Four-way two-property exchange between related parties using an intermediary disallowed §1031 treatment

Reported by Bradley Markano

A property owner entered into an agreement to sell property to a buyer in a sale structured to transfer title through an intermediary. The proceeds from the sale were received by the intermediary and then used to purchase replacement property from a person related to the owner. The owner reported his profits on the sale as exempt from taxation under United States Code (USC) §1031, claiming the use of an intermediary to take title to the purchased property qualified the sale as an acquisition for §1031 treatment since the owner had not held the right to receive cash on demand at any time during the sale and purchase process, but had only dealt with conveyances in the sale and purchase of like-kind properties. The Internal Revenue Service (IRS) claimed the exchange did not qualify as an exempt §1031 transaction, since the transfer of title through an intermediary only circumvented the prohibition against obtaining replacement property in a §1031 transaction from a related party when either related party is cashed out of the property  within two years of the transaction. A United States Tax Court held the owner was not eligible for the §1031 exemption on the sale since the intermediary was merely a “straw man” whose sole purpose was to avoid constructive receipt of the cash on the sale of a property in what was otherwise a direct exchange  of ownership between the owner and his related party. [Teruya Brothers, LTD v. Commissioner of Internal Revenue (September 8, 2009)__TC ___]