In a technical advice memorandum (TAM 201437012), the IRS determined that if certain properties that were previously matched as replacement property under Section 1031 are later determined to be ineligible as replacement properties, other eligible replacement properties that were identified and acquired in a timely way, but not reported as matched, qualified as replacement properties.
Under the facts of the TAM, the taxpayer's equipment rental business established a Section 1031 like-kind exchange program (LKE program) as permitted under Rev. Proc. 2003-39. The revenue procedure sets forth safe harbors to assist taxpayers in administering high-volume LKE programs. During an IRS audit, the exam team determined that some of the taxpayer's replacement properties weren't eligible for exchange under Section 1031 because they were held primarily for sale, rather than for productive use in a trade or business or for investment.
In response, the taxpayer argued that Section 1031 required the taxpayer to rematch the eligible relinquished properties to the other previously unmatched eligible replacement properties that were acquired within the relevant 45-day period. The exam team argued that the taxpayer's matching of ineligible replacement properties with the relinquished property was binding on the taxpayer upon filing of its return and later rematching wasn't permitted.
The IRS stated in the TAM that Section 1031 isn't an elective provision. It applies to defer gains and losses whenever property held for productive use in a trade or business or for investment is exchanged for like-kind property that is also held for productive use in a trade or a business or for investment. A taxpayer's characterization of a transaction on a Form 8824 "Like-Kind Exchanges" or elsewhere on an income tax return cannot override the application of Section 1031, the IRS said.
The IRS concluded that the unmatched replacement properties were properly identified because they were received by the taxpayer under the LKE program before the identification period ended. Thus, the time requirements for identification and receipt of previously unmatched replacement properties were satisfied.
Rev. Proc. 2003-39 introduces the concept of matching of relinquished properties with replacement properties primarily to facilitate computation and administration for large-scale LKE programs. The IRS stated that the revenue procedure doesn't mandate any particular procedure for matching replacement properties with relinquished properties. Further, as a safe harbor revenue procedure, Rev. Proc. 2003-39 doesn't support the conclusion that a taxpayer is bound by its election of replacement property if that property is later found ineligible and the taxpayer has other eligible replacement property that was not already treated as replacement property in an exchange.
The exam team also argued that to allow rematching of replacement properties after the due date of the taxpayer's tax return is contrary to the intent of Congress. The IRS agreed that long delays in the identification and receipt of replacement properties would raise doubts about whether properties are of like kind or whether they were truly exchanges. Under the taxpayer's facts, however, the relevant properties were of like kind and the potential replacement properties were received within the 45-day identification period. Accordingly, the IRS allowed the taxpayer to rematch its eligible relinquished properties to previously unmatched eligible replacement properties that were acquired within 45 days.
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