The following article was taken from the Section 1031 Like-Kind Exchange section of the 1998 Statewide Title Real Property Series. It was provided by Skip Sacks of Asset Preservation, guest speaker in this series.
I. CASE NAME: DAVID A. and MARILYN P. KNIGHT, v. COMMISSIONER OF INTERNAL REVENUE T.C. Memo 1998-107 Tax Ct. Dkt. No. 16522-96
II. CASE NAME: TERRY D. SMITH,
INTERNAL REVENUE SERVICE
Cite: 80 AFTR2d Par. 97-5577
III. CASE NAME: DAVID DOBRICH and NAOMI DOBRICH,
COMMISSIONER OF INTERNAL REVENUE
Tax Ct. Dkt. No. 3832-95
IV. LETTER RULING NO.: 9748006
The individual owned a one-third interest in unimproved investment property and his mother owned a two-thirds interest in the same property. An unrelated third party wanted to acquire the unimproved land, and the individual and his mother agreed to sell. The mother then purchased a residence for her own use. After he entered into the sale agreement, the individual decided he wanted to do a like-kind exchange. After determining that obtaining replacement property from an unrelated party was unfeasible, he entered into a purchase agreement with his mother to acquire the residence. Ultimately, the following series of steps occurred.
First, the individual transferred his interest in the unimproved property and his obligations under the sale agreement to a qualified intermediary. Second, the individual assigned his obligation to acquire the residence to the qualified intermediary. Third, the intermediary sold the interest in the unimproved property to the unrelated purchaser. Fourth, the intermediary paid the proceeds from the sale of the individuals unimproved property to the mother, and the individual paid an additional amount directly to his mother, for the residence. Fifth, the mother transferred the residence through the intermediary to the individual. Separate from the exchange but at the same time, the unrelated purchaser paid the mother for her interest in the unimproved property.
The Service reasoned that the economic result of the series of transactions was the same as what would have occurred in a direct exchange of the individuals interest in the unimproved property for the residence owned by the mother. Further, said the IRS, the mere interposition of a qualified intermediary will not correct a transaction that would otherwise run afoul of the restriction on like-kind treatment for exchanges with related parties. The Service concluded that the individual did not demonstrate that the use of the qualified intermediary was not to avoid the purpose of the related party rules of section 1031(f), and that the exchange with the qualified intermediary is not eligible for nonrecognition treatment under section 1031(a).