Read the opinion: VIP’s Industries [PDF 76 KB]
The taxpayer leased property, beginning in August 1993, for a period of 33 years. The taxpayer built a motel on the leased property.
In March 2006, the taxpayer sold its interest in the motel to an investment firm and deposited the proceeds with a qualified intermediary. At the time of the sale, the lease was subject to a term of 21 years and four months (the lease was nonrenewable and nonrefundable). The taxpayer then used the proceeds on deposit with the qualified intermediary to purchase fee interests in two pieces of real property.
The taxpayer claimed it did not recognize approximately $2.2 million on the sale of the motel property pursuant to the like-kind exchange provisions of section 1031. The IRS issued a deficiency notice, asserting that the exchange did not qualify for nonrecognition under section 1031.
Tax Court's opinion
The Tax Court today upheld the deficiency notice, finding that pursuant to Reg. section 1.1031(a)-1(c), a short-term leasehold of real property is not equivalent to a fee interest for purposes of section 1031. The Tax Court looked to prior decisions and noted that it had previously held that leasehold interests with similar or even longer terms than the one in this case are not equivalent to fee interests.
- In one case, the court found a 20-year leasehold was not equivalent to a fee interest.
- In a second case, the court held a leasehold interest with a term of one year and an option to renew for a term of 24 years was not equivalent to a fee interest.
While Reg. section 1.1031(a)-1(c) provides that a leasehold of a fee in real property with 30 years or more to run is like kind to other real estate, the Tax Court today did not hold that Reg. section 1.1031(a)-1(c) mechanically excludes all exchanges of leaseholds with terms of less than 30 years for fee interests.
The Tax Court also held that the motel built by the taxpayer on the leased property was not like-kind to a fee interest. The court concluded because the motel would belong to the lessor of the ground lease upon termination of the lease, the motel was a short-term real property interest like the leasehold interest.