PLR 200901004 - Non Safe Harbor, Reverse Construction Exchange on Property Owned by Taxpayer
The Internal Revenue Service issued PLR 200901004 on September 29, 2008 and published it on January 2, 2009. This ruling implicitly approves a non safe harbor, reverse construction exchange with improvements constructed on the Taxpayer's existing property.
Taxpayer is in the business of transporting processed minerals. A foreign corporation, through its domestic subsidiary (Domestic-Sub), engages in the same business. Taxpayer is not related to the foreign corporation or to Domestic Sub for purposes of IRC S 267 or 707 (the provisions which define a related party for Section 1031), even though the foreign corporation owns a substantial interest in Taxpayer. Foreign corporations are generally not members of a "controlled group" for the purposes of Section 267(b). Domestic-Sub has a wholly owned subsidiary ("LT") that engages in construction. LT is a disregarded entity for federal tax purposes.
Taxpayer proposes to exchange "Old Facility," which will be sold to an unrelated third party, for "New Facility," which will be constructed for Taxpayer by LT. Taxpayer owns some of the right-of-way easements that are necessary for the construction of New Facility and will purchase the other right-of-way easements that it needs with non-exchange funds. Taxpayer will retain ownership of all of these easements, but will assign to LT for cash, at fair market value, the non-exclusive right to use those easements. This portion of the transaction will not be part of the like-kind exchange. Pursuant to the easement assignments, LT will have the right to construct, own and operate New Facility on the assigned easements (and any other facilities subsequently acquired by LT to the extent lying within the assigned easements) and will be fully liable for its share of property taxes imposed on the assigned easements and any damages caused by its activities on the assigned easements.
LT will acquire the construction funds for New Facility through a combination of equity contributions received from the foreign parent and nonrecourse loans received from a syndicate of third party lenders. This financing will be secured by New Facility, and the lenders would have the right to foreclose on New Facility, including LT's rights under the assigned easements, in the event LT defaults on the financing. Taxpayer has no debt obligations to the lenders, to Domestic-Sub or to LT. These liabilities will not be later assumed by Taxpayer in connection with the exchange.
The ruling only covers the exchange of the real property improvements, and tangible and intangible personal property that comprise the Old Facility and the New Facility will be exchanged. It does not cover any land interest (i.e., fee simple interests, leaseholds, easements, right-of-ways, etc.).
The Service had no objection with this exchange in principle. Although the PLR does not describe the precise nature of the tangible and intangible property, the IRS specifically noted that, while the tangible and intangible property do not share any like-class, nevertheless, they satisfy the requirements of Reg. 1.1031(a)-2(c)(1) by being "essentially the same type of properties." However, the Service pointed out that the proposed transaction will be a multiple property exchange, governed by Reg. 1.1031(j)-1. Therefore, each of the relinquished properties will have to be matched to like-kind replacement property. If the value of the relinquished properties in any group exceeds the value of the replacement properties in the matching group, then there will be boot to the extent of that difference.
Unfortunately, the ruling does not address the interesting issues raised by this fact pattern. The exchange is essentially a non safe harbor, reverse construction exchange on property owned by the Taxpayer (the Taxpayer's easements), but the ruling does not mention, or even hint at, the Decleene case (115 TC 457 (2000)) or other authorities on these types of exchanges. Note that: (1) the parent corporation of the accommodator also substantially owns the Taxpayer, but the accommodator is technically not a related party to the Taxpayer because the parent is a foreign corporation; (2) the accommodator has no equity in the project other than funds from its parent (who substantially owns the Taxpayer); (3) the third-party construction loans are non recourse loans secured by the New Facility and are not guaranteed by the Taxpayer or secured by the Taxpayer's interest in the easements; and (4) the accommodator is responsible for its share of property taxes on the assigned easements and any damages caused by its activities. Unlike the DeCleene case, the ruling does not examine whether the accommodator has burdens and benefits of ownership, whether it is acting as the Taxpayer's agent in constructing the New Facility, or whether the exchange is step transaction resulting in taxpayer acquiring improvements on its own property. The ruling implies that an exchange can be structured in this fashion using an accommodator in which the taxpayer has a substantial ownership interest, or otherwise exercises control over. For example, the accommodator could be an LLC in which the taxpayer owns 50% and controls the management.
*Information source FEA
