• California’s Changing Approach to Like-Kind Exchanges

    Internal Revenue Code (IRC) Section 1031 allows nonrecognition of gain or loss where property held for investment or for productive use in a trade or business is exchanged for like-kind property held for the same purpose. An issue arising under Section 1031 involves multiple owners of a real estate business entity holding one or more investment properties, where some owners want to maintain their investment while others want to cash out their investment. One common technique when the owners want to go their separate ways with investments is for the entity to redeem the interest of the member in exchange for an undivided interest in the property (a so-called “drop-and-swap”). Thereafter, the entity and the former owner join in the sale of the property to a buyer. Following the sale, the former owner can direct its share of the sale proceeds to a qualified intermediary to be reinvested in like-kind property without recognizing gain.

    While California law conforms to Section 1031, the California Franchise Tax Board (FTB) has historically taken a much more restrictive approach than the IRS. Particularly in the area of drop-and-swaps, the FTB has disqualified attempted 1031 exchanges by asserting the step transaction doctrine and examining a series of integrated transactions as a whole. But in 2015, the California State Board of Equalization (BOE) departed from the FTB’s narrow interpretation of the rules, unanimously overruling the FTB’s disallowance of like-kind exchange treatment under Section 1031. The BOE does not often issue formal guidance that may be cited as precedent. However, the 2015 decision—In re Rago Development Corp., 2015-DBR-001— was issued as a formal opinion. The decision involved a “swap-and-drop,” which is an exchange followed by a capital contribution of the replacement property to an entity in return for an ownership interest in the entity. In that opinion, the BOE rejected the FTB’s assertion that the step transaction doctrine should treat it as though the taxpayer had exchanged real property interests for interests in an LLC.

    More recently, in August 2018, the new California Office of Tax Appeals (OTA) (which replaced the BOE as an administrative board) issued an opinion rejecting the FTB’s disqualification of Section 1031 like-kind treatment based on the step transaction doctrine. In Appeal of Mitchell, the taxpayer held an interest in a general partnership owning a single property as its sole asset. The majority of the other partners sought to cash out their interest, but the taxpayer wanted to maintain her investment in real estate through a 1031 exchange. A sale of the property was arranged and the partnership redeemed the taxpayer’s partnership interest for a TIC interest in the property. Thereafter, through a qualified intermediary, the taxpayer’s proceeds from the sale were reinvested in qualified property outside of California.

    The FTB issued a Notice of Proposed Assessment to the taxpayer in Mitchell, asserting that the transaction did not qualify as a 1031 exchange and that she must recognize gain from the sale of the property. Asserting the step transaction doctrine, the FTB argued that the taxpayer failed to meet the “exchange” requirement of Section 1031 because the partnership, rather than the taxpayer, made the sale of the property and the taxpayer was only a conduit for the sale.. On this point, the FTB stressed the fact that the partnership, and not the taxpayer, negotiated the sale of the property with the buyer. Additionally, the FTB asserted that the taxpayer did not satisfy the holding requirement for a Section 1031 property because she only held her TIC interest in the property for two days—the days between the redemption of her partnership interest and the sale of her TIC interest in the property to the buyer. The OTA disagreed.

    As to FTB’s argument that the step transaction doctrine applied, the OTA referred to the Tax Court and Ninth Circuit decisions in Magneson v. Commissioner, 753 F.2d 1490 (9th Cir. 1985) and Bolker v. Commissioner, 760 F.2d 1039 (9th Cir. 1985) to ignore the series of integrated transactions accomplishing the exchange. In Magneson, the court acknowledged that combining the steps of a transaction may not be appropriate if the transaction could not have been achieved directly. In Mitchell, the fact that some of the partners sought to cash out their investment while others sought to continue their investment presented such a situation. The OTA also rejected the FTB’s support for the argument that the transaction failed because the taxpayer did not negotiate directly for the sale, since the taxpayer worked directly with the managing partner and the partnership’s attorney in structuring the multiple steps leading up to the sale. Further, in response to the FTB’s argument that the taxpayer did not “hold” the property for investment, the OTA explained that Section 1031 does not require ownership of the relinquished property for any period of time. Moreover, citing Bolker, the OTA noted that courts have allowed simultaneous or immediate transfers of replacement property following an exchange.

    A potential distinction between the facts of Mitchell and Magneson is the nature of the interests held by the taxpayers. While both cases involved general partnership interests, Magneson involved a limited partnership and Mitchell involved a general partnership. While the court in Magneson did focus a significant portion of its opinion on the nature of a general partnership interest, it did not make any distinction based on which type of partnership the general partner held its interest in. Rather, the opinion explained the similarities between holding property via a general partnership interest and through a TIC interest. This portion of the decision, however, was mostly aimed at distinguishing partnership interests from corporate shares. Ultimately, the court in Magneson focused much more on the underlying property, providing that the “critical basis for [the] decision is that the partnership, in this case, had as its underlying assets property of like kind to the Magnesons’ original property, and its purpose was to hold that property for investment.”

