Comments on proposed regulations under section 1031 of the Internal Revenue Code.
On April 25, 1990, the Internal Revenue Service issued proposed regulations under section 1031 of the Internal Revenue Code, concerning additional rules for exchanges of personalty and multiple properties. The proposed regulations were published in the Federal Register on April 26, 1990 (55 Fed. Reg. 17635) and in the May 31, 1990, issue of the Internal Revenue Bulletin (1990-21 I.R.B. 9).
For simplicity's sake, the proposed regulations are referred to as the "proposed regulations" and specific provisions are cited as "Prop. Reg. [Section]." References to page numbers are to the proposed regulations (and preamble) as published in the Internal Revenue Bulletin.
Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 4,500 members represent more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works - one that is administrable and with which taxpayers can comply.
Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that our diversity and the professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed regulations relating to like-kind exchanges.
1. Prop. Reg. [Section] 1.1031(a)-2(b)(1):
Exchanges of Personal
Prop. Reg. [Section] 1.1031(a)-2(b) provides rules for exchanges of depreciable tangible personal property held for productive use in a trade or business. For this purpose, two items of depreciable tangible personal property are of like kind or like class if both are either (i) within one of the 13 General Business Assets Classes (GBACs) set forth in Prop. Reg. [Section] 1.1031(a)-2(b)(2) or, (ii) in the case of property not within a GBAC, within the same Product Class (PC) under Prop. Reg. [Section] 1.1031(a)-2(b)(3).
The definition of a GBAC under Prop. Reg. [Section] 1.1031(a)-2(b)(2) is based on asset classes 00.11 through 00.28 and 00.4 of Rev. Proc. 87-56, 1987-2 C.B. 674 (as modified), and is relatively broad in nature. For example, there are wide varieties of office furniture, fixtures, and equipment (asset class 00.11) that would be considered within a like class for purposes of Prop. Reg. [Section] 1.1031(a)-2(b)(i).
By contrast, subparagraph (3) of the regulation narrowly defines a Product Class as the five-digit Standard Industrial Classification (SIC) code published by the Bureau of the Census. The use of the five-digit SIC code is so restrictive that, for example, woven carpets (SIC Code No. 22731) are not "like" tufted carpets (SIC Code No. 22732). This classification for PCs simply does not make sense, especially in light of the broad GBAC categories. Thus, there is a fundamental inconsistency in the application of the like-kind requirements for different types of tangible personal property.
This problem is compounded by the rules pertaining to miscellaneous property not listed in a PC. Prop. Reg. [Section] 1.1031(a)-2(b)(4) provides a facts-and-circumstances test for determining whether such properties are within a like class. The regulations fail, however, to provide any examples of property falling within this classification. Such an omission will surely breed additional confusion and uncertainty and ultimately lead to audit disputes.
TEI recommends that the IRS incorporate all categories of Rev. Proc. 87-56 by reference into the proposed regulations, thereby allowing a much wider spectrum of property to be considered as within a like class. Reliance on the revenue procedure would facilitate better tax administration by ensuring that future modifications remain within the purview of the IRS, rather than the Bureau of the Census (which may revise a SIC code for reasons other than tax policy). The use of a revenue procedure would also permit the IRS to make those modifications in a more expeditious manner.
An alternate, albeit less desirable, solution would be to base the categorization of personal property exchange groups on the four-digit SIC codes established on an industry-by-industry basis. Using these codes would expand the unduly narrow PCs in the proposed regulations.
The proposed regulations also state that "to the extent possible" any subsequent modifications to Rev. Proc. 87-56 and the SIC codes will apply to GBACs and PCs. The IRS should clarify, however, that prior GBACs and PCs will remain effective until the IRS conforms them to the modifications, or that such categories will be deemed to automatically conform.
2. Prop. Reg. [Section] 1.1031(a)-2(c)(1):
Intangible and Nondepreciable
Personal Property and
Personal Property Held for
Prop. Reg. [Section] 1.1031(a)-2(c)(1) provides that an exchange of intangible or nondepreciable personal property or personal property held for investment does not qualify for nonrecognition treatment under section 1031 unless the exchanged properties are like kind.(1) Whether intangible personal properties are of a like kind depends not only on the right involved (e.g., a patent or copyright), but also on the type of underlying property to which the intangibles relate.
This provision fails to address how two patents or trademarks can be of like kind, whether the appropriate standard for making this determination is similarity between the products to which the patents or trademarks relate, and, if so, how similar the products must be. The regulations should be clarified to take into account these issues. For example, the regulations could provide that two intangibles are of like kind if they are used within the same line of business or if the products to which they relate are within the same four-digit SIC Code.
3. Prop. Reg. [Section] 1.1031(a)-2(c)(2):
Goodwill and Going-Concern
Prop. Reg. [section] 1.1031(a)-2(c)(2) provides that goodwill and going-concern value of dissimilar businesses are not of a like kind and, further, that goodwill and going-concern value of similar businesses are of like kind only in rare and unusual circumstances. The provision effectively prohibits the tax-free exchange of such property.
