In several recent private letter rulings (PLRs 202416012, 202449007, 202450005, 202450006, 202450007, 202450008 and 202450009), the IRS concluded that a trust's distribution of tenancy-in-common (TIC) interests in real property to its beneficiaries would not preclude treating those interests as held for investment or for productive use in a trade or business within the meaning of IRC Section 1031(a) for purposes of a like-kind exchange.

Facts

The taxpayer in each PLR is one of several beneficiaries of a testamentary trust (Trust) established by a decedent's will for the benefit of the decedent's daughters and their descendants. Under the will, the Trust would cease upon the death of the daughters' last surviving child who was living at the death of the decedent (Terminating Event), at which point the trustees were to distribute the Trust corpus, including real property held by the Trust (Property), to the beneficiaries.

Before the Terminating Event occurred, the trustees determined that it would be in the best interests of the beneficiaries to engage in a like-kind exchange of Property for other real properties and, therefore, began negotiating with a buyer for the sale of the Property. During negotiations, however, the Terminating Event occurred. The trustees entered into a contract with the buyer for the sale of the Property but determined that the occurrence of the Terminating Event precluded the completion of the contemplated like-kind exchange. As part of the Trust's termination plan, which was expected to be approved by the state probate court, the trustees agreed to accommodate any beneficiary's interest in completing an exchange.

The taxpayer in each PLR informed the trustees that they wished to engage in a like-kind exchange. To effectuate the Trust termination and exchanges, each taxpayer would form and solely own a disregarded limited liability company (LLC), and the trustees would distribute undivided TIC interests in the Property to the LLCs. Shortly after the distributions, the trustees would cause the disposition of the TIC interests, and the taxpayers, through their respective LLCs, would engage in separate exchange transactions.

Each taxpayer represented that (1) the Property was held by the Trust for investment purposes; (2) any replacement properties acquired by Taxpayer through their LLC would be held for investment purposes; (3) the disposition of Taxpayer's TIC interest and acquisition of replacement properties would qualify as an IRC Section 1031 like-kind exchange (aside from the issue addressed in the PLRs); and (4) the Trust's winding-up period had not been unduly postponed.

Law and analysis

Under IRC Section 1031(a), no gain or loss is recognized on the exchange of real property held for productive use in a trade or business or for investment if it is exchanged solely for real property of like kind that is to be held either for productive use in a trade or business or for investment.

The PLRs state that the IRC Section 1031 "holding" requirement (i.e., the requirement to hold both the relinquished property and the replacement property for productive use in a trade or business or for investment) "was designed, in part, to postpone the recognition of gain or loss when property used in a trade or business or held for investment is exchanged for other property in the course of the continuing operation of that trade or business, or in the course of investment." In such circumstances, a taxpayer has not economically received a gain or incurred a loss, and the exchange of property does not result in a termination of one business or investment and the start of a new one.

In Revenue Ruling 75-292, pursuant to a prearranged plan, a taxpayer exchanged real property used in its business for replacement real property and immediately contributed the replacement property to a newly formed corporation. The IRS concluded that the IRC Section 1031 holding requirement was not met because the taxpayer acquired the replacement property for the purpose of transferring it to the new corporation. In Revenue Ruling 77-337, pursuant to a prearranged plan, a taxpayer liquidated its wholly owned corporation, receiving a shopping center in a liquidating distribution, and then transferred the shopping center to a third party in exchange for replacement real property. The IRS reasoned that the IRC Section 1031 holding requirement was not met because the corporation's previous trade or business use of the shopping center was not attributable to the taxpayer as the sole shareholder.

In each of the recent PLRs, the IRS reasoned that the Trust's termination was involuntary as the Terminating Event was set by the decedent and could not be changed. The IRS also emphasized that the Trust's distribution of the TIC interests to the taxpayers was independent from their proposed exchanges of the interests as the Trust would be terminated regardless of whether the taxpayers then exchanged the TIC interests for like-kind replacement property. These facts distinguished the taxpayers' proposed exchanges from the facts of Revenue Ruling 75-292 and Revenue Ruling 77-337, in which taxpayers voluntarily transferred properties under prearranged plans.

Accordingly, the IRS ruled in each PLR that the Trust's distribution of the TIC interests, subject to a sales contract, to the taxpayers as a result of the Trust's involuntary termination would not preclude the TIC interests from being held for investment or for productive use in a trade or business within the meaning of IRC Section 1031(a).

Implications

The PLRs are the latest in a series of PLRs addressing involuntary terminations of non-grantor trusts and the holding requirement under IRC Section 1031. See PLRs 200521002, 200651030 and 200812012. Like PLRs 202416012, 202449007, 202450005, 202450006, 202450007, 202450008 and 202450009, the prior PLRs concluded that an involuntary termination of a trust resulting in a distribution of real property to the trust's beneficiaries before or after a like-kind exchange that was independent from the trust's termination did not preclude the holding requirement from being met. See also PLR 200528011 (similar but addressing IRC Section 1033).

It is worth noting that the IRS did not address Commissioner v. Court Holding Co., 324 U.S. 331 (1945) (holding that in substance a corporation sold certain property where the corporation distributed the property to its shareholders, who then sold the property to a purchaser that had originally negotiated the acquisition of the property with the corporation) in these PLRs, despite the fact that the Trust entered into a sales contract for the Property before distributing the TIC interests in the Property to the taxpayers, subject to the sales contract. Based on these PLRs, it appears that the IRS affords taxpayers significantly more flexibility in meeting the IRC Section 1031 holding requirement in an involuntary trust termination than in a voluntary "drop-and-swap" or "swap-and-drop" transaction under a prearranged plan (as in Revenue Ruling 75-292 and Revenue Ruling 77-337).

Accordingly, the scope of these rulings is limited to involuntary trust terminations, and taxpayers should consult with their tax advisors before engaging in any IRC Section 1031 transactions.