Rev. Rul. 82-147

ISSUE

Under the circumstances described below, does the sale of a resort hotel constitute an involuntary conversion within the meaning of section 1033 of the Internal Revenue Code?

FACTS

In 1975, A purchased a fishing lodge situated on the shores of a lake in northern Minnesota. A operated a fishing resort until 1979, offering lodging, meals, and boats for guests. The resort was closed during hunting and winter seasons.

In 1978, Pub. L. No. 95495, 92 Stat. 1649 (1978) (the Act), was approved. The Act designated more than one million acres of northern Minnesota, including the lake and the land on which the resort is located, as the Boundary Waters Canoe Area Wilderness. The purposes of the Act are to provide for the protection and management of the fish and wildlife of the wilderness region so as to enhance public enjoyment, and to provide for the orderly and equitable transition from motorized recreational uses to nonmotorized recreational uses on the lakes and waterways specified in the Act.

Section 4(c)(1) of the Act provides that, effective January 1, 1979, the use of motorboats with motors of greater than 25 horsepower shall be prohibited on the lake.

Section 5(a) of the Act provides that an owner of a resort in commercial operation during 1975, 1976, or 1977 and located on land riparian to certain specified lakes (including the lake) may require purchase of that resort, including land and buildings appurtenant thereto, by submitting a written notice to the Secretary of Agriculture prior to September 30, 1985. For purposes of such a sale, the value of a resort shall be the greater of its fair market value as of July 1, 1978, or the date of the written notice, without regard to the restriction imposed by the Act.

The Congressional debates on the Act state that the option of selling to the government was included to assist resorters forced out of business in adjusting to the Act's new management plan. Further, concerning the reduction and eventual phase out of motorized access, it was stated that limited motorized access to a lake or part of the lake is not sufficient for most of the resorts to remain in operation.

The restriction on the horsepower of motors permitted on the lake effectively denied A the former economic use of the resort. Because of the lake's size, this restriction would substantially curtail fishing on the lake, the primary recreational activity offered by the resort. The resort was closed during the 1980 fishing season and sold to the federal government in September of that year.

LAW AND ANALYSIS

Section 1033 of the Code concerns the federal income tax treatment of involuntary conversions. The general rule permits nonrecognition of any gain realized if property is compulsorily or involuntarily converted into property similar or related in service or use to the converted property. Alternatively, if property is converted into money or dissimilar property, then gain is recognized only to the extent the amount realized upon the conversion exceeds the cost of qualified property that is purchased as a replacement. These rules apply, however, only if the involuntary conversion of the property is a result of its complete or partial destruction, theft, seizure, or requisition or condemnation or the threat thereof.

Involuntary conversion, within the meaning of section 1033 of the Code, means that a taxpayer's property, through some outside force or agency beyond the taxpayer's control, is no longer useful or available to the taxpayer for its purposes. One of the conversions specified in section 1033 is condemnation, which refers to the process by which private property is taken for public use without the consent of the property owner but upon the award and payment of just compensation.

In Rev. Rul. 76-69,1976-1 C.B. 219, the Service considered an act of Congress that authorized the Secretary of Agriculture to acquire any lands or interests for the protection or preservation of the natural beauty and historic values of a particular valley area. These interests included "scenic easements," which are defined in the act as the right to control the use of the land in order to protect the aesthetic values of the land. Pursuant to the act, the United States acquired a scenic easement on a taxpayer's land through a sale made under threat of condemnation. The ruling holds that even though the taxpayer retained legal title to the land and retained rights and privileges that could be used and enjoyed without abridging the easement conveyed, the taxpayer, in conveying the scenic easement, gave up a beneficial use of the property. Accordingly, the taxpayer was entitled to treat the sale as an involuntary conversion for purposes of section 1033 of the Code.

In the instant case, because of the expected reduction in income resulting from the curtailed fishing on the lake, it would have been impossible to continue profitable operation of the resort. Thus, the resort was no longer useful or available to A for its purpose.

This conclusion follows from the restriction imposed on the taxpayer's right to use and control its property and the Congressional intent underlying the Act to force resorters out of business and change the use of the area from motorized recreational activities to nonmotorized recreational activities. This restriction, in addition to the provision authorizing purchase of a resort at its fair market value without regard to the restriction, effectively constitutes a taking of the property upon payment of fair compensation. While it is recognized that the taxpayer could have retained possession of its property, it was no longer suitable for commercial use because of the Act's restrictions, and thus was no longer useful or available to the taxpayer for its originally intended purpose.

HOLDING

The sale of the resort constitutes an involuntary conversion within the meaning of section 1033 of the Code.