The taxpayer, a calendar-year corporation, wants to change its company's headquarters currently consisting of a ten-story building.

The taxpayer, a calendar-year corporation, wants to change its company's headquarters currently consisting of a ten-story building. The company owns the building outright. The taxpayer has identified some potentially more suitable properties. One of the possible properties is a single-story building on a large, attractive lot. The other property consists of a two-building complex, with retail shops on the ground floor of one building and residential rental property in a portion of the other building.

After further discussions with the client and a review of relevant documents, you discover the following additional facts: Each of the new properties has a fair market value that slightly exceeds that of the current ten-story building. The taxpayer would demolish the single-story building if the company purchases that property. It would then build a specially designed building on the lot. The sellers of both properties appear to be interested in entering an exchange transaction whereby the company's property would be exchanged for one of the other properties.

After many discussions with the taxpayer, the company decided to exchange its existing property for the retail and residential building complex. You assisted the company in structuring the exchange. Both parties used a middleman corporation, to whom the properties were to be initially conveyed. The agreement with the middleman included the requirement that the taxpayer sell its property to the middleman and then, within 45 days of the initial closing, formally identify which of the two new properties it intended to acquire. The identified property was also to be sold to the middleman corporation. The corporation would then transfer title to the taxpayer within 180 days after the date of the initial closing.

Unfortunately, the transaction has not proceeded as planned. The taxpayer transferred its property to the middleman, receiving its fair market value of $10,000,000 in cash. The company formally identified the property with the retail and residential building complex as the property it intended to acquire. Unfortunately, one week before the 180 days was up, the seller of the property backed out of the arrangement. The taxpayer is certain it will not be able to identify and cause the transfer of other suitable property within the time limit.

The taxpayer's basis in the ten-story building is only $2,000,000. The company is concerned that it will now have to report the $8,000,000 in gain.

a. What relevant primary authority did you locate?

b. Does the authority adequately address the research question(s)? If so, what are your conclusions and reasoning upon which they are based?

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c. Were there additional questions that required research beyond a reference service?

d. What resources did you use in your research?

e. How much time did you spend on this portion of your research?

SOLUTION

a-c In addition to the Code and Regulation cites listed above, they should have located a case directly on point to the facts before them. The Tax Court, in Knight v. Commissioner, 75 TCM 1992 (1998), held that the Code is clear in its requirement that the transfer of the replacement property must occur within 180 days after the initial transfer. In Knight, the sellers of the identified replacement property backed out of the arrangement. The court stated that even though such an action was beyond the taxpayer’s control, and even though the taxpayer’s made a “good faith attempt to adhere to the statute,” the Code and Regulations state that if the timing requirements are not met, the provisions of IRC §1031 are not available. The taxpayers in Knight argued that the court should take a more “citizen-friendly” approach. However, the court stated that that is not the role of the Tax Court stating, “The Internal Revenue Code, not general equitable principles, is the mainspring of this Court’s jurisdiction.” The case is also interesting for its comments about the authority of IRS publications: “It is well settled that authoritative tax law is contained in statutes, regulations and judicial decisions and not in informal publications. IRS publications...are merely guides published by the IRS to aid taxpayers.” As of February, 2008, the Knight case remains authoritative.

Therefore, they should conclude that in this situation, the taxpayer will be required to recognize the $8,000,000 of gain on the sale of the property. They will also want to research the character of the gain – capital in this case. Had the researcher properly advised the taxpayer about the identification rules, a second or third property should also have been identified within the required 45 days. Then there might have been some possibility, even at this late date, to effect a transfer of the alternate property within the 180-day deadline. However, the facts do not indicate that any such property was identified - an apparent flaw in the planning. Therefore, the taxpayer appears to be out of luck.

d-e This is a good opportunity to analyze with the class the reference services they used - what they liked and did not like, challenges and how they might be overcome. They who did not discover the Knight case will want to hear from others who may have been assigned this question how others discovered this case. Requesting them to record the time they spent allows you to report back to them with the range of time required. They can then learn whether they are within the normal range or outside.