Joint Report on IRC Section 1031
Open Issues Involving Partnerships
February 8, 2001

Contents | Introduction | I | II | III | IV | V

Discussion of Partnership Section 1031 Open Issues: Questions and Answers

Q-1: Can like-kind property satisfy the "qualified use" requirement, under the following circumstances:

1. If the relinquished property is distributed to one or more partners by a partnership in anticipation of the distributee’s transfer of the property in an exchange?
2. If like-kind replacement property received by a partnership in an exchange is distributed to one or more partners by the partnership immediately following the exchange?
3. If like-kind property is contributed to a partnership in anticipation of the partnership’s transfer of the property in an exchange?
4. If like-kind property is contributed to a partnership following its receipt by the contributing partner as replacement property in an exchange?

A-1: Yes, in all cases, if the person or entity who owns the relinquished or replacement property immediately before the exchange does not intend to liquidate the investment or to convert the relinquished property or replacement property to a personal purpose, the taxpayer engaging in the exchange has satisfied the qualified use requirement. Transferring either replacement property or prospective relinquished property to a partner who does not sell the property or convert it to a personal use should not bar the satisfaction of the qualified use standard by distributor/partnership or the distributee/partner. Similarly, if a partner contributes prospective relinquished property or replacement property to a partnership in a transfer governed by Section 721, the receiving partnership or the contributing partner should be viewed as satisfying the qualified use standard.

The IRS has been unwilling to attribute an entity’s qualified use to the taxpayer before or after a tax free transfer to or from the entity. For example, in Rev. Rul. 75-292, the IRS found that the taxpayer had not held the replacement property for qualified use when, immediately after the exchange, the taxpayer contributed the replacement property to his wholly-owned corporation. In Rev. Rul. 77-337, the IRS found that a taxpayer had not held the relinquished property for a qualified use when the taxpayer received the relinquished property as a liquidating distribution from his wholly-owned corporation and then immediately exchanged the relinquished property for a replacement property.

Similarly, in Rev. Rul. 84-121, 1984-2 C.B. 168, the IRS ruled that property acquired by a taxpayer for purposes of acquiring another property upon exercise of an option could not be transferred to the owner of the optimal property in a Section 1031 exchange because the taxpayer had not held the relinquished property for a qualified use.

The IRS has cited some of these rulings in a partnership context in TAM 9645005, in ruling that a partner who received a distribution of partnership property immediately prior to a sale under Section 1033(g) had not held the property for a qualified use. (Section 1033(g) has a qualified use requirement similar to Section 1031(a)(1)).

However, it is not necessary to "attribute" a predecessor owner’s purpose in holding a property to a subsequent holder of the same property in order to satisfy the qualified use requirement. In Bolker v. Commissioner, 181 TC 782 (1983), aff’d 760 F.2d 1039 (CA9 1985), the taxpayer entered into an exchange agreement the same day he received the relinquished property in a liquidating distribution from his wholly-owned corporation in a tax free liquidation governed by former Section 333. The exchange closed three months later. The Court held that if a taxpayer does not intend to liquidate the relinquished property or use it for personal pursuits, then the taxpayer satisfies the qualified use requirement. Thus, the most appropriate interpretation of the qualified use requirement is an interpretation that facilitates like kind exchanges that do not represent an effort to "cash in" the taxpayer’s investment.

In Maloney v. Commissioner, 93 TC 89 (1989), ³ a corporation exchanged real property and, at the time of the exchange, intended to liquidate and distribute the replacement property to its shareholders. One month following the exchange, the corporation did liquidate (tax free under former Section 333), distributing the replacement property to the shareholders. The Court found that the exchange satisfied the qualified use requirement because there was continuity of investment even though there was a change in the form of ownership. The taxpayers had not "cashed in" their investment and continued to have an economic interest in the same investment. The Court concluded that a Section 1031 exchange may be preceded or followed by a tax free transfer under Section 721.

The IRS did not appeal or issue a nonacquiescence with respect to the Maloney case, which may suggest that the IRS may not be prepared to litigate this issue, notwithstanding the earlier holdings in Rev. Rul. 75-292, Rev. Rul. 77-337, and Rev. Rul. 84-121.

In Magneson v. Commissioner, 753 F.2d 1490 (9th Cir. 1985) aff’d 81 TC 767 (1983), the taxpayer exchanged a fee interest in real property for an undivided interest in another property in a Section 1031 exchange. Immediately thereafter, the taxpayer contributed the replacement property to a partnership in a transaction governed by Section 721. The contribution of the replacement property to the partnership was treated as a continuation of the taxpayer’s investment in another form and not a liquidation of the taxpayer’s investment, and the Section 1031 exchange was respected by the courts.

There is no compelling policy reason why Section 1031 should be administered in a manner that imports a vague or indefinite temporal holding period requirement into Section 1031(a)(1). The statute does not literally impose a durational requirement.

The absence of taxpayer intent to liquidate an investment in the subject property or convert the subject property to a personal use should be recognized as the appropriate standard for satisfying the "qualified use" test of Section 1031. Such a standard is most consistent with the judicial precedents. ⁴

Contents | Introduction | I | II | III | IV | V