Estate of Bartell v. Comm'r
Opinion
Decisions will be entered for petitioners.
In 1999, BD, a drugstore chain, entered into an agreement to purchase property L from a third party. In anticipation of structuring an exchange transaction under
In late 2001, BD contracted to sell its existing property E to a fourth party. BD next entered an exchange agreement with intermediary SS and assigned to SS its rights under the sale agreement and under the earlier agreement with EPC. SS sold E, applied the proceeds of that sale to the acquisition of L, and had the title to L transferred to BD on December 31, 2001.
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Decisions will be entered for petitioners.
In 1999, BD, a drugstore chain, entered into an agreement to purchase property L from a third party. In anticipation of structuring an exchange transaction under
In late 2001, BD contracted to sell its existing property E to a fourth party. BD next entered an exchange agreement with intermediary SS and assigned to SS its rights under the sale agreement and under the earlier agreement with EPC. SS sold E, applied the proceeds of that sale to the acquisition of L, and had the title to L transferred to BD on December 31, 2001.
*141GALE,
| Estate of George H. Bartell, Jr., etc. | 2001 | $231,001 |
| George D. and June M. Bartell | 2001 | 167,898 |
| 2002 | 14,216 | |
| David H. and Jean B. Barber | 2001 | 49,604 |
| 2002 | 19,707 | |
| 2003 | 5,091 |
These cases have been consolidated for purposes of trial, briefing, and opinion. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended and in effect for the years at issue, and all Rule references *142 are to the Tax Court Rules of Practice and Procedure.
The principal issue for decision is whether a property transaction undertaken by the Bartell Drug Co. (Bartell Drug), an S corporation owned by petitioners, qualified for nonrecognition treatment pursuant to
Some of the facts have been stipulated and are so found. The stipulations, with accompanying*22 exhibits, are incorporated herein by this reference. At the time the petitions were filed, all petitioners were residents of Washington State.
Bartell Drug owned and operated a chain of retail drugstores during the years at issue and had been doing so in Seattle, Washington, and surrounding areas for more than 100 years. Ownership of the company has remained in the Bartell family since its founding in 1890. During the years at issue, all shares in Bartell Drug were held by petitioners George H. Bartell, Jr.,3 and his two children George D. Bartell and Jean B. Barber.
The foregoing family members served on the company's board of directors in various capacities and as officers during the period under consideration. Jean B. Barber (sometimes Jean Barber) served as chief financial officer of Bartell Drug, as well as secretary and a director on the board throughout that period.
In conducting its retail business, Bartell Drug owned some of the properties in which its stores operated and leased others. Before the 1980s, most*23 of Bartell Drug's stores were in shopping centers anchored by grocery stores, generally in a strip-mall format with the drugstore space sited between two other merchants. Developers of those centers would typically *143 approach Bartell Drug, offering space in an already-planned complex.
In the ensuing decades, however, two key, and to some degree interrelated, developments affected the business model for retail drugstores. First, grocery stores began including pharmacies within their stores. That innovation both reduced the attractiveness of the grocery-anchored centers for competing drugstores and prompted grocery stores to have developers restrict leasing to such competitive merchants. Second, Walgreen Co. (Walgreens), a national drugstore chain, introduced on a massive scale and to notable success a store format that shifted the paradigm for drug retailing. The emphasis became freestanding corner locations with drive-through pharmacies. Walgreens entered the Seattle area market in the early to mid-1990s, at which point Bartell Drug came under increasing pressure. The national chains Walgreens, Rite Aid Corp., and Safeway, Inc., became increasingly influential and Bartell Drug's chief*24 competitors in the market.
Given the foregoing, Bartell Drug management faced the prospect of the growing obsolescence of its retail locations and sought to formulate a strategy to update its portfolio of owned and leased properties. The changed business climate generally required Bartell Drug to undertake development of new sites itself in order to open freestanding stores. Such a project often necessitated a significantly greater financial commitment, frequently encompassing land acquisition and/or building construction costs, than that involved in merely occupying a space built by a third-party developer. Additionally, the properties owned by Bartell Drug at that juncture generally had very low bases, such that outright sale could produce significant taxable gain.
In the early to mid-1990s, Jean Barber was introduced to the concept of
*144 In executing the
Bartell Drug had operated a small store in Lynnwood, Washington, since the mid-1980s. That store was in a poorly maintained strip mall. By 1999 only a few years remained on the existing lease for the Lynnwood store, and Bartell Drug was interested in considering other properties. The company's real estate manager began looking into potential sites. At the time, it was rumored that Walgreens was also scouting locations in the Lynnwood area, one of which was likewise attractive to Bartell Drug.
That property was a recycling center, owned*26 by Mildred M. Horton,4 across the street from Bartell Drug's existing Lynnwood store. On April 1, 1999, Bartell Drug's real estate manager had an initial meeting with Mildred Horton and her attorney regarding the property. Further negotiations followed, and as they proceeded Bartell Drug ordered a first commitment for title insurance for the site (hereinafter the Lynnwood property), effective April 21, 1999. The commitment identified Mildred Horton as "Seller" and Bartell Drug as "Buyer/Borrower" and "Proposed Insured". Bartell Drug also contacted an engineering firm about providing a boundary and topographic survey of the Lynnwood property, and the firm responded with a proposal dated April 23, 1999.
