesleyan Station. These gains would have yielded over $2 million in tax liability. Ocmulgee Fields counters that the exchange required Treaty Fields to recognize just over $4 million in gains it would not otherwise have recognized. But, as an economic unit, Ocmulgee Fields and Treaty Fields still netted a reduction of $2 million in immediately recognized gains. Ocmulgee Fields also points out that the 26 exchange caused it to recognize $475,396 in installment income. However, as the tax court explained, Ocmulgee Fields failed to quantify the cost of accelerating otherwise deferred income, which “was surely much less than $475,396,” see Ocmulgee Fields, Inc., 132 T.C. at 119, and insubstantial when compared to the value of avoiding immediate recognition of $2 million in gains. iii. Shifting the tax burden to Treaty Fields In addition to reducing the amount of gain Ocmulgee Fields and Treaty Fields would have to recognize immediately, the exchange also shifted the entire burden of taxation (the accelerated installment income aside) to the party with the lowest tax rate, Treaty Fields. Unlike Ocmulgee Fields, which was taxed at the corporate rate of 34%, the gains recognized by Treaty Fields were passed through to its partners, who were taxed on the gains at the lower rate of 15%. In fact, one partner in Treaty Fields was able to further reduce his tax burden by offsetting the gains passed through to him with a charitable deduction of $2,021,375. iv. Ocmulgee Fields’ unpersuasive rebuttal evidence Together, the cashing in on the low-basis property, the immediate tax savings, and the shifting of taxation to Treaty Fields, support the tax court’s finding that Ocmulgee Fields’ had a principal purpose of tax-avoidance for the exchange. See § 1031(f)(2)(C). Ocmulgee Fields attempts to counter this evidence 27 by arguing it believed adverse future tax consequences would outweigh any immediate tax savings from the exchange, but that, despite these adverse future tax consequences, it went ahead with the exchange for legitimate business reasons. Ocmulgee Fields’ arguments, however, do not persuade us that the tax court committed clear error. Ocmulgee Fields first highlights three adverse future tax consequences of the exchange: (1) that gains from a future sale of the Barnes & Noble Corner property by Ocmulgee Fields would be taxed at a 34% rate instead of the 15% rate that the partners of Treaty Fields would have paid if they later disposed of the property, (2) that one of Treaty Fields’ partners lost a future § 754 partnership election for the Barnes & Noble Corner property that would have been available upon the death of the other partner, and (3) that the exchange reduced the amount of depreciation deductions that could be taken on the Barnes & Noble Corner Property. 18 But these arguments do not establish that the tax court clearly erred. As the tax court explained, the advice Ocmulgee Fields claims to have relied on with respect to the first two tax consequences was, at best, speculative and unquantified. See Ocmulgee Fields, 132 T.C. at 119-20. The same can be said 18 Ocmulgee Fields raises an additional argument that a real estate commission clause in its contract to sell Wesleyan Station to the McEachern Family Trust also undermines the tax court’s finding of a tax-avoidance purpose. Ocmulgee Fields, however, failed to develop this argument in a manner sufficient to have any persuasive effect. 28 regarding the advice about the value of the lost depreciation deductions: Ocmulgee Fields failed to quantify the value of those future deductions, which would have been offset, at least to some degree, by Treaty Fields’ ability to invest the proceeds from the sale of the Barnes & Noble Corner property in new depreciable property.19 The speculative and unquantified nature of this tax advice provides an adequate basis to support the tax court’s discrediting of Ocmulgee Fields’ arguments and witnesses on this issue. Ocmulgee Fields’ next argues that it had legitimate business purposes for the exchange, but this argument also fails to establish clear error. Ocmulgee Fields claims it acquired the Barnes & Noble Corner property in the exchange because acquisition of that property would yield operational efficiencies, increase the value 19 The tax court ambiguously stated that Ocmulgee Fields’ “adjusted basis in Wesleyan Station shifted to the Barnes & Noble Corner and, therefore, it gave up no depreciable basis.” See Ocmulgee Fields, 132 T.C. at 119. To the extent the tax court was stating that Ocmulgee Fields would still be able to make depreciation deductions, we agree. But to the extent that the tax court was stating that there was no difference in the amount of deductions available to Ocmulgee Fields and Treaty Fields, we disagree, but that disagreement does not lead us to find clear error in the tax court’s ultimate factual finding. See Lucas v. W.W. Grainger, Inc., 257 F.3d 1249, 1256 (11th Cir. 2001) (“[W]e may affirm [a lower court’s] judgment on any ground that finds support in the record.”) (quotations omitted). If Treaty Fields had retained the Barnes & Noble Corner property, the property would have had a basis of over $2 million against which to take depreciation deductions. By engaging in the exchange, however, the Barnes & Noble Corner property took on the $716,164 basis of Wesleyan Station, thereby reducing the basis against which Ocmulgee Fields could take depreciation deductions. Because we consider the tax consequences to Ocmulgee Fields and Treaty Fields as a unit, the exchange did reduce the amount of depreciation deductions available to that unit. 29 of its property holdings, and increase the value of Ocmulgee Fields. As the tax court explained, however, Ocmulgee Fields offered only “self-serving testimony” that legitimate business purposes motivated its decision. Id. at 120. Moreover, these purported business reasons do not explain why Ocmulgee Fields engaged in a complex transaction structure when it could have achieved the same business gains through a far less complex structure. And, even assuming Ocmulgee Fields in fact had legitimate business reasons for acquiring the Barnes & Noble Corner property, the mere existence of legitimate business purposes does not preclude a finding that Ocmulgee Fields’ principal purpose for the exchange was tax avoidance. Cf. Slappey Drive Indus. Park v. United States, 561 F.2d 572, 585 (5th Cir. 1977) (asking, in applying a different but comparable statute, whether tax-avoidance purposes predominated over non-tax-avoidance purposes because the statute disallowed certain deductions, credits, and other allowances “where the principal purpose of the underlying transaction was tax avoidance”) (emphasis added).