Technical Advice Memoranda (TAMs)

• TAM 9525002 Timber Interest -- The right to harvest timber for two years is not like-kind to a fee interest.  Believed by many to be inconsistent with D.G. Smalley V. Commissioner, 116 TC 29.

• TAM 9748006 Related Parties -- An exchange was disqualified when the Taxpayer acquired the replacement property from a related party.

• TAM 9818003 Partnership Dissolution -- Interest in a partnership does not qualify for a Section 1031 Exchange.

• TAM 9907029 Partnership Exchange -- The Service allowed an exchange at the partnership level when several partners each signed separate exchange agreements.

• TAM 9937038 Tax Free Liquidation -- A subsidiary’s use of assets could not be attributed to its parent in the event of a tax free liquidation.

• TAM 200035005 Exchange of FCC Radio Licenses for FCC Television License -- FCC Radio and Television licenses meet the ‘like-kind’ test; as the underlying property is the ‘electromagnetic spectrum’ under which both licenses operate.

• TAM 200039005 (May 31, 2000) Reverse Exchange -- Issued prior to Rev. Proc. 2000-37, the Service disqualified the exchange, ruling that, in this instance, the Qualified Intermediary was an agent of the Taxpayer.

• TAM 200130001 (March 1, 2001) Substantial Compliance with Regulations

• TAM 200126007 (March 22, 2001) Related Party Exchange

• TAM 200424001 (December 8, 2003) Like-Kind Property -- The ‘like-Kind’ test in a Section 1031 Exchange refers to the nature or character, not the grade or quality, of the exchanged assets.

TAM 9525002 Timber Interest: This Technical Advice Memorandum holds that a right to harvest timber for two years on land owned by the Taxpayer is not like-kind to a fee. This holding is consistent with U.S. Tax Court's holding in Fleming v. Commissioner, 24 T.C. 818 (1995) and Koch v. Commissioner, 71 T.C. 54, 65 (1978), and is inconsistent with dicta in D.G. Smalley v. Commissioner 116 TC 29 infra.

TAM 9748006 Related Parties: Taxpayer entered into a contract to sell relinquished property to an unrelated party and assigned the contract to a qualified intermediary. Taxpayer then entered into a contract to acquire replacement property from a related party who had very recently purchased the property. Taxpayer argued that the exception in 1031(f)(2) should apply because there was no tax avoidance motive because (i) the replacement property was acquired by the related party after the Taxpayer signed the contract to sell, (ii) there was no pre-existing commitment or pre-arranged plan to circumvent the related party rules, and (iii) the Taxpayer could have acquired the replacement property directly from the seller, who only very recently sold it to the related party.

A review of the legislative history of Sections 1031(f) and (g) discloses that the Joint Committee on Taxation determined that "if a related party exchange is followed shortly thereafter by a disposition of the property, the Related Parties have, in effect, 'cashed out' of the investment, and the original exchange should not be accorded non-recognition treatment." H.R. Rep. No. 247, 101st Cong. 1st Sass. 1340 (1918) (emphasis added). TAM 9748006 is evidence of the Service's willingness to re-characterize exchanges involving related parties and treat the related parties as a single Taxpayer. The preceding disposition of the relinquished property is then treated as a "cashing out" by the related party prior to the expiration of the two year holding period imposed by Section 1031(f)(1).

While this Technical Advice Memorandum is the first meaningful ruling on the related party rules of Section 1031 (f) its application may be limited. According to Kelly Alton, IRS special counsel to the assistant chief counsel at the time the TAM was issued, this case at issue was not a typical situation. "Unlike most exchanges, the point of this one was real tax avoidance." (ABA Tax Section Meeting, Sales, Exchange and Basis Committee, May 16, 1998).

TAM 9818003 Partnership Dissolution: Taxpayer, a partnership, owned and leased the relinquished property to a limited partner of Taxpayer. Taxpayer entered into a contract to sell the property to A and Taxpayer assigned its rights under the contract to a qualified intermediary. The partnership agreement provided that upon dissolution and liquidation of Taxpayer, the managing partner could effect one or more deferred like-kind exchanges through a qualified intermediary. The partnership agreement allowed each partner to designate one or more properties which Taxpayer would acquire using the respective partner's share of the net proceeds from the sale of the relinquished property. Replacement properties were conveyed directly to the individual partners in liquidation of their partnership interests. Taxpayer cited Revenue Ruling 90-34 as authority for its position that the direct deeding of replacement properties to partners of Taxpayer does not affect the status of the transaction as an exchange by Taxpayer. However, Revenue Ruling 90-34 held that Taxpayer's transfer of property to Y in exchange for property conveyed to Taxpayer directly from Z qualifies Taxpayer for nonrecognition. The relevant inquiry is whether the transaction is an exchange with respect to Taxpayer, not with respect to the partners of Taxpayer. The Service ruled that the exchange failed to qualify because Section 1031(a) does not apply to any exchange of an interest in a partnership under Code § 1031(a)(2)(D). Contrast this with TAM 9907029 in which the Service reached the opposite conclusion.

