Deferred Like-Kind Exchanges

If a taxpayer wants to exchange business or investment property tax-free under the IRC section 1031 like-kind exchange rules, when must he or she receive the replacement property? Section 1031 establishes two conditions a taxpayer must meet to qualify a transaction as a deferred like-kind exchange:

1. The replacement property must be identified within 45 days.
2. The taxpayer must receive the replacement property by the earlier of the due date of his or her tax return (including extensions) or 180 days after the transfer.

Orville Christensen owned business property which he transferred to a facilitator (someone who is paid to arrange a like-kind exchange) on December 22, 1988, as the first step in a tax-free, deferred like-kind exchange. Christensen identified the replacement properties on February 3, 1989. He received those properties from the facilitator between April 25 and June 20, 1989. While Christensen met the first condition for a section 1031 exchange, he and the IRS disagreed over whether he met the second. He appealed the IRS decision.

Result: For the IRS. The Ninth Circuit Court of Appeals rejected the taxpayers claim that, because of the availability of an automatic extension to file his tax return, the due date should include the extension period even if the taxpayer did not request an extension. According to the court, the IRC is clear. It says the property must be received no later than the due date of a return, including extensions. That can only mean extensions that are actually granted.

Christensen argued that he had substantially complied with the requirement. He contended that, by filing his return on the actual due date, he had provided the IRS with the information it needed. Therefore, he substantially complied with the requirements in section 1031. The Ninth Circuit rejected the argument that filing a return is substantially equivalent to an extension.

If the taxpayers return is due prior to 180 days after the property transfer in question, he or she must apply for a filing extension in order to have the entire 180 days to obtain the replacement property. The courts will reject all arguments that the extension is not necessary or that the taxpayer substantially complied with all requirements. If it turns out the property is not received on time, the sale will usually qualify for installment treatment, allowing the taxpayer to report the gain in the year the property is received rather than in the year of the original transfer.

• Orville Christensen v. Commissioner, 98-1, USTC 50, 352 (Ninth Circuit Court of Appeals).

Prepared by Edward J. Schnee, CPA,
PhD, Joe Lane Professor of Accounting and
director, MTA program, Culverhouse
School of Accountancy, University of
Alabama, Tuscaloosa.