Printer Friendly

Defining an involuntary conversion.

The tax law provides relief for taxpayers that reinvest money obtained from an involuntary conversion. Because the nature of involuntary conversions varies in different industries, taxpayers constantly confront new situations. The Tax Court recently considered the question of an involuntary conversion in the timber industry.

Willamette Industries is a forest products company that owns timberland it converts to lumber, paper and the like. From 1992 to 1995, ice, windstorms, wildfires and insect infestations damaged the trees Willamette was growing for future harvesting. To avoid further losses, it harvested and processed the damaged trees as if they were fully mature. On its corporate tax returns, the company treated the difference between its basis in the trees and their value at the time of the harvest as an involuntary conversion eligible for deferment under IRC section 1033.

The government denied Willamette Industries deferral treatment on the grounds section 1033 applied only to gains that stemmed directly from a casualty. The company responded it was compelled to harvest the trees early and therefore was entitled to involuntary conversion treatment.

Result. For the taxpayer. The legislative history of section 1033 indicates the rule was designed for taxpayers that reinvested the proceeds from an involuntary conversion in qualified business property. There is little dispute if the property is completely destroyed. However, numerous questions arise when property is only partially destroyed. A review of the early case law involving partial destruction points out two requirements for claiming an involuntary conversion:

* The property must be damaged.

* The damage is such that the property is no longer suitable for its intended purpose.

The government originally had ruled that the involuntary conversion of timber required the trees to be directly converted into cash. In revenue ruling 80-175, however, it changed its position and allowed the sale of damaged timber to qualify for section 1033 treatment.

The Tax Court concluded the government's position in the current case was an attempt to reestablish a direct conversion requirement before permitting an involuntary conversion. The court rejected this effort. To qualify, a taxpayer must show that unexpected damage occurred that prevented it from using the asset as originally intended. The fact that Willamette chose to process the damaged timber rather than sell it doesn't change the fact that the timber was damaged--forcing the company to use the trees before the normal time. Therefore a valid involuntary conversion had taken place.

The court raised an interesting question in a footnote. Section 1033 requires taxpayers to reinvest the proceeds in qualified replacement property. Given that Willamette processed the trees rather than sold them, how would it demonstrate compliance with the reinvestment requirement? Since the IRS did not raise the question, the court did not address the issue.

Although this case involved timber, it applies to all taxpayers that suffer partial damage to their property that prevents them from using it as originally intended. The method of converting the damaged property to cash no longer should prevent a taxpayer from receiving the benefits of involuntary conversion treatment. It will not have to show it converted the property directly to cash to qualify for tax deferral. However, the taxpayer must be able to prove it reinvested the proceeds in qualified replacement property if the IRS raises the question.

* Willamette Industries Inc. v. Commissioner, 118 TC no. 7.

Prepared by Edward J. Schnee, CPA, PhD, Joe Lane Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.
COPYRIGHT 2002 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2002, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
Printer friendly Cite/link Email Feedback
Author:Schnee, Edward J.
Publication:Journal of Accountancy
Geographic Code:1USA
Date:Jul 1, 2002
Previous Article:Education expense deduction: "unemployed" taxpayer may be "employed".
Next Article:The industry issue resolution program: settling disputes through other than IRS examination.

Related Articles
Minimizing gain from involuntary conversions.
IRS follows AICPA position in guidance on proceeds received for homes and contents destroyed by disasters.
Twisters, gains and involuntary conversions.
Do environmental regulations constitute an involuntary conversion?
Tax Court disallows deduction for decrease in property value due to rezoning.
"Threat" of involuntary conversion defined for sec. 1033 Purposes.
Accountant details condemnation rules. (Insiders Outlook).
Tax Court expands Sec. 1033's scope.
Calculating depreciation on a like-kind exchange or an involuntary conversion: temporary regulations have modified the rules for computing...
Depreciating MACRS property in tax-free exchanges.

Terms of use | Privacy policy | Copyright © 2020 Farlex, Inc. | Feedback | For webmasters