The U.S. Tax Court today issued a memorandum opinion concluding that the taxpayer’s gain related to a disposition of real property in 2007 was not entitled to nonrecognition treatment under section 1031(a) because the replacement property was purchased from a wholly owned subsidiary that had sufficient net operating losses (NOLs) to fully offset its regular tax liability relating to the sale.
The Tax Court concluded that the transaction was structured to avoid the purposes of section 1031(f), and that the taxpayer was not entitled to defer recognition of the gain realized on the exchange of the property under section 1031(a)(1).
The case is: Malulani Group, Ltd. v. Commissioner, T.C. Memo 2016-209 (November 16, 2016). Read the Tax Court memo opinion [PDF 87 KB]
The taxpayer would have had to recognize approximately $1.89 million gain had the property been sold to an unrelated third party. Because the transaction was structured as a like-kind exchange, only the subsidiary reported that it recognized gain of $3.1 million that then was almost entirely offset by NOLs.
The Tax Court held that as a result of structuring the transaction as a deferred exchange, the taxpayer and its subsidiary were able to cash out of the investment in the property almost tax-free. Thus, it was inferred that the transaction was structured with a tax-avoidance purpose.
The Tax Court observed that the transaction at issue was similar to two prior cases in which the deferred exchange between related parties was found to violate section 1031(f)(4)—Ocmulgee Fields, Inc. v. Commissioner, 132 T.C. 105 (2009) and Teruya Bros., Ltd. v. Commissioner, 124 T.C. 45 (2005).
<p>© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.</p> <p>KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.</p>
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.