Teruya Brothers Ltd. owned the fee-simple land under a
condominium complex whose owners wished to purchased the land and cancel its
long-term lease. Teruya also owned the Royal Towers Apartments, which a
developer wished to acquire.
Wishing to avoid capital gains tax on its potential
profitable sales of these properties, Teruya transferred title to its two
properties via a tax-deferred exchange intermediary to Times Super Market Ltd.
in which Teruya owns 62.5 percent of the stock.
Purchase Bob Bruss reports online.
Times Super Market then sold the properties at a profit to
the condo owners and the realty developer. Teruya reported the transactions as
Internal Revenue Code 1031(a)(3) tax-deferred Starker delayed exchanges.
But Teruya was audited by the IRS. Because Times Super
Market resold the two properties immediately, the IRS auditor said IRC 1031(f)
requires taxing Teruya on the resale profits because the properties were sold
within 24 months after acquisition by a related party. Teruya took its tax
dispute to the U.S. Tax Court.
If you were the U.S. tax court judge would you rule Teruya
owes tax on the profitable resales by Times Super Market because this is a
related party sale?
The judge said yes!
Internal Revenue Code 1031(f) is very clear, the Tax Court
judge began, that when a related party acquires property in a tax-deferred
exchange, if that party resells the property within 24 months at a profit, that
profit is taxed back to the original investor.
In this case, the judge continued, Teruya Brothers owned two
parcels they exchanged with Times Super Market, a corporation in which Teruya
owned 62.5 percent of the common stock. Immediately after the exchange, Times
resold the two properties at substantial profits to unrelated third parties,
the judge explained.
Because Teruya made tax-deferred exchanges to Times Super
Market in which Teruya controls 62.5 percent of the common stock, this was an
IRC 1031(f) "related party" exchange where the resale profit is taxed
back to original property owner Teruya Brothers, the judge ruled.
Based on the 2005 U.S. Tax Court decision in Teruya
Brothers Ltd. v. Commissioner, 124 T.C. 4.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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