Exchanging Ideas

Beginning in 2008, small tax-exempt organizations will have a new filing requirement. It’s short, easy and electronic – it’s the new e-Postcard. If you are a tax-exempt organization that normally has annual gross receipts of $25,000 or less and does not have to file Form 990 or 990-EZ, you must file the e-Postcard. The e-Postcard is due by the 15th day of the fifth month after the close of your tax year. So if your organization operates on a calendar year, the e-Postcard is due by May 15 of the following year.

What happens if you don’t file? The IRS says that you risk losing your tax-exempt status. If you think this new filing requirement may apply to your organization, go to www.irs.gov/eo for complete details and while you’re there sign up for Exempt Organization’s free email newsletter, EO Update, to receive up-to-date information posted on the charity pages of irs.gov.

Private Letter Ruling 200730002, released on July 27, 2007 covered some old ground and even added a little insight into how the IRS views related party exchanges. Taxpayer was the trustee of a Trust created by his deceased brother for the benefit of Taxpayer’s Niece. The Niece had the right to terminate the trust at any time, but had not done so. Taxpayer, his surviving Brother and the Trust owned two properties, Greenacre and Blackacre, as equal tenants in common in each property. Taxpayer proposed to resign as trustee of the Trust in favor of his Niece. Then he would exchange his 1/3 interest in Greenacre for the 2/3 interest in Blackacre owned by his Brother and by the Trust. Greenacre is worth about twice what Blackacre is worth. Therefore the exchanged properties have comparable value. The Brother and the Niece would then sell Greenacre, and the Taxpayer proposed to continue to hold Blackacre as an investment.

The IRS approved the arrangement. First and foremost, the IRS pointed out that Congress did not intend for §1031(f)(2)(C) to apply to exchanges of undivided interests in different properties that results in each taxpayer holding either an entire interest in a single property or a larger undivided interest in any of such properties, and therefore the parties are not presumed to have engaged in the transaction for tax avoidance. This exception to the two year holding period is important in the partition of family properties, such as farms and other inheritances, as the heirs attempt to divide up their holdings. Second, the IRS noted that the Brother’s basis in the properties was lower than Taxpayer’s, so as for the Taxpayer and the Brother, there would in fact be no tax avoidance through this swap followed by a sale. On the contrary, less tax would have been paid if the Taxpayer rather than the Brother sold the same interest in Greenacre. Third, and finally, the Taxpayer and the Niece are not related parties by blood, but only through their relationship as Trustee and beneficiary. By resigning as trustee of the Trust, Taxpayer effectively terminated the related party issue between himself and both the Trust and his Niece, even though this would be done just prior to the exchange and specifically in contemplation of the exchange.

Therefore, nothing in this transaction was deemed to constitute tax avoidance pursuant to §1031(f)(2)(C) or to have been structured to avoid the purposes of §1031(f) within the meaning of §1031(f)(4).

In PLR 200709036, the taxpayer, who was the operating partnership of a publicly traded real estate investment trust (REIT), sold an office and retail property (Relinquished Property) to a related taxable REIT subsidiary (TRS) for cash consideration at a fair market value price. Utilizing an unrelated QI, taxpayer used the proceeds from the sale to acquire replacement property from a third party seller. The TRS planned to sell the Relinquished Property within two years of the exchange.

The IRS held that under IRC §1031(f)(4), these transactions were not designed to avoid application of the related party rules of IRC §1031(f). The legislative history indicates that congress designed IRC §1031(f) to apply to exchanges of low basis property for high basis property followed by a sale of the high basis property. In the present case, taxpayer and TRS did not actually exchange properties because the TRS did not own the replacement property prior to the exchange. Accordingly, taxpayer would not be required to recognize gain under IRC §1031(f)(1)(C)(i), if TRS disposed of the Relinquished Property within two years of the exchange.

This private letter ruling is not precedent and may not be relied upon by anyone other than the taxpayer obtaining the ruling, but it does indicate the current thinking of the IRS on this issue.

The Internal Revenue Service has launched a new Web-based version of its Exempt Organizations Workshop covering tax compliance issues confronted by small and mid-sized tax exempt organizations.

The free online workshop – Stay Exempt – Tax Basics for 501(c)(3)s – consists of five interactive modules on tax compliance topics for exempt organizations:

• Tax-Exempt Status – How can you keep your 501(c)(3) exempt?
• Unrelated Business Income – Does your organization generate taxable income?
• Employment Issues – How should you treat your workers for tax purposes?
• Form 990 – Would you like to file an error-free return?
• Required Disclosures – To whom do you have to show your records?

Users can access this new training program at www.stayexempt.org. Users can complete the modules in any order and repeat them as many times as they like. The online training website does not require registration and its visitors will remain anonymous.

In PLR 200651030, the IRS determined that properties that are subject to a contract for disposition and that are transferred from a trust to a limited liability company (”LLC”) taxed as partnership for federal tax purposes before the disposition still qualify for like-kind exchange treatment. Upon the decedent’s death, a trust was established to administer his assets. Under the terms of the decedent’s will, the trust was drafted terminate 20 years after the death of the decedent’s last surviving child. Under a plan for terminating the trust, a percentage of the trust’s net asset value will be contributed to a single-member LLC, with the trust acting as the sole member of the LLC and the LLC will be a disregarded entity for Federal tax purposes. Once the trust is terminated, all of the shares in the LLC will be distributed among certain of the remaining beneficiaries and the LLC will then become a multi-member LLC and therefore a partnership for Federal tax purposes. The multi-member LLC intends to continue the trust’s real estate investment operations in a manner consistent with past practices, and much of the current managerial and operational structure will remain in place after the trust terminates.

In order to exercise their fiduciary duty to increase rental income, the trustees determined that it would be in the best interests of the trust to exchange a few of the trust’s real estate investment properties each year. The trust anticipates that, following the trust’s termination, the LLC will continue to periodically conduct Section 1031 exchanges. The trust has two pending dispositions of relinquished properties that it expects it will be unable to close before its termination and, accordingly, desires to transfer its interests in these relinquished properties to the LLC prior to the trust’s termination, with the resulting multi-member LLC disposing of the relinquished properties and exchanging into replacement property after the termination.

In this case, each of the relinquished properties will be subject to a contract of disposition at the time the trust terminates and the properties are automatically transferred to the LLC (with the subsequent automatic transformation of the disregarded entity from an LLC to an entity which is taxed as a partnership). The primary concern in PLR 200651030 is that the LLC will not meet the “holding” requirement with respect to the relinquished properties because the properties are subject to contracts for their disposition at the time they are received by the LLC and the LLC is converted to a partnership for Federal tax purposes.

The IRS ruled that the transfer of the relinquished properties to the LLC subject to the contracts for their disposition will not violate the holding requirement of Section 1031(a) with respect to the exchanges. In so holding, the IRS cited the fact that after the trust’s terminating distribution of membership interests in the LLC to multiple beneficiaries, the resulting entity will be functionally like the trust and will be treated as a partnership among the beneficiaries merely for Federal income tax purposes. The IRS also cited the fact that the members of the LLC will be substantially identical to the trust beneficiaries, that the LLC will continue the trust’s real estate investment operations in a manner consistent with past practices, and that primarily the same managerial and operational structure will remain in place after the trust terminates. These facts distinguish this PLR from Rev. Rul. 77-337. Also note that this PLR’s guidance is virtually identical to the guidance of PLR 200521002.