Related party LKE gains may be deferred


The IRS ruled in PLR 202053007 that related parties that engaged in a series of like-kind exchange (LKE) transactions may defer gains under Section 1031, upon showing that the principal purpose of the LKE was not the avoidance of federal income taxes under Section 1031(f)(2)(C) and that the taxpayer and its related parties will hold onto the replacement properties for at least two years under Section 1031(f)(1)(C).

The taxpayer in the PLR and its related parties engaged in a series of LKE transactions through a qualified intermediary (QI). The initial taxpayer transferred the relinquished property to an unrelated party (through the QI), but the remainder of the series of transactions included related, but non-consolidated, parties.

Generally, Section 1031(f)(1) provides that a taxpayer may not defer gain or loss from an LKE if the exchange involves related parties, and if a related party relinquishes the replacement property within two years. However, Section 1031(f)(2)(C) provides an exception to this general rule that the principal purpose of the like-kind exchange was not the avoidance of federal income taxes.

The taxpayer argued that the principal purpose of the exchanges was not the avoidance of federal income taxes by asserting that: 1) there was no cash transferred as part of the transfers, 2) upon completion of the transactions, all related parties owned property that is of like-kind to the property the respective party transferred in its exchange and 3) that the related parties will hold their respective replacement properties for more than two years.

The IRS agreed with the taxpayer and held that the nonrecognition treatment was proper. It is an important reminder that like-kind exchanges involving related parties may continue to qualify for the nonrecognition treatment of Section 1031, but there are additional factors to consider.



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