Case Law Development

• Mercantile Trust Company of Baltimore v. Commissioner, Board of Tax Appeals, 1935
• Coupe v. Commissioner, 52 T.C. 394 (1960)
• Alderson v. Commissioner, 317 F.2d 790 (9th Cir. 1963), rev'd 38 T.C. 215 (1962)
• Rogers v. Commissioner, 44 T.C. 126 (1965), 377 F.2d 534 (9th Cir 1967)
• Carlton v. United States, 385 F.2d 238 (5th Cir. 1967)
• Biggs v. Commissioner, 632 F.2d 1171 (5th Cir. 1980) aff'd 69 T.C. 905 (1978)
• Garcia v. Commissioner, 80 T.C. 491 (1983) acq. 1984-2 Cum.Bull. I
• Starker v. US, 1975-1 USTC 8443 (D. Ore. 1975)
• Starker II, 602 F.2d 1341 (9th Cir. 1979)
• Maxwell v. Commissioner, T.C. Memo 1986-8447
• Rutherford v. Commissioner, T.C. Memo 1978-505
• Garbis S. Bezdjian v. Commissioner, T.C. Memo 1987-140
• Nixon v. Commissioner, T.C. Memo 1987-318

Mercantile Trust Company of Baltimore v. Commissioner, Board of Tax Appeals, 1935. Mercantile involved a property owner/exchanger, a buyer of the exchanger's property, and a seller of like-kind replacement property. Interestingly, it also involved a title company that acted as a fourth party facilitator in the transaction. Because of the tax consequences, Mercantile did not want to sell its property. Instead, they transferred it to the title company which in turn transferred it to the buyer. The title company took the buyer's money and used it to buy the replacement property and having bought it transferred it to Mercantile. All of the legs of this transaction were carried out pursuant to appropriate contracts entered into between the respective parties of each leg.

Faced with this unique transaction, the Board of Tax Appeals rejected the Service's argument that the transaction did not give rise to a valid tax deferred exchange because the title company acted as the agent of the buyer and held that the purported exchange did in fact meet the requirements of 112, the precursor of 1031.

The court's reasoning was that even if the title company was the agent of the buyer it would not have mattered because is still would have resulted in an integrated transaction in which the Taxpayer received, and was entitled only to receive, like-kind replacement property and not the buyer's purchase price. The only way the Service could have won its argument, said the court, would have been to show that the title company acted as Mercantile's agent in the transaction. If this were the case, there would have been two separate and unrelated transactions: 1) a sale of property by Mercantile to the Buyer; and 2) a purchase by Mercantile of the replacement property, and as such would not have qualified as a tax deferred exchange.

The key is that all steps constitute an integrated mutually dependent transaction. It is as simple as that. There hasn't been any significant change in the test enunciated in Mercantile in the 70 years following the decision.

Coupe v. Commissioner, 52 T.C. 394 (1960), acquiesced in 1970-2 Cum.Bull.X1X, a Taxpayer agreed to sell his farm to a buyer for a "set" price. After consulting an attorney, Coupe realized an exchange was possible which would defer taxation. The agreement was amended so that the buyer would purchase suitable farm property for Coupe with the purchase money and exchange that farm property for Coupe's. The resulting transaction had the buyer depositing cash in an escrow payable to the titleholders of Coupe's farm and Coupe exchanging his farm property with his lawyer who had contracted to buy other farms. The lawyer transferred Coupe's farm to the buyer for cash and paid off the sellers of the farm which Coupe now owned. Despite amending the contract, the court held in this transaction that Coupe did not sell his lands to the buyer but exchanged them for like-kind property in accordance with Code §1031(a).

