Quick resale hinders tax-deferred real estate exchange
Investor transfers title to related party, faces IRS' wrath

Wednesday, May 25, 2021

By Robert J. Bruss
Inman News

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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