The sale negotiations culminated on May 7, 1999, with the execution by Mildred Horton as "Seller" and Bartell Drug as *145 "Buyer" of a Real Estate Purchase and Sale Agreement (sale agreement). The sale agreement*27 recited a total purchase price of $1,898,640, payable in cash at closing, and set forth a closing date of August 1, 2000. In addition, the sale agreement specified a series of steps and deadlines to occur in the interim, relating to due diligence, title, survey, inspections, and environmental reports, as well as requirements for periodic earnest money payments totaling $100,000 to be deposited by Bartell Drug in escrow. The sale agreement also contained the following clause: 14.5
After execution of the sale agreement, Bartell Drug began to undertake the steps contemplated therein and related actions aimed at finalizing the acquisition and construction of a drugstore on the Lynnwood property. Bartell Drug ordered a second commitment for title insurance effective May 18, 1999, that modified certain listed exceptions not pertinent here. In July 1999 Mildred Horton and Bartell Drug agreed to extend the period for*28 the company to complete its inspection of the Lynnwood property, so as to allow sufficient time for refining building and site plans. Then, as the extended inspection period drew to a close, Bartell Drug began remission of the stipulated earnest money payments by six checks dated September 1, 1999, through January 31, 2000.
Bartell Drug likewise continued preparations for the construction of a drugstore on the Lynnwood property. On January 5, 2000, Bartell Drug applied to the City of Lynnwood for a building permit for the site. That application listed Bartell Drug as applicant and Mildred Horton as owner of the subject real estate. Bartell Drug also engaged a traffic engineering firm to perform a traffic study and review of site access, and that firm invoiced Bartell Drug for the work on February 15, 2000.
Meanwhile, Bartell Drug sought to progress on structuring and financing the sale transaction. At some point not clearly disclosed in the record, but before March 2000, Bartell Drug approached
KeyBank's commitment letter for the full package, dated March 1, 2000, and sent to Bartell Drug, described the borrower of the $4 million loan as "The Bartell Drug Company or an entity such as EPC TWO LLC acceptable to the bank with a guaranty provided by The Bartell Drug Company" and the purpose as "to finance the acquisition of land and construction of a new store in Lynnwood, WA. under the benefits of
On March 13, 2000, the Bartell Drug board of directors authorized management to proceed in obtaining the facilities, and Jean Barber countersigned the commitment letter on that date. EPC Two, in turn, on March 17, 2000 (in conjunction with the loan documentation detailed
On March 17, 2000, KeyBank as "Lender" and EPC Two by Exchange Structures, its sole member, as "Borrower" executed a Business Loan Agreement in the principal amount of $4 million. The loan was structured as a line of credit and required that a guaranty by Bartell Drug be furnished before the disbursement of any loan proceeds.*31 EPC Two simultaneously executed in favor of KeyBank a promissory note in the principal amount of $4 million and three London Interbank Offered Rate addenda designating the pertinent variable interest rate schedule, as well as a disbursement request and authorization for the funds. The disbursement request recited the specific purpose of the loan as being to "finance construction of new store in Lynnwood". At the same time, Bartell Drug signed a corporate resolution to guarantee and corresponding commercial guaranty of the $4 million note made by EPC Two.
On April 4, 2000, 2. We take title to the Replacement Property with funds loaned by you and/or a third party lender obtained by you. Enclosed are the executed warehousing and exchange letters. I have talked to Key Bank and they have no problem with issuing a side letter to make the new loan non-recourse to EPC II. However, the bank cannot do this until they receive an executed copy of the Exchange and Cooperation Agreement. I have talked to Dan Pepple, our attorney, and asked him to draft this document. Once we have that document completed, I will contact Key Bank to get the Loan Agreement modified.*33
As preparations for closing on the Lynnwood property proceeded, a corporate resolution dated July 13, 2000, was executed in which it was represented that the Bartell Drug board of directors in a previous meeting held March 13, 2000, had resolved, inter alia: (1) to enter into a
During 2000 and 2001, EPC Two was a single purpose entity formed for the exclusive purpose of providing services to Bartell Drug. It was a disregarded entity for Federal income tax purposes at all times relevant to these cases (its sole member being Exchange Services, Inc.), and it had no assets during 2000 and 2001 other than, as more fully discussed hereinafter, a right to acquire the Lynnwood property and then title to the Lynnwood property, subject to various contractual terms governing the property's disposition.*34
On July 31, 2000, Bartell Drug and EPC Two entered into a Real Estate Acquisition and Exchange Cooperation Agreement (REAECA) with respect to the Lynnwood transaction. Through the REAECA, Bartell Drug and EPC Two (referred to as SPE in the REAECA) contracted to cooperate in effecting an exchange of current property (i.e., property currently owned by Bartell Drug but to be relinquished) for replacement property. The document set forth the contracting parties' rights and responsibilities in that endeavor. *149 The current property was identified as of that time as the White Center site, and the replacement property as the new Lynnwood property. The REAECA addressed acquisition and ownership of the replacement property, including assignment of the existing purchase agreement, financing, construction of improvements, and leasing; disposition of the current property through cooperation in an exchange via a qualified intermediary (i.e.,
As regards acquisition of the Lynnwood property, Bartell Drug assigned and EPC Two accepted*35 the rights and obligations under the May 7, 1999, sale agreement with Mildred Horton. The REAECA then specified that EPC Two "shall acquire title to" the replacement property and then "shall cause to be constructed on" the replacement property certain improvements "pursuant to plans and specifications approved by Bartell and undertaken by a general contractor and subcontractors approved by Bartell".