TAM 9907029 Partnership Exchange: In a surprising ruling the Service allowed an exchange, at the partnership level, where four partners executed separate exchange agreements and separate escrow agreements. The Service concluded that the separate agreements had the effect of a written agreement between the partnership and the accommodator. The Service went on to say that even though one partner received cash boot before the partnership acquired replacement property, an obvious violation of the "(g)(6)" restrictions, that there was actual or constructive receipt only as to the partner who cashed out, and not as to money held on behalf of the other three partners in the separate accounts.

TAM 9937038 Tax Free Liquidation: Advised that a corporation is not considered to have been holding assets in a trade or business where it disposes of assets just received in a tax free liquidation of a wholly owned subsidiary. The TAM concluded that the subsidiary's use of the assets could not be attributed to its parent upon the tax free liquidation.

TAM 200035005 Exchange of FCC Radio Licenses for FCC Television License: Based on the language in the regulations and the IRS' position with regard to goodwill, many practitioners would have expected the IRS to take a very conservative approach to intangibles in general. However, in TAM 200035005 (May 11, 2000), the IRS reached a very generous and surprising conclusion concerning the exchange of FCC radio licenses for an FCC television license.

The Taxpayer had transferred three FCC radio licenses, involving AM and FM frequencies, in three different cities in exchange for one FCC television license in a fourth city. The IRS could perhaps have concluded, based on the regulations, that (a) radio licenses are fundamentally not like kind to television licenses, (b) AM and FM frequencies are fundamentally different from each other and certainly from television frequencies and/or (c) a license in one city cannot be exchanged for a license in a different city.

Instead, in applying the two pronged test referred to above, the IRS concluded that the rights conferred on FCC radio and television licensees are "basically the same", and that the "underlying property" referred to in the Regulations is the "electromagnetic spectrum" under which both radio and television licensees operate, although they are assigned different specific frequencies.

Although the IRS recognized differences in radio and television frequencies (e.g. assigned different frequency bands of the spectrum; television broadcasts require a much larger bandwidth than audio broadcasts; and that a radio licensee cannot use its frequency to broadcast television (and vice versa). Nevertheless, the IRS concluded that these differences are not differences in nature and character but are merely differences "in grade or quality."

The generosity of the TAM is likely to result in Taxpayers taking fairly aggressive positions in a variety of areas that were previously considered unlikely to achieve success. Commentators are already suggesting that perhaps FCC broadcast licenses can be exchanged for FCC licenses to use a cellular communications system, since they all use portions of the electromagnetic spectrum. It is doubtful that the IRS would go this far and caution should be exercised in extending the TAM beyond its facts.

TAM 200039005 (May 31, 2000) Reverse Exchange: Prior to the issuance of Rev Proc. 2000-37, the IRS issued TAM 200039005, which involved a simultaneous exchange that went "bad" at the closing. At the last minute, the buyer of the relinquished property refused to close and the Taxpayer nevertheless demanded that the closing on the replacement property proceed.

The TAM states as a factual matter that the "Taxpayer closed on the purchase of the replacement property," but directed that title be deeded to "A", an entity that apparently otherwise could have been a QI. The TAM also states that the Taxpayer, of course, and not A, negotiated the purchase of the replacement property, the Taxpayer provided the funds (although it does not state whether this was done by way of a loan), Taxpayer was personally liable on the third party mortgage, while A was not, "there is no evidence that A would have been involved in the transaction but for Taxpayer," and "a written exchange agreement did not exist at the time A acquired title to the replacement property." On the basis of these factors, the IRS concluded that A was acting as the Taxpayer's agent.

There is some confusing language in the TAM concerning reverse exchanges. One could read the TAM to state that reverse exchanges are simply not permissible. We know from past experience that one cannot read adverse TAMs too literally, but this does seem to be what the TAM is saying. On the other hand, it is odd that the IRS would announce this conclusion concerning reverse exchanges (which, as stated above, was reserved in the Regulations) through a TAM. If that is their conclusion (this is not at all clear), how would they distinguish LTR 98114019? It cannot be distinguished simply on the grounds the letter ruling involved a two party exchange.

