This Letter Ruling involves an interpretation of the related person rules contained in I.R.C. §1031(f). Unlike Private Letter Ruling 9748006, the I.R.S. here concludes that §1031 treatment is allowed and that the transaction does not have federal income tax avoidance as a primary purpose.
The Taxpayer and Decedent acquired substantial timberlands (39,000 acres in approximately 120 separate parcels) for investment during the course of their marriage. Approximately one-quarter (1/4) of the acreage contains valuable "old-growth" timber. Upon their divorce, the timberlands were divided equally and title was held as co-tenants. The Decedent subsequently died, leaving the Decedents Estate as a tenant-in-common with the Taxpayer.
During the Decedents lifetime, an option was granted to Lumber Corp. to acquire his undivided one-half (1/2) interest in the timberlands. Lumber Corp. (and its wholly owned subsidiaries) is in the business of owning and managing timberlands, harvesting timber, and manufacturing and selling wood products. Lumber Corp. intends to exercise its option. Naturally, Lumber Corp. desires to harvest the "old-growth" timber and the Taxpayer desires to hold such property indefinitely for investment.
The Taxpayer and Lumber Corp. want to exchange undivided interests in the "old-growth" timber parcels so that each will own 100% interests in half of the parcels. The remainder of the timberlands will continue to be jointly owned.
Lumber Corp. is a related person to the Taxpayer under §1031(f)(3) since the Taxpayer and Son (son of the Taxpayer and Decedent) own all of its voting common stock and a majority of its non-voting common stock is either owned by the Taxpayer, Son or Sons trust for the benefit of his children.
The I.R.S. first finds that §1031 is applicable to undivided interests being exchanged (Revenue Ruling 79-44 and Revenue Ruling 73-476) and that timberlands may be exchanged (Revenue Ruling 72-515). Next, a review of the related person rules of §1031(f) is conducted setting forth the 2-year hold requirement for subsequent dispositions of the property received by (or from) the related person in the exchange. Exceptions to the 2-year hold requirement exist in §1031(f)(2) and include transfers (A) resulting from death, (B) due to an involuntary conversion or "(C) with respect to which it is established to the satisfaction of the Secretary that neither the exchange nor such disposition had as one or its principal purposes the avoidance of Federal income tax."
The main concern for the Taxpayer is (1) whether the harvesting of the "old-growth" time by Lumber Corp. from the property she formerly owned is subject to the 2-year hold requirement or (2) if the exception contained in §1031(f)(2)(C) for non-tax avoidance purposes is applicable. In resolving this concern, the I.R.S. finds in the legislative history of §1031(f)(2)(C) instances which are identified as non-tax avoidance transactions, including exchanges of undivided interests which result in the parties owning a single property or a larger undivided interest in some of the properties. Accordingly, the I.R.S. rules that the harvesting of the "old-growth" timber by Lumber Corp. will not constitute a disposition for the purposes of §1031(f)(1)(C) and that no gain to the Taxpayer will be triggered upon such harvest.
A comparison to Private Letter Ruling 9748006, where the I.R.S. found that tax avoidance exception contained in §1031(f)(4) overrode the 2-year hold requirement under its factual situation, is natural. In this instance, ample reasonable business motivations seem to be present to justify the untangling of the interests of the Taxpayer and Lumber Corp. After the exchange, The Taxpayer appears to own essentially what she owned before the exchange (only without co-owner). No evidence of a basis shift within the economic family unit appears to be present either; no low basis property is being sold to a third party instead of a high basis property. In Private Letter Ruling 9748006, ignoring standard exchange practices, the I.R.S. viewed the involvement of a qualified intermediary as evidence of tax avoidance purpose for the transaction as a whole and, therefore, not within the §1031.