To that end, the REAECA provided that to finance the acquisition of and construction of the improvements to the site, EPC Two would borrow funds from an agreed lender and would have no obligation to become liable for any payments or to advance any funds in excess of those so borrowed or funds supplied by the qualified intermediary from the sale of the current property. Similarly, EPC Two was to have no responsibility: (1) "to investigate, review or otherwise inquire into the nature of any work for which payment is requested, it being expressly agreed that SPE's responsibility is solely to disburse funds on request by Bartell"; or (2) "to review, supervise, inspect or otherwise become involved in the construction" of the improvements.
The REAECA also stipulated that upon substantial completion*36 of the improvements, EPC Two was required to lease the replacement property to Bartell Drug. The lease was to be a triple net lease and was to "provide for rental equal to all debt service payable under any and all" loan agreements with respect to the replacement property.
If Bartell Drug then elected to go forward with an exchange of the current property, that property would be sold to a third party through the qualified intermediary, with the intermediary having been assigned Bartell Drug's rights *150 under such a sale contract and receiving the proceeds thereof. Bartell Drug would next assign to the qualified intermediary its rights and obligations under the REAECA, which included a right to acquire the replacement property. At Bartell Drug's direction, the qualified intermediary would then remit to EPC Two the proceeds from the sale of the current property up to an amount not in excess of the "Purchase Price" of the replacement property. To complete the exchange, the qualified intermediary would direct EPC Two to deed the replacement property to Bartell Drug.
Per the REAECA, the "Purchase Price" for the replacement property was equal to its "Fair Market Value". "Fair Market Value", in*37 turn, was defined: "Fair Market Value" of the Replacement Property shall mean the fair market value determined by an appraisal conducted by a nationally recognized real estate appraiser as may be agreed to by Bartell and SPE * * *; provided, however, that if the Replacement Property is purchased from SPE within twenty-four (24) months after the date on which SPE acquired the Replacement Property, then the "Fair Market Value" shall be deemed to equal its "Acquisition Cost" as hereinafter defined. "Acquisition Cost" shall mean the sum of (i) the purchase price paid by SPE to the Seller to acquire the Replacement Property; (ii) all sales, transfer or similar taxes, and all charges and closing costs paid by SPE in connection with its purchase of the Replacement Property; (iii) all interest and stated fees (including pre-payment fees in connection with mandatory pre-payments) under the Credit Agreements which are not paid as rent pursuant to the Lease, (iv) the cost of construction of all Improvements which are paid by SPE, and (v) any and all unreimbursed costs, liabilities and expenses of any kind incurred by SPE in connection with*38 the acquisition, ownership and operation of the Replacement Property and the completion of the Exchange except for "Excluded Costs" as defined * * *
Two indemnity provisions were set forth in the REAECA. One was a general indemnification clause whereby Bartell Drug agreed to indemnify and save EPC Two and/or KeyBank "harmless from all loss, cost, damages, expenses and attorneys' fees suffered or incurred" as a result of any claim, investigation, proceeding, or suit in connection with *151 the ownership or exchange of the replacement property "except to the extent * * * [that party] is liable for such loss as a result of its gross negligence, willful misconduct or breach of its obligations under" the REAECA. The other provision was a specific environmental release and indemnity mandating that Bartell Drug indemnify and hold harmless EPC Two and/or KeyBank for any claims in connection with contamination of the current and replacement properties by any hazardous substance.
Other matters pertaining to security were likewise*39 documented during this period. Contemporaneously with entry into the REAECA, EPC Two on July 31, 2000, executed a deed of trust on the Lynnwood property for the benefit of Bartell Drug. The deed of trust secured Bartell Drug with respect to EPC Two's obligations under the REAECA, which was expressly referenced therein, as well as any liability paid by Bartell Drug under the provisions of its guaranty of payment on the KeyBank loan. Effective August 1, 2000, KeyBank as "Lender" and EPC Two as "Borrower" executed an amendment to the $4 million promissory note. The amendment rendered the note "expressly nonrecourse to Borrower" and stipulated that all payments thereunder were to be made "only from the income and proceeds from the Borrower's interest in the Replacement Property and Improvements to be acquired with the proceeds of the loans(s) evidenced by the Promissory Note".
