I Fought the Law,
and I Won
– 1031 “Drop and Swap” by Christina Weed
A like-kind exchange pursuant to Internal Revenue Code (IRC) §1031 permits a taxpayer to exchange likekind property and defer the recognition of gain on the transfer of said property. This allows a taxpayer to continue their investment until such time as their investment is eventually cashed out, i.e., sold. There are strict requirements under the Code and Regulations with respect to properly completing a like-kind exchange. Things become more complicated when, prior to exchanging real property, the property is first transferred out of a partnership or other business entity and exchanged – the property is dropped, then swapped. The state of California has historically pursued these types of transactions aggressively to prevent the deferral of gain when property is exchanged. The Franchise Tax Board (FTB) has been able to successfully challenge these drop and swap exchanges by alleging that the taxpayer did not “hold the property for investment.” The FTB has applied a one year holding period in a blanket fashion to
nearly all drop and swap 1031 exchange cases without any statute or case law as support. Remarkably, the taxpayer in the following case held the property in issue as a tenant in common for approximately ten days. In the Appeal of Sharon Mitchell,1 Sharon was a partner of Con-Med, a general partnership, since 1991. Sharon’s mother, Caroline Mitchell, was a partner of Con-Med long before Sharon became a partner. Con-Med owned a single piece of commercial property in Walnut Creek, California. As early as 1990, the tenant of the property indicated interest in potentially purchasing the property. Early on in the negotiations, several partners expressed an interest in doing a 1031 exchange of their interest in the underlying property. Con-Med ultimately decided it wanted to sell the property, but it also wanted to allow some of its partners to do 1031 exchanges of their interests in the underlying property if possible. In December of 2006, the tenant offered to buy the property from Con-Med. Con-Med made a counteroffer, and the parties entered into a purchase agreement. All throughout this process, Con-Med continued to assure the partners who wanted to do a 1031 exchange that it wanted to permit them to be
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CONTRA COSTA COUNTY BAR ASSOCIATION CONTRA COSTA LAWYER
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