    In both Magneson and Bolker, the court reasoned that the individual transactions in either series would not have triggered a tax, and therefore the combination of transactions should not have triggered a tax. Following this reasoning, the OTA found that the transaction involved “the use of a series of reasonable, necessary, and integrated transactions to delay, not avoid, the recognition of gain, which section 1031 allows.” These decisions by the BOE and the OTA are an indication that California may be finally aligning itself with the federal standards for qualifying 1031 exchanges (although the FTB has not yet decided whether it will request a rehearing).

    For more information, contact Tax Partner Jeffry Bernstein at jbernstein@coblentzlaw.com. Research analysis provided by Jessica N. Wilson.

  • Four Coblentz Partners Awarded Lawyers of the Year & 18 Recognized by Best Lawyers in America® 2019

    Four Coblentz Partners were awarded Lawyers of the Year and 18 were recognized by Best Lawyers in America® in its 2019 listing of the nation’s top legal talent.

    Jon Bass was named the Best Lawyers 2019 Litigation – Real Estate Law “Lawyer of the Year,” Alan Gennis was awarded Best Lawyers 2019 Real Estate Law “Lawyer of the Year,” Harry O’Brien was awarded Best Lawyers 2019 Land Use and Zoning Law “Lawyer of the Year,” and Tay Via was awarded Best Lawyers 2019 Litigation – Land Use and Zoning Law “Lawyer of the Year,” all in San Francisco.

    Congratulations to these Coblentz attorneys for inclusion in the Best Lawyers in America® 2019 guide in the following categories in San Francisco:

    • Jon Bass: Commercial Litigation, Litigation – Land Use and Zoning, Litigation – Real Estate
    • Jeff Bernstein: Litigation and Controversy – Tax, Tax Law
    • Tim Crudo: Criminal Defense: White-Collar
    • Pam Duffy: Environmental Law, Land Use and Zoning Law, Litigation – Environmental, Litigation – Land Use and Zoning, Real Estate Law
    • Phil Feldman: Litigation – Trusts and Estates, Trusts and Estates Law
    • Gregg Ficks: Bankruptcy and Creditor Debtor Rights / Insolvency and Reorganization Law, Litigation – Bankruptcy
    • Karen Frank: Copyright Law, Litigation – Intellectual Property
    • Alan Gennis: Real Estate Law
    • William Hutton: Tax Law
    • Jeff Knowles: Commercial Litigation
    • Danna Kozerski: Real Estate Law
    • Barbara Milanovich: Real Estate Law
    • Jim Mitchell: Trusts and Estates Law
    • Harry O’Brien: Land Use and Zoning Law, Real Estate Law
    • Richard Patch: Litigation – Antitrust
    • Doug Sands: Real Estate Law
    • Bob Stein: Real Estate Law
    • Tay Via: Land Use and Zoning Law, Litigation – Land Use and Zoning

    The Best Lawyers annual guide is based on peer review and feedback from tens of thousands of leading attorneys who confidentially evaluate their professional peers. For the 2019 Edition of Best Lawyers, 7.8 million votes were analyzed, which resulted in almost 60,000 leading lawyers being included in the new edition.


    Categories: News
  • Coblentz Family Wealth Partners are Again Top-Ranked by Chambers High Net Worth 2018

    Coblentz Partners Philip Feldman, James Mitchell, and Jaime Mannon are listed as Leading Lawyers in the Private Wealth Law category of the 2018 Chambers HNW (High Net Worth) guide for Northern California, published by Chambers & Partners.

    Jim Mitchell is again ranked as a Leading Lawyer in Band 2. One source was “impressed by his personal qualities and the depth of his knowledge. His advice is always helpful and he pays attention to the details.” Another client adds that ” Technically he’s perfect. Jim is an incredible listener. When he speaks he is spot-on, there is no waste of time. He’s honest, smart and a great listener.” A market insider notes that Jim “has been around and is at the top of his game. He is excellent; anyone in his care is in good hands.”

    Phil Feldman is again ranked as a Leading Lawyer in Band 2, where one client or colleague interviewed note that Phil “exhibits an impressive combination of strong technical skills and strong interpersonal skills.” Another adds that he “has a great combination of strong technical knowledge and being able to relate well to many different types of clients and make a personal connection with them.”

    Jaime Mannon is listed as an Up and Coming Leading Lawyer by Chambers. Clients and colleagues love working with Jaime and noted that her “strengths are that she takes the time to understand complex matters, she is efficient and professional at all times. She is extremely reliable.” Another interviewee raves over her abilities, saying “She is young, she is dynamic and she is just brilliant. Her documents are chameleon-like – things can change in a family situation and the documents still stick. She’s young but has so much talent, she should lead the world.”

    The Coblentz Family Wealth practice is also listed by Chambers HNW in Band 2 for Private Wealth Law, Northern California. Chambers writes that the group “has deep experience advising wealthy families on a range of wealth transfer matters. The firm assists with estate and gift tax planning, the administration of trusts and estates, and business succession planning. It also handles litigation.” Colleagues and clients mention that “They are an excellent firm with wonderful lawyers. I have found the best representatives in Coblentz – I would be lost without them.” Another source adds “I think they are excellent, they’re good communicators and straightforward.”

    Independent and objective, Chambers USA and Chambers HNW are carefully researched and widely considered to be the most reputable law firm directories in the world. Ranking criteria include technical legal ability, professional conduct, client service, commercial astuteness, diligence, commitment and other qualities most valued by legal clients.

    Categories: News