Closing on the Lynnwood property took place on August 1, 2000. The final selling price, incorporating any pertinent amendments to the May 7, 1999, contract, was $1,878,640.5 Various other charges and expenses were also settled through the escrow process, and EPC Two received out of the*40 escrow $9,493 in payment of a "Warehousing Lease Fee".6 On that date, a statutory warranty deed conveying the Lynnwood property from grantor Mildred Horton to grantee *152 EPC Two was recorded. The deed of trust on the property from EPC Two in favor of Bartell Drug was also recorded on August 1, 2000. A final title insurance policy on a fee simple interest in the Lynnwood property, dated August 1, 2000, was issued to EPC Two as the named insured.
Work on the new property itself advanced on August 1, 2000, with the commencement of site demolition and the clearing of existing site debris. J.R. Abbott Construction, Inc. (J.R. Abbott), invoiced Bartell Drug for the demolition and clearing on August 31, 2000, and Bartell Drug paid directly the $61,690.23 due in early September of 2000. Bartell Drug was subsequently*41 reimbursed that amount through a construction draw from the KeyBank loan. As the project moved into the phase of store construction, Bartell Drug managed the process. For instance, throughout the following months Bartell Drug was engaged in applying for and obtaining appropriate permits and bonding to enable the work to proceed. In September of 2000, Bartell Drug applied to the City of Lynnwood for a public works permit. On December 20, 2000, the City of Lynnwood issued to Bartell Drug the building permit which had been applied for in January of that year, as noted
Performance bonds were required by the City of Lynnwood for the construction of the drugstore. EPC Two executed two commercial surety bond applications dated January 5, 2001, in favor of the City of Lynnwood. Bartell Drug signed those applications as third-party indemnitor. Two performance bonds were issued for the construction listing "EPC TWO, LLC c/o BARTELL DRUG COMPANY" as "Principal" and Travelers Casualty and Security Company of America*42 as "Surety" and were signed on January 8, 2001, only by Bartell Drug and filed with the City of Lynnwood.8
Bartell Drug selected J.R. Abbott, the same firm that had performed the demolition, as the contractor for the construction. *153 A contract for the work on the new drugstore dated January 8, 2001, was executed between "EPC Two L.L.C. c/o THE BARTELL DRUG COMPANY" as "Owner" and J.R. Abbott as "Contractor". Both EPC Two and Bartell Drug signed the document via signature blocks labeled "OWNER". All requisite building and similar permits for construction of the drugstore were issued to Bartell Drug.
One key component of the drugstore project was site access. Bartell Drug believed that having two driveway access points was critical, but applicable governmental regulations would have limited the Lynnwood property to one curb cut. Accordingly, Bartell Drug worked closely with the City of Lynnwood to formulate an easement plan involving the drugstore site and the adjacent corner lot.*43 Those negotiations culminated in an Agreement for Joint Access Agreement [sic] dated June 15, 2001, between EPC Two and Bartell Drug as grantors and the City of Lynnwood as grantee. The agreement opened with the following recitals: A. EPC Two LLC holds title to the real property (the " B. As a condition to the issuance of a building permit, the City required Bartell to agree to grant access easements in favor of the adjacent parcel * * *
As construction progressed, periodic payments for the work were typically made in the following manner: (1) J.R. Abbott would send an invoice to Bartell Drug; (2) a Bartell Drug employee would send written authorization to EPC Two for requesting a construction draw from the KeyBank loan in the amount of the invoice; (3) EPC Two would send written authorization to KeyBank for disbursement of funds from the construction loan to be paid by wire transfer to J.R. Abbott;*44 (4) KeyBank would pay J.R. Abbott the amount specified in the EPC Two authorization. During the period from February through July 2001, six such payments were made. Various other expenses, including those incurred after the $4 million loan was depleted, were paid by Bartell Drug directly. A promissory note dated July 6, 2001, was executed *154 by EPC Two in favor of Bartell Drug in the amount of $248,562.33, with respect to at least a portion of the expenses so paid. The note bore no interest for the first 180 days, and thereafter was to bear interest at 7% per annum.
As the construction phase came to a close, EPC Two as landlord and Bartell Drug as tenant entered a lease agreement for the Lynnwood property and new store effective July 11, 2001. The lease term was for 24 months beginning June 1, 2001. The rent obligation was summarized at the outset of the lease as follows: The initial net rent of the Lease shall be $9,493.00, which has been previously paid by Tenant. As of the Commence Date, net monthly rent shall be $2,000.00 per month, with a total net rent under the lease not to exceed $19,413.00. "Net" rent shall mean the amount of rent owing*45 by Tenant after offsets for any interest owed by Landlord to Tenant related to the Premises. * * * Tenant may offset the rent owing with payments due Tenant under that certain Note payable by Landlord to Tenant of even date herewith. Tenant shall also be responsible for payment of all utilities, taxes and insurance of the Premises, as set forth below. As additional Rent, Tenant shall make all payments due from Landlord on the Loan secured by the Premises to the applicable lender. * * *
Consistent with the REAECA, the lease also incorporated indemnification clauses in favor of EPC Two, one general and one specifically focused on environmental hazards. In the former, tenant agreed to hold landlord harmless against all liabilities arising from acts or omissions of tenant or visitors to the premises. In the latter, tenant undertook to indemnify landlord against all claims related to*46 hazardous materials brought to or used on the premises.
