Internal Revenue Service (IRS)
Revenue Ruling (Rev. Rul.)
26 USC § 1031; 26 CFR § 1.1031(a)-1
26 USC § 1033; 26 CFR § 1.1033(a)-1
Published: April 25, 1983
Involuntary Conversions; Replacement Property; Fee Simple Interest for 15-Year Leasehold
Involuntary conversions; replacement property; fee simple property interest for 15-year leasehold. A timely acquired fee simple property interest qualifies under section 1033(a) of the Code as replacement property similar or related in service to an involuntarily converted 15-year leasehold because the fee property is to be used in the same business and for the identical purposes as the condemned leasehold.
Whether, for purposes of section 1033 of the Internal Revenue Code, the investment of condemnation proceeds in a fee simple property interest, under the circumstances described below, can qualify as replacement property similar or related in service or use to a leasehold interest involuntarily converted?
Y, a domestic corporation, is engaged in the business of hauling, handling, and storage of furniture.
Y leased from individual A 10 acres of land improved by an office building and several small warehouses in which it stored furniture. The lease was a net lease and commenced on August 1, 1975, for a term of 20 years. There were no renewal options under the lease.
In 1980, city X, under its condemnation authority, condemned the property Y was leasing from A.
Y (lessee) received a portion of the condemnation proceeds as compensation for Y ‘s property interest in the unexpired term of the leasehold. The taxpayer realized a gain upon the receipt of its share of the condemnation proceeds.
Y, within the period specified in section 1033(a)(2)(B) of the Code, acquired a fee simple interest in real property improved with a warehouse and an office building. The property is to be used by Y in the same business and for the identical purposes as the condemned leasehold.
Law and Analysis
Section 1033(a)(2)(A) of the Code provides that if property is compulsorily or involuntarily converted into money and the taxpayer during the period specified purchases other property similar or related in service or use to the property so converted, at the election of the taxpayer, the gain shall be recognized only to the extent that the amount realized upon such conversion exceeds the cost of such other property.
Section 1033(g) of the Code provides that, for purposes of section 1033(a), if real property (not including stock in trade or other property held primarily for sale) held for productive use in trade or business or for investment is (as the result of its seizure, requisition, or condemnation, or threat or imminence thereof) compulsorily or involuntarily converted, property of a like kind to be held either for productive use in trade or business or for investment shall be treated as property similar or related in service or use to the property so converted.
Section 1.1033(g)-1(a) of the Income Tax Regulations provides that the principles set forth in section 1.1031(a)-1(b) shall be used in determining whether replacement property is property of like kind.
Section 1.1031(a)-1(b) of the regulations provides that the words “like kind” have reference to the nature or character of the property and not to its grade or quality. Section 1.1031(a)-1(c) illustrates this point by providing that the exchange of a leasehold of a fee with 30 years or more to run for real estate will be treated as a like kind exchange.
Therefore, for purposes of determining whether a leasehold interest will be treated like a fee interest under section 1033(g) of the Code, the leasehold interest must have a remaining term of at least 30 years in order to be of the same “nature” as a fee interest in real property. Under the facts described above, the condemned leasehold interest had a remaining term of only 15 years. Because the leasehold interest condemned had a remaining term of less than 30 years, the taxpayer cannot rely on the “like kind” provisions of section 1033(g) to defer recognition of the gain.
However, under section 1033(a) of the Code, a leasehold interest may be “similar or related in service or use” to a fee interest. In Davis Regulator Company v. Commissioner, 36 B.T.A. 437 (1937), acq., 1937-2 C.B. 7, the United States Board of Tax Appeals held that a taxpayer did not have to recognize gain on the receipt of proceeds received with respect to the condemnation of a leasehold interest to the extent that the proceeds were invested in the construction of a building on land owned by the taxpayer. The new building was used for the identical purpose as the converted leasehold. The court’s decision was based on the “similar or related in service or use” standard currently found in section 1033(a)(2)(A) of the Code.
Y ‘s timely acquired fee simple property interest qualifies under section 1033(a) of the Code as replacement property similar or related in service or use to Y ‘s involuntarily converted 15-year leasehold because the fee property is to be used by Y in the same business and for the identical purposes as the condemned leasehold.