By Ronald A. Shellan, LLB, CPA
Miller, Nash, Wiener, Hager, & Carlsen LLP

The IRS has held that a partnership cannot complete a tax-free exchange if the replacement properties are immediately transferred to various partners of the partnership.

In TAM 9818003 (Dec.24, 1997), the partnership had owned the relinquished property for 14 years. The partnership agreement contemplated eventually disposing of a property owned by the partnership as part of a tax-free exchange. The partnership agreement allowed each partner to designate replacement properties that would be funded from the sale of the relinquished property as part of a tax-free exchange.

The partnership did in fact sell relinquished property through a bank that served as the partnerships exchange accommodator. Some of the partners then designated replacement properties as part of an exchange that was simultaneous with the liquidation of the partnership. The IRS held that the transaction did not qualify for tax-free treatment because the transaction was not reciprocal. (i.e. the parties receiving the replacement properties (the partners) were not the same as the party disposing of the relinquished property (the partnership)).

Although the IRS did not mention this argument in the ruling, the IRS might have analyzed the transaction as an exchange by the partnership for replacement property that the partnership transferred to its partners in complete liquidation of the partnership. Viewed in this light, the transaction would be subject to IRS challenge on the basis that the property was not acquired by the partnership with the intent of holding the replacement property in its trade or business or for investment, but rather for immediate transfer in liquidation the partners.

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