On July 18, 2001, the City of Lynnwood issued a certificate of occupancy for the new Bartell drugstore. In August of 2001, J.R. Abbott sent to Bartell Drug an application and *155 certification for payment for $93,744.05 remaining due on the project. A conditional release and waiver of lien rights for the project, such as any applicable mechanic's or similar lien, contingent upon payment of the $93,744.05, was included with the invoice. Bartell Drug paid the requested amount by check dated August 24, 2001.
Meanwhile, Bartell Drug was also proceeding with steps directed toward the property to be relinquished in the exchange. In August 2000 Bartell Drug had acquired a retail drugstore in Everett, Washington (Everett property), as part of a [T]he new Lynnwood store under construction, and which is being financed by this loan, is now approximately 80% completed and will not be finished and ready for customers until the month of July. In addition, management needs extra time after completion of the Lynnwood Store to determine the most appropriate repayment source - either from sale/leaseback of the company's White Center Store as originally planned or from the sale of the existing Everett Store, which may or may not be leased back depending on management's negotiations on acquisition of a new Everett Store site. The new maturity date of this loan will afford management more than adequate time to make the best economic and strategic decision for repayment. Bartell's continues to produce excellent financial results. For the year 2000, * * *
On or about September 21, 2001, Bartell Drug entered into a purchase agreement to sell the Everett property to William and Theresa Eng. The transaction was structured as a sale-leaseback, and after a*48 series of amendments negotiated between Bartell Drug and the Engs during September and *156 October, the selling price was stipulated at $4,300,250. Among other provisions, the purchase agreement included a seller exchange clause stating: "Buyer agrees to cooperate should Seller elect to sell the property as part of a like-kind exchange under
By mid-October of 2001, however, Bartell Drug had received two offers to purchase the Lynnwood property that would have enabled the company to use the site in a sale-leaseback arrangement. Consequently, Bartell Drug management requested from KeyBank an additional extension of the construction loan to negotiate that possibility. KeyBank acceded to the request and a concomitant modification and/or extension agreement dated October 17, 2001, was executed by EPC Two. On November 28, 2001, however, the Bartell Drug board of directors approved the sale of the Everett store, observing that the "proceeds will be used to purchase our store in Lynnwood".
On December 17, 2001, Bartell Drug as "Exchangor" and
By letter dated likewise December 17, 2001,
Finalization of the transfers of the Everett and Lynnwood properties took place between December 26, 2001, and January 3, 2002. On December 26, 2001, Bartell Drug executed an assignment of the purchase agreement for the Everett property, and
On December 27 or 28, 2001, EPC Two executed a statutory warranty deed conveying the Lynnwood property to Bartell Drug, and the deed was recorded on December 31, 2001. On January 3, 2002,9*51Bartell Drug executed an assignment of the REAECA to
Through the respective escrow processes, sale of the Everett property provided a net amount after charges of $4,132,752.09, which was applied toward purchase of the Lynnwood property. From that balance, charges paid out of the escrow included $10,249.81 remitted to Exchange Structures as "Final Rent Payment" and $1,500 remitted to
For 2001 and prior years, Bartell Drug filed with the IRS Forms 1120S, U.S. Income Tax Return for an S Corporation. Included with the 2001 return was a Form 8824, Like-Kind Exchanges, addressing the transfers of the Everett and Lynnwood properties. Bartell Drug reported that the property relinquished in the subject exchange had been acquired on August 1, 2000, and had been transferred to another party on December 28, 2001. The company further reported that like-kind property was actually received on January*52 2, 2002. The fair market value of the property received was shown as $4,134,592 and the basis of the property given up as $1,329,729, for a deferred gain of $2,804,863.
Schedules K-1, Shareholder's Share of Income, Credits, Deductions, etc., were prepared for each of Bartell Drug's shareholders, i.e., George H. Bartell, Jr., George D. Bartell, and Jean B. Barber, setting forth his or her respective shares of Bartell Drug's items of income and deduction. Petitioners filed Forms 1040, U.S. Individual Income Tax Return, for 2001 and subsequent years at issue reflecting, inter alia, amounts flowing through from Bartell Drug's corporate returns. The gain realized from the sale of the Everett property, having been treated as deferred by Bartell Drug, was not reported by the individual petitioners.
In early 2004, the IRS commenced an examination of Bartell Drug's 2001 corporate return. That audit culminated in a Form 5701, Notice of Proposed Adjustment, dated December 10, 2004, and corresponding Form 886A, Explanation of Items. The single adjustment proposed was the disallowance of tax deferral treatment under
As a general rule, the Commissioner's determinations are presumed correct, and the taxpayer bears the burden of proving error therein.
