In Exelon, the Seventh Circuit held that exchanges by Exelon Corporation (“Taxpayer”) of nuclear power plants for long-term leasehold interests in power plants located in other states were not exchanges qualifying for like-kind exchange treatment under Code Section 1031. According to the court, the Taxpayer did not acquire the benefits and burdens of ownership but rather received an interest more in the nature of a loan, which was not like-kind with the relinquished real property.
The IRS issued notices of deficiency for tax years 1999 and 2001. The tax deficiency for 1999 was in excess of $431 million. On top of that, the Service imposed a 20% accuracy related penalty under Code Section 6662(a) that exceeded $86 million. For 2001, the deficiency was a bit over $5.5 million. Again, for good measure, the Service tacked on a 20% accuracy related penalty of about $1.1 million.
The U.S. Tax Court affirmed both the deficiency assessment and the imposition of accuracy related penalties. Exelon Corp. v. Comm’r, 147 TC 230 (2016). On October 3, 2018, the U.S. Court of Appeals for the Seventh Circuit affirmed the Tax Court. Exelon Corp. v. Comm’r, 122 AFTR 2d ¶2018-5299 (2018).
The saga of Exelon Corporation is a long and complex read, but the morals to the story definitely warrant tax advisors dedicating the time to understand the case.
As reported in my November 2014 blog post, President Obama’s administration wants to limit taxpayers’ ability to defer income under IRC § 1031. In response to former House Ways and Means Committee Chairman David Camp’s proposed Tax Reform Act of 2014, which would have eliminated IRC § 1031 altogether, the Obama administration proposed to retain the code section, but limit deferral with regard to real property exchanges to $1 million per taxpayer each tax year. Personal property exchanges, under the President’s proposal, would go unscathed.
In 2015, President Obama expanded his proposal relative to IRC § 1031 to limit personal property exchanges by excluding certain types of property from the definition of “like kind.” The excluded personal property included items such as collectibles and art. The President’s proposed $1 million real property exchange limitation was left intact.
Actual or constructive receipt of the exchange funds during a deferred exchange under IRC Section 1031 totally kills an exchange and any tax deferral opportunity. Treasury Regulation Section 1031(k)-1(f)(1) tells us that actual or constructive receipt of the exchange proceeds or other property (non-like-kind property) before receiving the like-kind replacement property causes the exchange to be treated as a taxable sale or exchange. This is the case even if the taxpayer later receives the like-kind replacement property. In accordance with Treasury Regulation 1.1031(k)-1(f)(2), a taxpayer is in constructive receipt of money or property if it is credited to his, her or its account; set apart for the taxpayer’s use; or otherwise made available to the taxpayer.
The goodwill of a business can never be exchanged for the goodwill of another business. Goodwill is not like kind property. Treasury Regulation 1.1031(a)-2(c)(2) makes that crystal clear, providing:
The goodwill or going concern value of a business is not of a like kind to the goodwill or going concern value of another business.
Larry J. Brant
Larry J. Brant is a Shareholder in Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long-term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "A Good Look At The Limitations to Code Section 1031 and Other Possible Deferral Alternatives," OSCPA 2021 Annual Real Estate ConferenceVirtual Event, 6.9.21
- To be rescheduled