The following article is adapted and reprinted from the M&A Tax Report, Vol. 9, No. 3, October 2000, Panel Publishers, New York, NY.

1031 EXCHANGES OF BUSINESSES?

By Robert W. Wood

Section 1031, long the favorite of Internal Revenue Code provision of real estate investors (and some real estate developers, too) has long been one of the IRS's heavy interest areas. But it was not until 1986 (with General Utilities repeal), that like-kind exchanges under Section 1031 truly became a subject of interest outside the real estate field. Section 1031 exchanges of businesses have become popular, albeit only in a limited sphere.

Actually, most businesses exchanged under Section 1031 have been radio or television stations. A recent example Is Technical Advice Memorandum 200035005, Tax Analysts Doc. No. 2000-22675, 2000 TNT 172-12. There, a corporation exchanged its FCC radio broadcast station licenses for an FCC television broadcast license, and the exchange was ruled to be covered by Section 1031.

Section 1031 of the Code permits a tax-free exchange of property held for productive use in a trade or business or for investment, for property that is "like-kind." In the case of real estate, virtually any variety of realty is considered like-kind with other real estate. For example, unimproved real property is like-kind with respect to improved real property, and a leasehold interest with a 30-year or more term is considered like-kind to a fee interest in realty. In fact, about the only real property that doesn't qualify as like-kind is foreign property.

Still, problems have occasionally arisen with respect to Section 1031's "holding" requirement. Section 1031 only works if both the property exchanged out and the property exchanged in are held for use in a trade or business or for investment. If the property is received in exchange for property that is so held but is promptly disposed of, the IRS can be expected to challenge the applicability of Section 1031.

Basically, the IRS would say that the property received in the exchange was not "to be held" for the relevant purposes. Corporate taxpayers can have this problem to the same extent as other taxpayers. Unfortunately, there is no clear rule on how long after an exchange under Section 1031 the property that is received in the exchange must be held for investment or business use.

Mergers and Holding Period

In Letter Ruling 9850001 a corporation consummated a like-kind exchange and, as part of the plan, it liquidated into its parent. The parent promptly merged into a sister subsidiary. The question was whether the liquidation and the merger affected the requirement that the property be held by the taxpayer for investment or use in a trade or business. The ruling concluded that such transactions did not oust Section 1031 of jurisdiction. Each of the transactions (the liquidation and merger) was a transaction referred to in Section 381.

Whole Business Transfer

The deal in Technical Advice Memorandum 200035005 was accomplished by a subsidiary of an affiliated group entering into an asset exchange agreement and thereafter transferring several radio stations in exchange for a television station. The parent company treated this as a like-kind exchange, reporting gain only on the difference between the reported values of the licenses.

In the Tech Advice Memo, the IRS noted that the determination whether the licenses are like kind depends on: (1) the nature or character of the rights involved; and (2) the nature or character of the underlying property to which the intangible personal property relates. Each of these FCC licenses confers a right to broadcast (with a designated channel and frequency, etc), even though radio and television are different media. The IRS found that these were mere differences in grade or quality, not changing the nature of the right granted.

Furthermore, the IRS determined that although radio and television broadcasts are assigned to different frequency bands of the frequency spectrum, and that a broadcaster would be in violation of its license if it used a television frequency to broadcast radio transmissions (or vise-versa), the difference in assigned frequency is not a difference in character or nature.

1031 Exchanges of Businesses?, Vol. 9, No. 3, M&A Tax Report (October 2000), p. 6.