Petitioners assert that they have met the record retention, cooperation, and introduction of credible evidence requisites for a shift of the burden of proof. Respondent argues to the contrary. Nonetheless, we find it unnecessary to decide whether the burden should be shifted under
Petitioners argue that the transaction involving the Lynnwood property is properly treated as a like-kind exchange, thus permitting deferral of income realized upon the disposition of the Everett property. Respondent, conversely, asserts that the transaction in question*55 failed to qualify for
Respondent maintains that Bartell Drug already owned the Lynnwood property long before the December 2001 disposition of the Everett property, thereby precluding any exchange as of that date. Petitioners contend that Bartell Drug was not then the owner of the Lynnwood property; rather, EPC Two must be treated as the owner. These different results, in turn, are explained by the different tests employed by the parties to answer the ownership*56 question. Petitioners claim that an agency analysis is the appropriate standard and that such an analysis should be employed in a manner consistent with the wide latitude historically permitted in the context of like-kind exchanges. Respondent, on the other hand, advocates application of a benefits and burdens analysis as the traditional test in the myriad of situations raising questions of tax ownership of property.
Generally, under
The purpose for the foregoing deferral has been identified in jurisprudence involving
Given that rationale, courts have frequently interpreted the requirements of
The words "like kind" as used in
Historically, there has never been any question that (3) Requirement that property be identified and that exchange be completed not more than 180 days after transfer of exchanged property.--For purposes of this subsection, any property received by the taxpayer shall be treated as property which is not like-kind property if-- (A) such property is not identified as property to be received in the exchange on or before the day which is 45 days after the date on which the taxpayer transfers the property relinquished in the exchange, or (B) such property is received after the earlier of-- (i) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, or *163 (ii) the due date (determined with regard to extension) for the transferor's return of the tax imposed by this chapter for the taxable year in which the transfer of the relinquished property occurs.
Comprehensive regulations were later issued in
Nonetheless, even with these regulatory developments, the full reach and range of transactions entitled to protection under * * * * However, the Service will continue to study the applicability of the general rule of
The vacuum in any administrative guidance concerning reverse exchanges was not alleviated until the issuance by the IRS of a safe harbor under which the Internal Revenue Service will not challenge (a) the qualification of property as either "replacement property" or "relinquished property" * * * for purposes of
The revenue procedure was effective for qualified exchange accommodation arrangements entered into by an exchange accommodation titleholder on or after September 15, 2000. [n]o inference is intended with respect to the federal income tax treatment of arrangements similar to those described in this revenue procedure that were entered into prior to the effective date of this revenue procedure. Further, the Service recognizes that "parking" transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of "parking" transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure, whether entered into prior to or after the effective date of this revenue procedure.
The revenue procedure observed that in the years since the deferred forward exchange regulations were published, taxpayers had attempted to structure a wide variety of reverse "parking" transactions arranged "so that the accommodation*63 party has enough of the benefits and burdens relating to the property" to be treated as the owner.
Bartell Drug undertook the transaction involving the Lynnwood property before
The fundamental question in determining whether
Respondent contends that Bartell Drug already owned the Lynnwood property at the time of the disputed exchange because Bartell Drug--not EPC Two--had all the benefits and burdens of ownership of the property; namely, the capacity to benefit from any appreciation in the property's value, the risk of loss from any diminution in its value, and the other burdens of ownership such as taxes and liabilities arising from the property. By contrast, respondent contends, EPC Two did not possess any of the benefits and burdens of ownership of the property; it had no equity interest in the property, it had made no economic outlay to acquire it, it was not at risk with respect to the property because all the financing was nonrecourse as to it, it paid no real estate taxes, and the construction of improvements on the property was financed and directed by Bartell Drug. Moreover, respondent*65 contends, Bartell Drug had possession and control of the property during the entire period EPC Two held title, first by virtue of the REAECA provisions giving it control over the construction of site improvements and then possession through a lease that EPC Two was obligated *166 under the REAECA to extend to it, for rent equal to the debt service on the KeyBank loan plus EPC Two's fee for holding title. Respondent's position is that a benefits and burdens test, which is used in many contexts to determine ownership of property for Federal tax purposes,
Petitioners point out, however, that both this Court and the Court of Appeals for the Ninth Circuit, to which an appeal in this case would ordinarily lie, [O]ne need not assume the benefits and burdens of ownership in property before exchanging it but may properly acquire title
The somewhat formalistic approach of the caselaw on which petitioners rely is perhaps best explained by this Court's observations over 35 years ago in The touchstone of The "exchange" requirement poses an analytical problem because it runs headlong into the familiar tax law maxim that the substance of a transaction controls over form. In a sense, the substance of a transaction in which the taxpayer sells property and immediately reinvests the proceeds in like-kind property is not much different from the substance of a transaction in which two parcels are exchanged without cash. * * * * * * * [T]he conceptual distinction between an exchange qualifying for
Petitioners further point out that settled caselaw has permitted taxpayers to exercise any number*68 of indicia of ownership and control over the replacement property before it is transferred to them, without jeopardizing [C]ourts have permitted taxpayers great latitude in structuring
Respondent, however, relies in particular on our more recent decision in
The taxpayer in
The taxpayer claimed that he had effected a taxable sale of the Lawrence Drive property to WLC, followed by his transfer of the McDonald Street property to WLC in a like-kind exchange for WLC's reconveyance to him of the Lawrence Drive property.13 The Commissioner determined that the taxpayer had made a taxable sale of the McDonald Street property to WLC.