TEI submits that there is no statutory basis for denying like-kind treatment for goodwill or going-concern value. Section 1031 specifically excludes from nonrecognition treatment exchanges of certain items (such as stocks, bond, or notes); the statute does not, however, provide such a restriction with respect to goodwill or going-concern value. Moreover, we are aware of no case law or regulatory precedent for the "rare and unusual" circumstances test set forth in the proposed regulations. (The preamble cites no authority for the test.) There is no sound policy reason for excluding goodwill exchanges from nonrecognition treatment. If uniqueness of an asset is the basis for the exclusion, such a characteristic has never been a factor in obtaining the benefit of section 1031. Certainly, real property is always considered unique, but exchanges of realty qualify frequently for like-kind treatment. Nor does uniqueness disqualify exchanges of personal property: a one-of-a-kind antique desk and a mass-produced modern desk are considered like-kind property under Prop. Reg. [Section] 1.1031(a)-2(b)(2)(i).
Even in the intangible property area, the proposed regulations place a greater limitation on goodwill than on other intangibles. Example (1) of Prop. Reg. [section] 1.1031(a)-2(c)(3) treats copyrights on two novels as like-kind property. In contrast, Example (3) treats the goodwill of two laundry businesses as not of a like kind. The goodwill elements of the two laundry businesses, however, may be more alike than the copyrights.
For the foregoing reasons, TEI submits that the regulations should be modified to permit exchanges of similar businesses with goodwill or going-concern value to qualify for like-kind treatment.
4. Prop. Reg. [Section] 1.1031(b)-1(c):
Assumption of Liabilities
Section 1.1031(b)-1(c) of the existing regulations provides that consideration received in the form of an assumption of liabilities (or a transfer subject to a liability) is to be treated as "money or other property" for purposes of section 1031(b). In determining the amount of "money or other property" received in the exchange, consideration given in the form of an assumption of liabilities may be offset against consideration received in the form of an assumption of liabilities. The proposed regulations purport to "clarify" the existing regulations by providing that the liabilities cannot be netted if they are incurred by the taxpayer "in anticipation of" an exchange under section 1031. See 1990-21 I.R.B. at 10.
TEI submits that the proposed regulations represent not a clarification of existing law, but rather an unwarranted narrowing of that law. There is no current case law or other authority providing that liabilities incurred by a taxpayer in anticipation of an exchange under section 1031 are taxable. Indeed, what little authority exists tends to support the opposite conclusion. See Garcia v. Commissioner, 80 T.C. 491 (1983), acq. 1984-2 C.B. 1 (taxpayers were permitted to net all mortgage amounts in involved in computing the boot they received). In these circumstances, the proposed rule can hardly be called a "clarification" of anything other than the IRS's litigating position.(2)
Moreover, we believe that the proposed regulation will increase administrative burdens for both the taxpayer and IRS. The term "in anticipation of an exchange" is vague and undefined and can only lead to audit disputes and, ultimately, litigation. In these circumstances, the amendatory language should be deleted from the final regulations. Alternatively, an objective safe harbor could be provided whereby liabilities would be deemed not to have been incurred "in anticipation of an exchange" if they were assumed more than 30 days prior to the exchange.
5. Prop. Reg. [Section] 1.1031(f)-1:
Multiple Exchanges of
In general, section 1031 requires a property-by-property comparison for computing the gain recognized and basis of property received in a like-kind exchange. The proposed regulations provide an exception in the case of an exchange of multiple properties. Under Prop. Reg. [Section] 1.1031(f)-1, properties transferred and properties received are separated into like-kind exchange groups (i.e., assets that qualify for section 1031 treatment and are of like kind with each other). Money and property not qualifying for recognition are placed in a residual group. Prop. Reg. [Section] 1.1031(f)-1(d), Example (2)(ii).
If the taxpayer has received greater value within an exchange group than it transferred, an "exchange group surplus" exits. On the other hand, if the taxpayer has transferred greater value than it received, an "exchange group deficiency" exists. The recognized gain(3) within any group is the lesser of (i) the gain realized within the group or (ii) an exchange group deficiency within that group. Thus, to the extent the taxpayer receives less value within a group than it transferred, it is deemed to have received "boot" under section 1031.
The proposed regulations essentially require taxpayers to separately value each and every asset transferred or received in an exchange - an expensive and administratively burdensome task even when the assets not within an exchange group may constitute a small portion of the entire exchange. To minimize these compliance burdens, TEI recommends the adoption of a safe harbor under which an exchange of businesses within the same four-digit Industry Number of the Standard Industrial Classification System would not be subject to the multiple-asset exchange rules.
In addition, we recommend the adoption of a de minimis rule for exchanges in which a small percentage (say, 5 to 10 percent) of the basis of the assets transferred or the fair market value of the assets received is not within the same exchange group. Such a rule would significantly simplify the multiple-asset exchange provisions.
Tax Executives Institute appreciates this opportunity to present our views on the proposed regulations relating to like-kind exchanges. If you have any questions, please do not hesitate to call Lester D. Ezrati, chair of TEI's Federal Tax Committee, at (415) 857-2089 or the Institute's professional staff (Timothy J. McCormally or Mary L. Fahey) at (202) 638-5601.
(1) The proposed regulations do not provide for like classes for such property.
(2) In essence, the IRS seeks to adopt a rule similar to that provided under section 357(b) of the Code relating to property encumbered before a section 351 nonrecognition transaction. Section 1031, however, contains no similar statutory authorization.
(3) Consistent with section 1031(c), losses with respect to an exchange group are not recognized.
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|Date:||Sep 1, 1990|
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