In Estate of George H. Bartell, Jr. et al. v. Commissioner, (147 T.C. No. 5), the Tax Court held that a taxpayer's disposition and acquisition of property was not a self-exchange and qualifies for nonrecognition treatment pursuant to Section 1031.

Facts

In August 2000, Bartell Drug Co., an S corporation, arranged through a qualified exchange facilitator to purchase property (Lynnwood property) on which to build a new drug store. Bartell used Exchange Structures, Inc. as the intermediary, which created a wholly owned limited liability company, EPC Two, LLC, to hold the property. Upon purchase of the property a statutory warranty deed was recorded listing EPC Two as the owner. A final title insurance policy on a fee simple interest in the Lynnwood property was issued to EPC Two as the named insured.

Bartell arranged financing for the purchase and constructed a new drugstore on the property. EPC Two held the property and the proceeds of the financing. EPC Two had no obligation to become liable for any payments or to advance any funds in excess of those borrowed or funds supplied. Bartell was billed by the construction company and reimbursed by EPC Two from the loan proceeds for the amounts paid. Bartell was responsible for effecting the construction and handled tasks such as acquiring permits, bonds and insurance. Once construction was completed, a final title insurance policy on a fee simple interest in the Lynnwood property was issued to EPC Two as the named insured.

Under the terms of the Real Estate Acquisition and Exchange Cooperation Agreement (REAECA), after construction was complete, EPC Two was required to lease the Lynnwood property to Bartell. As planned, Bartell leased it from EPC Two until ownership was transferred to Bartell upon completion of the exchange transaction.

At the same time, Bartell was working to find a buyer for the property to be relinquished. The identified property (the Everett property) was an older retail drugstore. Upon finding a buyer, the transaction was structured as a sale-leaseback. The contract included a clause that the buyers would cooperate if Bartell decided to sell the property as part of a like-kind exchange.

In December 2001, Bartell Drug as "Exchanger" and Section 1031 Services as "Intermediary" executed an exchange agreement for the exchange of relinquished property, identified as the Everett property, for replacement property, identified as the Lynnwood property. These transfers were done through a direct deeding process by Section 1031 Services. Bartell reported the transaction on its IRS Forms 1120S as receiving the property on January 2, 2002 with a fair market value of the property received shown as approximately $4.1 million and the basis of the property given up as approximately $1.3 million for a deferred gain of approximately $2.8 million.

Upon examination, the IRS disallowed tax deferral treatment under Section 1031.

Law and analysis

Section 1031 allows for non-recognition of gain when the transaction is the exchange of like-kind property. The court held in DeCleene v. Commissioner, 115 T.C. 457, 469 (2000), that non-recognition treatment is not available if a taxpayer is dealing with itself, a self-exchange.

The IRS argued that Bartell owned the Lynnwood property long before the disposition of the Everett property in December 2001 and, thus, following DeCleene, may not qualify for non-recognition treatment. The IRS argued that EPC Two had none of the benefits and burdens of ownership and Bartell should be treated as the owner of the Lynnwood property as of August 2000. The IRS also noted that Bartell had full direction and burden for the construction. Bartell argued that an agency analysis is the appropriate standard to determine ownership and that EPC Two was the property owner.

In Alderson v. Commissioner, 317 F.2d 790 (9th Cir. 1963), rev'g 38 T.C. 215 (1962), the court expressly rejected the proposition that a person who takes title to the replacement property must assume the benefits and burdens of ownership in that property to satisfy the exchange requirement. Alderson and Biggs v. Commissioner, 632 F.2d 1171 (5th Cir. 1980) established that where a Section 1031 exchange is contemplated from the outset and a third-party exchange facilitator, rather than the taxpayer, takes title to the replacement property before the exchange, the exchange facilitator need not assume the benefits and burdens of ownership of the replacement property. The court has applied Alderson to a variety of transactions where a third party facilitator was used and contractually insulated from any beneficial ownership of the replacement property.

The court distinguished the present case from DeCleene. In DeCleene, the taxpayer purchased the replacement property outright more than a year before the exchange. The taxpayer later transferred legal title to the replacement property to the purchaser of his relinquished property. The court held then that he was the beneficial owner and had made a taxable sale of the property.

The court stated that Alderson applies and held that Bartell's disposition of the Everett property and acquisition of the Lynnwood property in 2001 qualify for nonrecognition treatment pursuant to Section 1031.

It is worth noting that the parking safe harbor permitted under Revenue Procedure 2000-37, 2000-2 C.B. 308, did not apply for several reasons, including the fact that the transaction began before the effective date thereof.

Implications

Bartell is a significant case supporting a taxpayer's ability to park replacement property, including build-to-suit replacement property, outside the safe harbor of Revenue Procedure 2000-37. Relying heavily on pre-deferred exchange case law, the court in Bartell allowed the taxpayer to structure a reverse exchange/parking transaction to satisfy the Section 1031 requirements even though the taxpayer held the benefits and burdens of ownership of the replacement property, but not title to the replacement property, more than one year prior to the sale of the relinquished property. Placing the form of the transaction over the substance, the court in Bartell provided an expansive permissive approach to structuring transactions to satisfy the requirements under Section 1031, including allowing improvements constructed by the taxpayer on the replacement property to qualify as replacement property under Section 1031. It is unclear at this time whether the IRS will appeal this decision and what effect this decision will have on the market place that typically had structured reverse exchange/parking transactions to satisfy the safe harbor requirements under Revenue Procedure 2000-37.

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