In resolving the issue, after noting the historically lenient attitude of courts towards taxpayers in like-kind exchange cases, we put considerable emphasis on the taxpayer's failure to use a third-party exchange facilitator. The subject transactions present a case of first impression in this Court. They reflect the effort of * * * [the taxpayer] and his advisors to implement a so-called reverse exchange directly with WLC, * * * * *72In the case at hand, * * * [the taxpayer] did not just locate and identify the Lawrence Drive property in anticipation of acquiring it as replacement property in exchange for the McDonald Street property that he intended to relinquish. He purchased the Lawrence Drive property
We analyzed the transaction to determine whether the taxpayer, having acquired the Lawrence Drive property outright and directly held it for more than a year, actually ceased being its owner for tax purposes during the three-month period that WLC held legal title in anticipation of a
In contending that
Our analysis must also take into account the position of the Court of Appeals for the Ninth Circuit, where an appeal in this case would lie absent stipulation to the contrary.
The taxpayers in
As recounted by the Court of Appeals for the Ninth Circuit, the taxpayers then took a series of steps with respect to the Salinas property--the replacement property--that warrant close scrutiny in view of the arguments respondent has advanced in this case. The taxpayers negotiated the $190,000 sale price of the Salinas property with its owners and then, on August 19, 1957, through written instructions to the Salinas Title Guarantee Co. (Salinas Title) executed on that *172 date,15 the taxpayers dictated the terms for the disposition of the Salinas property.
By deed dated the next day (August 20, 1957), title to the Salinas property was transferred to Salinas Title.
The taxpayers took the position that they had effected a *173[T]here was no need for Alloy to acquire a "real" interest in the Salinas property by assuming the benefits and burdens of ownership to make the exchange qualify under the statute although * * * [the Commissioner] asserts that failure of Alloy to hold a "real" interest in the Salinas property precluded the transactions involved from being construed as constituting an exchange. [O]ne need not assume the benefits and burdens of ownership in property before exchanging it but*78 may properly acquire title
Neither Salinas Title, the third-party exchange facilitator, nor Alloy, the acquirer of the taxpayer's relinquished property, assumed any benefits or burdens of the Salinas property (the replacement property) before the exchange. Salinas Title obtained title to the Salinas property subject to a contractual obligation in the Buyer's Instructions to transfer it to Alloy. Then Alloy obtained title to the property under a contractual obligation that it immediately transfer title to the taxpayers. Consequently, the beneficial ownership of the Salinas property necessarily resided with the taxpayers during the period that Salinas Title and Alloy held bare legal title to the property; it could be nowhere else. Thus, the taxpayers in
The transaction in
In
Before the transfer of title, the taxpayer and Shore entered into an agreement concerning the Virginia property that entitled
Shore then held the Virginia property for the next 4 1/2 months, during which time it entered into a contract to sell the Virginia property to Powell, and Powell thereupon assigned its contract right to purchase the Virginia property to the taxpayer as part of the consideration for an agreement pursuant to which the taxpayer agreed to sell the Maryland property to Powell.
The Court of Appeals for the Fifth Circuit and this Court both concluded that a
Notably for the issue at hand, Shore did not have any beneficial ownership of the replacement property. Shore made no outlay to acquire the replacement property and held title to it subject to contractual provisions that precluded the company from benefiting from any appreciation in the property's value or from being exposed to any risk of loss from a diminution in its value or any liability arising from holding *176 title. The agreement between Shore and the taxpayer, set out in detail in each court's opinion, gave the taxpayer a "call" on the replacement property at any time for consideration equal to the price Shore paid to acquire the property, plus any costs Shore incurred to hold the property, and satisfaction or release of Shore from any obligations it assumed or became bound by as a result of holding title. Shore could likewise "put" the property to the taxpayer for the same consideration. It is thus readily apparent that the taxpayer, not Shore, held the benefits and burdens of ownership of the replacement property during the period Shore held legal title. Nevertheless Shore, a third-party exchange facilitator, was treated as the owner of the*84 replacement property for purposes of satisfying the exchange requirement of
Thus,
Respondent contends that
Second, even forward exchange cases, including
To be sure, the transaction at issue involved a period before consummation of the exchange during which EPC Two was obligated to, and in fact did, lease the replacement*87 property to Bartell Drug. Bartell Drug leased the replacement property and used it as a drugstore for approximately six *178 months, from the completion of the improvements in early July 2011 until consummation of the exchange at yearend. There was no such leasing of the replacement property to the taxpayer by the exchange facilitator in
It is also true that the transaction at issue spanned a greater period than those countenanced in
For the foregoing reasons, we conclude and hold that Bartell Drug's disposition of the Everett property and acquisition of the Lynnwood property in 2001 qualify for nonrecognition treatment pursuant to
To reflect the foregoing,
Footnotes
1. Cases of the following petitioners are consolidated herewith: George D. and June M. Bartell, docket No. 22829-05, and David H. and Jean B. Barber, docket No. 22891-05.↩
2. Final disposition of petitioners' request for a protective order under
Rule 103↩ and an evidentiary dispute are the subject of separate orders.3. George H. Bartell, Jr., died in early 2009 after the filing of the case at docket No. 22709-05. His estate was substituted as a party-petitioner.↩
4. Mildred M. Horton owned the property both in her individual capacity and as trustee of a testamentary trust established under her deceased husband's will. For simplification, Mildred M. Horton and Mildred M. Horton, Trustee, will be referred to, without distinction, as Mildred Horton.↩
5. The $20,000 reduction in the sale price from the amount stated in the May 7, 1999, sale agreement apparently resulted from an addendum to the sale agreement sought by Mildred Horton pertaining to the removal of personal property from the site.↩
6. This $9,493.20 payment equals 0.5% of the original $1,898,640 contract purchase price for the Lynnwood property.↩
7. All permits issued by the City of Lynnwood in the record list Bartell Drug as "Applicant" and Mildred Horton as "Owner", regardless of the date of application and/or approval.↩
8. A performance bond prepared previously, dated December 28, 2000, and listing Bartell Drug as "Principal" was apparently not in proper form and not relied upon to meet the bonding obligation for the Lynnwood site.↩
9. Although the pertinent signature is dated "1/3/01", the document refers to the parties' having executed the exchange agreement, which did not occur until December 17, 2001.
