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Use New Construction on Property You Already Own for 1031 Exchange Capital Gains Tax Deferral
A 1031 Exchange is a popular capital gains deferral strategy for business and investment property. When properly implemented, a 1031 Exchange defers tax on property “sold” if the taxpayer acquires new property within a 180-day window, usually in coordination with an intermediary. Related-party rules typically prohibit use of property owned by the taxpayer or a related party as the purchased property.
A newly-released IRS ruling enables some taxpayers to circumvent the related-party rules, to indirectly use property owned by the taxpayer or a related party to complete a 1031 Exchange. This is accomplished by leasing the property to an intermediary, using the proceeds from the property “sold” for new construction, and then acquiring the newly constructed property and the leasehold, all within the 180-day exchange period.
Here is a link to the ruling: www.irs.gov/pub/irs-wd/1408019.pdf. Here is a more technical summary of the ruling:
In PLR 201408019, the taxpayer used a qualified exchange accommodation agreement to exchange a fee interest in improved real estate for a long-term lease in land and improvements. The taxpayer used an unrelated qualified intermediary (QI) to hold the relinquished property. The replacement property came from a related party to the taxpayer and was parked using an exchange accommodation titleholder (EAT).
Although there are several rules limiting the use of 1031 exchanges between related parties, the IRS said those rules didn’t apply here because (1) the taxpayer was exchanging property with the QI, which was not related to the taxpayer, (2) although the replacement property came from a related party, neither the taxpayer nor the related entity selling the relinquished property would be cashing out within two years, and (3) the taxpayer never owned the replacement property prior to the exchange. The exchange otherwise satisfied all the QI and EAT safe harbors, and was signed off on by the IRS in the ruling.
PLR 201408019 provides reassurance to taxpayers who want to use complex planning structures to achieve tax-free exchanges of property. With proper planning and conformity with the existing safe harbors, taxpayers can even enjoy tax-free exchanges between related entities.
E. John Wagner, II
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E. John Wagner, II.
