Deferred like-kind exchanges of a target corporation.

As a general rule, Sec. 1031 requires that the relinquished property and the replacement property in a like-kind exchange be "held for productive use in a trade or business or for investment." In a letter ruling dated Sept. 13, 1991, the IRS has concluded that holding a property for productive use in a trade or business or for investment is a tax attribute within the meaning of Sec. 381(c).

A C corporation held four parcels of noninvestment quality real estate. The corporation wanted to merge with a real estate investment trust (REIT) in a Sec. 368(a)(1)(C) reorganization. The taxpayer decided to exchange the four parcels, merge with the REIT, and allow the REIT to identify the replacement property. If the REIT were unable to qualify as a successor to the C corporation, the C corporation would not have been able to satisfy the requirements of Sec. 1031, since it would have ceased to exist and therefore could not have acquired the replacement property to complete the exchange.

Regs. Sec. 1.381(a)-1(b)(3)(i) states that only the items and tax attributes specified in Sec. 381 carry over in a C reorganization; Sec. 1031 is not one of the items or tax attributes enumerated in Sec. 381(c). However, in the letter ruling, the IRS stated that "Congress did not intend the tax-attributes listed in [sections of] 381(c) to be the exclusive list of tax attributes available for carryover. Moreover, the legislative history reveals that the purpose of [sections of] 381 is to put into practice the policy that economic realities rather than...'such artificialties as the legal form of the reorganization' ought to control in the question whether a tax attribute from an acquired corporation is to be carried over to the acquiring one."

Broadening the scope of Sec. 381(1) may allow corporations more flexibility in engaging in like-kind exchanges. Sec. 1031 treatment should be available if a corporation that relinquished property were to merge into another corporation in a Sec. 381 transaction, and the transferee acquired the replacement property to complete the exchange.

In the context of a consolidated group, the Service strictly interprets the "held for" test, by requiring that, both before and after the exchange, the same taxpayer (member) must satisfy the "held for" test. Accordingly, the Service will disallow a like-kind exchange in which an asset is relinquished by one subsidiary (S1) and the replacement property is acquired by a different subsidiary (S2). Thus, the holding in the letter ruling would not be extended to permit Sec. 1031 treatment if S1 relinquished property and, subsequent to an acquisition of replacement property by S2, S1 were merged into S2. The ruling did not address whether the target C corporation's accumulated earnings and profits would be inherited by the REIT, in violation of Sec. 857(a)(3)(B).

From Edward T. Hanley, CPA, Washington, D.C.