Alderson v. Commissioner, 317 F.2d 790 (9th Cir. 1963), rev'd 38 T.C. 215 (1962) the Taxpayers agreed to sell land with the buyer immediately depositing earnest money of approximately ten percent with an Escrowee. Subsequently, Taxpayers located like-kind property which they desired to obtain in an exchange, rather then selling their land, paying tax and buying the new parcel. Therefore, the escrow agreement was amended providing that in lieu of the original cash deal, the buyer would acquire the land Alderson desired, and would exchange that property for Alderson's. Having done so with the money he otherwise would have used to pay Alderson, the exchange was affected. The court held that the transaction that finally occurred was an exchange and not a sale and purchase.

Rogers v. Commissioner, 44 T.C. 126 (1965), 377 F.2d 534 (9th Cir 1967) Taxpayer entered into an option agreement to sell property. Prior to the exercise of the option, the Taxpayer entered into negotiations for the acquisition of similar property from a third party and the transfer to him of the property subject to the option. Taxpayer then deposited in escrow a deed with instructions that it be released to the third party when title to his property was vested in them. The third party's deposits were made, but prior to that time the optionee had exercised his right to buy and had deposited money with the escrow agent. The court held that no exchange took place, but rather that Taxpayers had sold their land to the optionee pursuant to the terms of the option. There could be no exchange here, the court said, because the petitioners received only cash, not property.

Carlton v. United States, 385 F.2d 238 (5th Cir. 1967), the Taxpayer failed to pay attention to details and ruined the exchange. Here, the Taxpayer agreed to sell or exchange ranch land to a developer. Taxpayer elected the exchange, found the land he desired, and made the deposit on the parcel personally. He then notified the developer that he would require him to purchase the land and exchange it for his ranch, and the actual agreements of sale were executed by the developer. However, when it came time to close, rather than duplicate title transfer costs, the transaction was structured so that the land which the developer was buying to exchange was conveyed directly to the Taxpayer and not to the developer and then to the Taxpayer. The Taxpayer had received cash and the assignment of the developer's right to buy that land in exchange for his ranch property. Consequently, the court found that since the developer had never acquired ownership of the property, it could not have exchanged it for Taxpayer's ranch land. Therefore, the court found a taxable sale rather than a tax-deferred exchange.

This problem could have been avoided by the use of Rev. Rul. 57-244, cited above, so Carlton would have received a deed to land (rather than cash and an assignment) in exchange for a deed to his land.

Despite the holding in Carlton, in PLR 8008113, the Service ruled that a three-party exchange constituted a valid like-kind exchange notwithstanding the fact that the property exchanged was deeded directly to the first party by the third rather than to the second party for transfer to the first party. However, in a case where Taxpayer's sales proceeds were placed in an escrow and then transferred to another escrow through which he acquired similar real estate, exchange treatment was denied. Despite the simultaneous closing and the fact that the Taxpayer received no cash, the court found that neither transfer could be considered part of an integrated transaction. Allen v. Commissioner, T.C. Memo 1982-188.

Biggs v. Commissioner, 632 F.2d 1171 (5th Cir. 1980) aff'd 69 T.C. 905 (1978) where a four-party exchange was sanctioned despite deficiencies in the contracts and the fact that the party to whom the Taxpayer's property was conveyed did not obtain an ownership interest in the exchange property prior to its conveyance.

Garcia v. Commissioner, 80 T.C. 491 (1983) acq. 1984-2 Cum.Bull. I The Tax Court greatly emphasized the Taxpayer's intent in deciding the tax consequences of a complex transaction. The court stated that contractual interdependence of escrow transfers is not a technical requirement for a finding that a multi-party exchange qualified for tax-deferred treatment. The Garcia standard requires that the Taxpayer desired to effect a tax-deferred exchange, that his actions comported with that desire, and that no cash proceeds from the sale of the original property were received by the Taxpayer, either actually or constructively.

Starker v. US, 1975-1 USTC 8443 (D. Ore. 1975) Taxpayer agreed to exchange timberland with two corporations and the corporations, in turn, agreed to transfer similar properties to Taxpayers in the future as those properties were located and proved acceptable to Taxpayers. The Taxpayers had to agree before each conveyance, however, on the value of the parcel conveyed in exchange. If the agreed value of the property received was not equal within five years to what was conveyed, buyers would have the right, but not the duty, to pay the balance to the Starkers in cash. In addition, the value of what the Starkers conveyed would be increased by six percent per annum to reflect the value of the growing timber. Despite the fact that the Starkers chose eight parcels, all of which were not owned by the corporations at that time, the transaction was held to be a Code 1031 exchange.

