Tax Update Blog: Permalink

« Previous · Tax Update Blog Home · Next »

Ninth Circuit agrees with Tax Court: Hawaii like kind exchange blows up

September 09, 2009

The tax law gives you 180 days to close a like-kind exchange through a qualified intermediary. The intermediary holds the cash from the sale of a property while you work out a deal on buying some replacement property. You have 45 days to identify candidate properties. If all goes well, the tax law pretends there was no cash involved and you are treated as swapping the sold property for the replacement property.

It's not always easy to work out that deal on the replacement property. As the deadlines loom, it can be very tempting to buy that replacement property from a related party. There be dragons.

Hawaii real estate company Teruya Brothers sold Royal Towers Apartments and Ocean Vista Condominiums. They had the intermediary buy replacement property from Times Super Market, a grocery chain. They a Section 1031 like-kind exchange to defer over $12 million in gain. As they owned 62.5% of Times, the deal probably went smoothly. Except for the tax part.

The Ninth Circuit Court of Appeals yesterday upheld the Tax Court, ruling that the deal failed. They said that when the intermediary bought replacement property from a related party to finish the swap, the tax law recasts the deal as:

1. An exchange between the Teruya Brothers and Times Super Market, followed by

2. A sale to the third party by Times Super Market.

The tax law says that a like-kind exchange with a related party retroactively fails if the related party sells the property to an outside party within two years. As recast, the related party is considered to immediately sell the exchanged property, and the swap fails out of the gate.

royal towers.jpg
Royal Towers Apartments, Salt Lake, HI