Firm Seeks Clarification of Issues Under Like-Kind Exchange Rules

June 18, 2020

Edward C. Schwartz, Esq.
Internal Revenue Service
Associate Chief Counsel (Income Tax & Accounting)
Attn: CC:ITA:B05
1111 Constitution Ave., N.W.
Washington, D.C. 20224
edward.c.schwartz@irscounsel.treas.gov

Dear Ed:

We want to congratulate you and your team on the recently proposed regulations that define "real property" for purposes of I.R.C. section 1031 (REG-117589-18). The proposed regulations evidence a very high level of thought and care, commensurate with the importance of defining that term.

We also commend you and your group for addressing a potential footfault created by the elimination of like-kind exchanges of personal property by P.L. 115-97 (the "TCJA"). We had previously discussed with you and your group the extent to which Treas. Reg. section 1.1031(j)-1 (the "(j) regulations") are still relevant, and whether the qualified intermediary ("QI") safe harbor is inapplicable if the QI uses exchange funds to acquire a relatively minor amount of personal property that is incidental to the real estate being acquired. Prop. Reg. section 1.1031(k)-1(g)(7)(iii) eliminates this uncertainty regarding the QI safe harbor by providing that such acquisition of personal property will not make the QI safe harbor inapplicable.

There are other issues that should also be considered concerning the continued relevance and application of the (j) regulations.¹ As you know, the general approach under the (j) regulations is to allocate the assets in a multi-asset exchange into exchange groups of like-kindproperty. See sections 1.1031(j)-1(a)(2)(i) and (b)(2)(iii). With respect to each exchange group, gain is recognized, essentially, only to the extent the value of the assets transferred in that group exceeds the value of the assets received in that group. See sections 1.1031(j)-1(b)(2)(iv) and (b)(3)(i). However, the impact of the TCJA is not clear, and is best explained with a simple example:

Taxpayer exchanges $100 of real property with a basis of $20, together with $15 of incidental personal property with a basis of $15, for $100 of like-kind real property and $15 of incidental personal property (which property would have been like kind prior to the TCJA).

Under the pre-TCJA law, the operation of the (j) regulations would be clear: Two exchange groups would be created (a real property group and a personal property group) with the result that gain would be realized in the real property group, but would be deferred (rather than recognized) under section 1031, and that no gain would be realized (and, therefore, would not be recognized) in the personal property group. However, unless the (j) regulations continue to apply in that respect, one might say now there is recognized gain (i.e., that a pro rata portion of the personal property was received for the transfer of the real property). In recognition of the fact that most, if not all, exchanges of commercial real estate involve some minor amount of personal property that is incidental to the real estate, and for ease of administration, we would urge the IRS to conclude that the (j) regulations will continue to apply in such a case, so that no gain would be recognized.

Another open question is the timing of gain recognized where real estate is transferred in an exchange for real estate and personal property incidental to the real estate, and the exchange straddles two taxable years. Is the gain recognized in the first or second year? Similarly, if the transfer of the real estate, pursuant to a bona fide intent to accomplish a section 1031 exchange, occurs toward the end of the first year, but there is no acquisition of replacement property, does the recognized gain with respect to the personal property (like the gain recognized for the real estate) occur in the second year?

We kindly request your consideration of these issues, which we would be happy to discuss with your further. Congratulations again on a job well done.

Sincerely,

Howard J. Levine

Aaron S. Gaynor

Roberts & Holland LLP
Washington, DC

CC:
John P. Moriarity, Esq.
Associate Chief Counsel (IT&A)