10. Under
Rev. Proc. 2000-37, 2000-2 C.B. 308 , the "exchange accommodation titleholder" is, generally, a person other than the taxpayer who is subject to Federal income tax and who holds legal title to, or other indicia or ownership of, property intended to be exchanged in a transaction qualifying undersec. 1031 .See Rev. Proc. 2000-37 , sec. 4.02(1),2000-2 C.B. at 309↩ .11. This discussion of the latitude afforded taxpayers in structuring
sec. 1031 transactions was later quoted in full with approval by the Court of Appeals for the Ninth Circuit.Starker v. United States , 602 F.2d 1341, 1353↩ n.10 (9th Cir. 1979)12. The construction loan for the building was nonrecourse to WLC and guaranteed by the taxpayer.
DeCleene v. Commissioner , 115 T.C. 457, 461↩ (2000)13. The taxpayer preferred a taxable sale of his high-basis Lawrence Drive property to a taxable sale of his low-basis McDonald Street property.↩
14. In
DeCleene we noted the paucity of applicablesec. 1031 cases in the Court of Appeals for the Seventh Circuit, where the appeal in that case lay.DeCleene v. Commissioner , 115 T.C. at 472↩15. These escrow instructions for the disposition of the replacement property were entitled "Buyer's Instructions", the Court of Appeals noted.
Alderson v. Commissioner , 317 F.2d 790, 791 (9th Cir. 1963)rev'g 38 T.C. 215↩ (1962) .16. The 10% deposit that Alloy had previously placed into escrow to purchase the Buena Park property was refunded to it.
Alderson v. Commissioner , 317 F.2d at 792↩17. Respondent cites in support of his position a number of cases where the taxpayers made outright purchases of the replacement property and then subsequently sought to retrofit the transaction into the form of a
sec. 1031 exchange.See, e.g., Bezdjian v. Commissioner , 845 F.2d 217 (9th Cir. 1988)aff'g T.C. Memo. 1987-140 ;Dibsy v. Commissioner , T.C. Memo. 1995-477Lee v. Commissioner , T.C. Memo. 1986-294sec. 1031↩ exchange from the outset. These cases are therefore not helpful on the question of whether the third-party exchange facilitator is to be treated as the owner of the replacement property for Federal income tax purposes before the exchange.18. We note in this regard that the safe harbors extended to reverse exchanges in
Rev. Proc. 2000-37 ,supra , cover the exchange accommodation title holder's leasing of the replacement property to the taxpayer, albeit within the time limits imposed therein.Id. sec. 4.03(4),2000-2 C.B. 308↩, 310 .19. We conclude, given that under the REAECA the purchase price Bartell Drug was obligated to pay for the Lynnwood property went from (i) the acquisition cost of the real property and improvements to (ii) the parcel's fair market value, after EPC Two had held title for 24 months, that the possibility that Bartell Drug would fail to purchase the Lynnwood property before the expiration of that 24 months was too remote to be considered a practical possibility.
20. In scrutinizing the length of the period during which EPC Two held title to the replacement property before its transfer to Bartell Drug, we do not suggest that the transaction at issue failed to comply with the time limits of
sec. 1031(a)(3) , nor do the parties dispute that point. The 45- and 180-day periods in which the taxpayer must identify the replacement property and receive it, respectively, begin to run on "the date on which the taxpayer transfers the property relinquished in the exchange".Sec. 1031(a)(3)(A) and(B)↩ . As the transfer of the Everett property occurred on December 28, 2001, and Bartell Drug received title to the Lynnwood property on December 31, 2001, the taxpayers satisfied those time limits.
147 T.C. No. 5 (Estate of Bartell v. Comm'r) — published by Counsel Stack Legal Research, free access to 12M+ legal documents.