Starker II, 602 F.2d 1341 (9th Cir. 1979) the same judge held that an exchange of real estate for a promise is not a like-kind exchange and the Taxpayer's gain or loss was to be recognized. The court held that the fair market value of the promise was equal to the fair market value of the land conveyed. In a major development regarding this issue, Starker II, was reversed by the 9th Circuit Court of Appeals. The court directed itself in this case to the question of whether 1031 required a simultaneity of transfers for a qualifying exchange. Its decision was that the contract right to receive additional property in the future, though personal property in nature, should not be treated any differently from the ownership rights themselves. Thus, the promise to deliver like-kind property in the future was held to be qualifying property in a like-kind exchange.

Maxwell v. Commissioner, T.C. Memo 1986-8447 an intended three party exchange was treated as a sale since the proceeds from the transfer of the relinquished property were placed in an escrow which the Taxpayer could have terminated at any time. The court noted that there can be a receipt of cash as a contingency in a like-kind exchange and simultaneity of transfer is not necessary. However, the court observed that the Taxpayer had the discretion to terminate the escrow prior to acquisition of replacement property and this proved fatal to the exchange.

Rutherford v. Commissioner, T.C. Memo 1978-505 wherein the court stated that, the fact that property constituting one side of an exchange was not in existence at the time of transfer, did not preclude the applicability of 1031(a). This was the first Court-sanctioned 'reverse' exchange.

Garbis S. Bezdjian v. Commissioner, T.C. Memo 1987-140: the Tax Court upheld the Service's disallowance of Taxpayer's purported tax-deferred exchange but supported its decision with an opinion filled with incorrect statements of multi-party exchange law. At the outset of its opinion holding in favor of the Service, the Tax Court stated the well established rule that a sale of property followed by a separate and unrelated purchase of property is not an exchange pursuant to 1031. On the other hand, said the court, if the Taxpayer's transfer and receipt of property were interdependent parts of an overall plan the result of which was an exchange of like-kind properties, 1031 applies. The court stated later in its opinion that the transfers involved in the case would not meet the exchange requirement of 1031 "even if the transfers were integrated, interdependent and aimed at a particular result." These two statements are simply irreconcilable under any circumstances and cast serious doubt on the quality of the court's scholarship in the case, although not on the decision itself.

Nixon v. Commissioner, T.C. Memo 1987-318 Taxpayers negotiated with a state conservation commission to sell 309 acres for $339,000 which was paid in the form of a check which Taxpayers then deposited into a food freezer for safekeeping. The Taxpayers later endorsed the check to a third party in exchange for 109 acres and cash of $218,900, which Taxpayers deposited into their bank account. In denying non-recognition treatment, the court stressed that the Taxpayers had unfettered and unrestricted control over the original check and that a cash sale and reinvestment took place. Note: Putting the cash on ice will not avoid constructive receipt.

Note: The Exchange Requirement: the "exchange" requirement poses an analytical problem because it runs headlong into the familiar tax law maxim that the substance of a transaction controls over form. In a sense, the substance of a transaction in which the Taxpayer sells property and later reinvests the proceeds in a like-kind property is much different from the substance of a transaction in which two parcels are exchanged without cash. Yet, if the exchange requirement is to have any significance at all, the formalistic difference between two types of transactions must, at least on occasion, engender different results.

At some point, the confluence of some sufficient number of deviations will bring about a taxable result. Whether the cause is economic and business realities or poor tax planning, prior cases make it clear that Taxpayers, who stray too far, run the risk of having their transactions characterized as a sale and reinvestment. (Barker, 74 T.C. 555 June 1980)