This was originally published on September 29th, 2010.
I have these silly rules that I make up and then go ahead and break all the time. One is to not use the word only in association with any sum of money greater than $4.00 (Yes there is a decimal point. Four dollars). Another is to rule out of the discussion the concepts of "making sense" and "being fair" when discussing what the tax rules actually are. I compound this latter rule by not paying much attention to theories about what the tax laws should be. This comes from some hard experience I had in 1987, trying to keep straight what actually made it into the Tax Reform Act of 1986 as opposed to the "Treasury II Proposals".
I somewhat relax the "making sense" and "being fair" proscriptions for purpose of enunciating one of my general rules of tax planning. "Any clever idea you have has been thought of and probably ruled against." An extension of this is that most of the thing that you think don't make sense actually do make sense. They are there to squelch an abusive transaction dreamed up by someone even more clever than you are. All of this is just me apologizing for saying that the Eleventh Circuit's decision in Ocmulge Fields v. Com (106 AFTR 2d 2010-5820) makes sense.
The case concerns like-kind exchanges, a topic which I discuss here and there. At issue is the application of the related party resale rules. Suppose you owned two companies (Call them Highoco and Lowco)and each one owned a piece of real estate worth $1,000,000. Further suppose that the basis of one property (High-B)was $900,000 and the other (Low-B) was $100,000. Along comes buyer who perversely is willing to pay $1,000,000 for Low-B, but has no interest in High-B. Wouldn't it be nice if you could move the basis in High-B over to Low-B ? Well you can. Highco and Lowco can do a like-kind exchange. Highco's basis in Low-B will be $900,000, its basis in the property that it surrendered. Clever.
Unfortunately, if Highco disposes of Low-B within two years of the exchange Lowco has to recognize gain.
There is another set of rules involving like-kind exchanges. Since the person that has the property you want is rarely the person who wants your property many exchanges use qualified intermediaries. The qualified intermediary receives the money from the sale of your property and uses it to purchase another property. You have 45 days from the date of sale to identify the target property and you must receive it within 180 days of the sale (If the sale is later in the year you may have to extend your tax return in order to have the full 180 days).
Ocmulgee Fields Inc decided that they should go the qualified intermediary route. The hired Security Bank of Bibb County to serve as qualified intermediary. The bank received the proceeds for the sale of Ocmulgee's property known as Wesleyan Station to the McEachern Family Trust. Ocmulggee then searched high and low for a replacement property. They used up all of six days. Finally they identified a Barnes and Nobles. It just kind of happened, sort of by coincidence, that the Barnes and Nobles was owned by a company named Treaty Fields. Come to find out, Treaty Fields was pretty much owned by the same people as owned Ocmulgee.
Seems like since they already were acquainted with one another, they did not really need a qualified intermediary. Just as well they used one, though, since it got them out of that nasty related party resale rule. Well that's what they thought. It's not what the IRS thought, though. And the Tax Court and the Eleventh Circuit agreed with the IRS. Treaty Fields, surprise, surprise, had higher basis in the Barnes and Nobles than Ocmulgee had in the Weslyan property. But that's not all. Ocmulgee was a C corp and Treaty Fields was a partnership.
I would have been awfully upset if Ocmulgee won this case. Not because I root for the IRS. I would have been upset at myself for not telling my own clients about such an obvious end run around the related party resale rules. The resale rules have this nice little ending (1031(f)(4)), which disallows any exchange which is a part of a transaction or series of transactions to avoid the purposes of the resale rules. It reads:
This section shall not apply to any exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection
Read by itself, it doesn't make a lot of sense. What it says is that you can't fix a bad exchange by throwing in a couple of extra seemingly good ones.