IRS allows nonrecognition treatment for series of like-kind exchanges involving related parties

When a taxpayer directly or indirectly exchanges property with a related party, the property received by each party must be held for at least two years after the exchange in order to qualify for nonrecognition treatment. The purpose of this two-year holding period is to discourage "cashing out" by related parties through the like-kind exchange of high-basis property for low-basis property in anticipation of the sale of the low-basis property to reduce or avoid the recognition of gain (or accelerate a loss) on the subsequent sale. This two-year holding period serves as a safe harbor for like-kind exchanges between related parties provided the other requirements for a like-kind exchange have been met. However, the IRS may still deny nonrecognition treatment if it determines that the "principal purpose" of an exchange between related parties is the avoidance of Federal income tax. The IRS can also deny nonrecognition treatment if it determines that an exchange is part of a transaction (or series of transactions) that is structured to avoid the purpose of the special rules established for exchanges between related parties. For purposes of these rules, a related person includes any person bearing a relationship to the taxpayer as described in Code Sec. 267(b) or Code Sec. 707(b)(1) - for example, this would include a partnership and a person owing, directly or indirectly, more than 50 percent of the capital interest, or the profits interest, in the partnership, or two partnerships in which the same persons own, directly or indirectly, more than 50 percent of the capital interests or profits interest. In Ltr. Rul. 201216007, the taxpayer engaged in a complex series of like-kind exchanges which included the acquisition of replacement property from related parties through a qualified intermediary. In one of the exchanges, the replacement property acquired by the taxpayer was also the relinquished property of a related party (OP) that was part of a subsequent like-kind exchange between the related party (OP) and one of its affiliates (Affiliate). After this series of exchanges, the taxpayer and its related parties (OP and Affiliate) held their replacement properties for at least two years after the date of the last property transfer. In addition, all of the other technical requirements for nonrecognition treatment were satisfied with respect to each of the like-kind transactions involved in this series of exchanges. Based on these facts, the IRS concluded that the series of exchanges involving the taxpayer and related parties qualified for nonrecognition treatment because (1) each related party transferring replacement property into the series of exchanges also engaged in its own like-kind exchange and (2) the taxpayer and the related parties held their replacement properties for at least two years after the date of the last transfer of property in the series of exchanges. Thus, there was no "cashing out" by any of the related parties within two years of the last transfer, as none of the related parties received more than a minimal amount of non-like-kind property in their transactions. As shown above, like-kind exchange transactions that involve related parties require careful planning. Ltr. Rul. 201216007 indicates that nonrecognition treatment can be obtained upon completion of a series of exchanges involving related parties provided the related parties have not "cashed out" of their investments and the transactions otherwise qualify as like-kind exchanges. Sandy Klein, CPA, is a partner at Shanholt Glassman Klein Kramer & Co., New York, N.Y.