Is this a taxable event?

[Unregistered]

If partnership owns 60% of real property and trust owns the other 40% as tenants in common, and the two entities (through the general partner and trustee) decide to draw actual, physical lines in the sand, and convert the ownership to two fee simples, would this be a taxable event? I know this sounds weird, so let me rephrase, hopefully with more clarity:

is there a taxable event upon Tenant A and Tenant B carving up their tenancy in common into separate fee simples? The appraiser would carve out the property lines in accordance with their current interests - so Tenant A would get 60% value and tenant B would get 40% value.

Thank you for any help, comments, ideas, whatever.

[Roland Slugg]

Tax-free exchange

What you described is a tax-free exchange. If one party received boot, either in cash or via net debt relief, the receiving party would be taxed on that, up to the amount of its gain.

If the parties are related (see Code §267), and one of them sells its land in the year of the exchange or in either of the next two years, the non-selling owner could be deemed to have sold a portion of its original share of the parcel.

[Unregistered]

would the exchange of a tenancy in common interest for a fee simple interest qualify as a 1031 exchange though? Is that "like-kind"?

[rosieea]

What exchange?

What you described is a tax-free exchange. If one party received boot, either in cash or via net debt relief, the receiving party would be taxed on that, up to the amount of its gain.

If the parties are related (see Code §267), and one of them sells its land in the year of the exchange or in either of the next two years, the non-selling owner could be deemed to have sold a portion of its original share of the parcel.

The post indicates that there is to be merely a re-titleing of the property in such a way that the owners end up with the same percent of the property as before. Nothing is being exchanged & no money is changing hands. I don't see any tax consequences - or, am I missing something?

[Unregistered]

I think the key is to see if there is more than one parcel involved. If the tenants in common have one parcel, or one tract of land, then it may very well be just a partition and not a taxable event as per PLR 9320037. If more than one parcel is involved, there could very well be an exchange as per Rev. Rul. 79-44.

The rationale is unclear, at best. Youre not missing anything, youre just trying to make sense out of the IRS's approach, which doesn't seem to make much sense.

[jainen]

don't tell the tax preparer

>>merely a re-titleing of the property in such a way that the owners end up with the same percent of the property as before<<

If you remember the text book definition of property ownership as a "bundle of rights," you can see that these parties do not end up with the same property they started with. They have exchanged property interests, and if the real estate was held for investment or business then Section 1031 would be mandatory.

If the transaction or its follow-up also involves a rewriting of the partnership agreement, Section 1031 will fail and it will be treated as a sale and repurchase. This goes a little further than the related party rules because partnership interests aren't ever eligible for 1031 treatment. I only mention it because this kind of deal often has a few extra goodies thrown in that they don't tell the tax preparer.

[Unregistered]

"If you remember the text book definition of property ownership as a "bundle of rights," you can see that these parties do not end up with the same property they started with. They have exchanged property interests, and if the real estate was held for investment or business then Section 1031 would be mandatory."

This is why the IRS's logic is somewhat distorted. Under PLR 9320037, there is no taxable event upon partition. Throw in another parcel for the same tenants in common, and all of the suddent you have a taxable transaction which 1031 governs if the requirements are met.

In EITHER case, a strong argument can be made that you have something different in the end compared to what you had in the beginning. Even in a mere partition where no taxable event occurs, you had a tenancy in common, and after the partition, you have a fee simple. Those are different economic interests and entail different rights.

[jainen]

off the hook

>>PLR 9320037.... Rev. Rul. 79-44<<

This will probably surprise you, but this morning I am more in the mood to just argue than to actually do any legitimate research.

I suppose it's a cheap shot to point out that a Private Letter Ruling is of no more value as precedent than my own august sayings (august meaning honorable or at least venerable, not three months late). In this case I can further point out that a PLR from more than ten years ago has indeed very little weight left, especially in light of all the attention IRS has given to 1031 since then.

Tell the clients they need a new PLR. That will get us all off the hook.

[Unregistered]

Actually that holding was stated in a Revenue Ruling, Rev. Rul. 56-437, which was distinguished on different facts but affirmed in PLR 7831035 and continues to be good law to this day:

"It is a well established precept of tax law that an equal division of jointly-owned property does not rise to the level of a taxable transaction under section 1001 of the Code. See, for example, Walz v. Commissioner, 32 B.T.A. 718 (1935); Rev. Rul. 56--437, 1956--2 C.B. 507. "

But this isn't the point - the point is that the logic is still questionable at best since the parties wind up with something of different economic value after the transaction. Whereas on the one hand, more than one parcel seemingly results in a taxable transaction, and on the other, a single parcel results in no taxable transaction. I'm not sure how I can state this more clearly. I know of a law review article you can read that probably does a better job explaining this murkiness.