The IRS was obviously working on Rev. Proc. 2000-37 at the time the TAM was considered by the National Office and this may have had an impact. The IRS may have felt compelled to take a somewhat harder line in a matter that would not factually have met all the technical requirements under the Rev Proc. This is understandable, given the generosity of the Rev Proc. However, since there has been no change in the law that prompted the Rev Proc, it would have been helpful for the IRS to clarify the substantive differences between the TAM and the factual setting of many pre-Rev Proc parking arrangements that have been in widespread use (not to mention the Rev Proc itself which by the end of May was presumably in its final stages). In any event the TAM is likely to be the subject of much discussion among practitioners, and IRS personnel will no doubt provide some clarification in future public forums and bar association meetings. In fact, after the TAM was made public, a representative of the IRS involved in the TAM indicated that, from her viewpoint, the most significant factor was the lack of an exchange agreement in place.

TAM 200130001 (March 1, 2001) Substantial Compliance with Regulations: Exchange disqualified because Taxpayer did not give proper notice of assignments as required in the Regulations and because the necessary (g)(6) restrictions were not set forth in the document. The Taxpayer argued that the Purchaser had "actual notice" of the assignment (if not written notice) and that they were in substantial compliance with the regulation - the Taxpayer even produced written affidavits from the Purchasers indicating that they'd been given notice of the assignment. As for the lack of language restricting the Taxpayer's rights to receive the sale proceeds, the Taxpayer attempted to point to certain contract provisions that effectively limited their rights to receive the cash. The Service reached a different interpretation of the language. Finally, the Service said there was no "substantial compliance" concept in the safe harbor and disallowed the transaction. A safe harbor is a safe harbor - you are either within it, our outside.

TAM 200126007 (March 22, 2001) Related Party Exchange: The Service, in disallowing this transaction stated that Section 1031(f)(4) could be invoked by "basis shifting, tax free or tax deferred cashing out of an investment by a Taxpayer or a related party, reduction or avoidance of tax, acceleration of losses, etc." [1031(f)(4) states that 1031 does not apply (regardless of compliance with the 2 year holding period) to any exchange transaction which is part of a series of transactions that is structured to avoid the purposes of this subsection]. The Service also concluded that the QI will be considered the agent of the Taxpayer for purposes of 1031(f), despite statements in the regulations, and that Sections 1031(f)(1) and (2) are applicable to a direct related party exchange, with a subsequent sale of the property received in the exchange, and that 1031(f)(4) applies to multi-party exchanges. There is no basis for this statement. [1031(f)(1) imposes a two year holding period on exchanges between related parties. 1031(f)(2) carves out certain types of dispositions, specifically, disposition of the property as a result of death of the Taxpayer, involuntary conversion, or other disposition that does not have as one of its principal purposes the avoidance of Federal income tax.].

The Service also argued that the fact that the Taxpayer had previously done Section 1031 exchanges and the fact that the transactions were structured as a result of tax planning were factors considered in applying the provisions of 1031(f)(4).

TAM 200424001: Like Kind Property, December 8, 2003: In this TAM, the Service considered whether components of railroad track that are assembled and attached to land and considered real property for state law purposes, are like-kind to unassembled railroad track components. A railroad operator exchanged railroad segments that were affixed to the land, along with some railroad ties that were removed from a line segment for new component materials used to make replacement track.

Citing the 1031 Regs. 1.103 (a)-1(b), which provide that the words "like kind" are used to refer to the nature or character of the property, not its grade or quality, the Service concluded that one kind or class of property may not be exchanged for property of a different kind or class. Additionally, the Service noted that it is well-established case law that real property and personal property are not like kind under Section 1031(a).

As a matter of law, property classified as real estate under local law can never been "like kind" to property classified as personal property under local law, regardless of the similarities between the properties. The TAM cites "well established" authority that in the application of a federal revenue act, state law controls in determining the nature of the legal interest which the Taxpayers had in the property - and that it is not uncommon that the federal income tax treatment of property varies depending on the controlling state law.

Editor's Note: The rationale (but not the result) appears incorrect. A court is unlikely to hold that identical properties are not like kind because one state treats the relinquished property as real estate while another state treats the same property as personalty. Additionally, it may not always be clear how a particular property is treated under local law. (i.e. a New York co-op).