As you know, Internal Revenue Code Section 1031(f) disqualifies certain types of related party like-kind exchanges from receiving the beneficial tax consequences provided for Section 1031 exchanges. Recently, the North Dakota District Court looked at an LKE program for a Caterpillar dealer’s affiliate in North Dakota. In this case, North Central Rental & Leasing, LLC v. United States, 112 AFTR 2d 2013-7045, the affiliate rented equipment and utilized a Rev. Proc. 2003-39 program to buy new equipment and sell equipment that was no longer being leased. Unlike notable earlier cases, such as Teruya Brothers v. Commissioner, 124 T.C. 45 (2005), aff’d 580 F.3d 1038 (CA-9, 2009), cert. den., and Ocmulgee Fields, Inc. v. Commissioner, 132 T.C. 105 (2009), aff’d 613 F.3d 1360, (CA-11, 2010), the taxpayer had a legitimate business reason to buy the replacement equipment from the affiliated dealer, Butler Machinery Company. Notwithstanding the significant differences between Teruya and Ocmulgee Fields on one hand and North Central on the other, the court found the reasoning of the two earlier cases persuasive and disallowed the transactions under Section 1031(f)(4).
North Central is not only an important case, it is a case of first impression. It raised for the first time in a judicial forum whether, as commentators have long contended, Section 1031(f)(4) should not apply if the related party acquired the replacement property in anticipation of transferring it to the exchanger as part of the exchanger’s like-kind exchange. However, the court seemed to confuse Section 1031(a) and Section 1031(f) by implying that the exchanger violated Section 1031(f)(4) because the related party temporarily had dominion over proceeds from the sale of the relinquished property. The court was highly influenced by the fact that the QI paid the dealer on closing for the replacement property, but the dealer did not have to pay Caterpillar until later.
I feel that the court missed an important opportunity to confirm or reject the inapplicability of Section 1031(f)(4) to this situation. If the inapplicability were confirmed, the court also missed the opportunity to delineate the “in-anticipation” rule and to explain how parties could factually substantiate in-anticipation acquisitions. With these concerns in mind, I co-authored an article with Brad Borden and Alan Lederman which analyzes where we believe the court may have been wrong and offers what we believe to be the correct analysis. The article is available here or you can find it on the Social Science Research Network (www.ssrn.com) and in the February 2014 edition of the Journal of Taxation.