In PLR 201609003, the IRS determined that a taxpayer was entitled to exclude gain attributable to the forced transfer of the taxpayer’s ownership of public use facilities, even though the taxpayer did not hold legal title to the facilities.
The taxpayer, through a subsidiary entity, built or bought certain public accommodation facilities. The taxpayer also operated these public accommodation facilities pursuant to a contract with a government agency. However, the taxpayer did not hold legal title to the facilities. To encourage the taxpayer to invest in the public accommodation facilities, the applicable contract provided that the taxpayer had the right to receive just compensation if the agency took the facilities or granted another person the right to operate those facilities. Congress later passed legislation giving the taxpayer a statutory beneficial ownership interest in the facilities (but not the underlying land). Related laws provide that a beneficial ownership interest cannot be extinguished by the expiration of the underlying contract and can be pledged as security for financing improvements with respect to the underlying property.
The agency subsequently bought a portion of the taxpayer’s beneficial ownership interest. The taxpayer was forced to sell its remaining beneficial ownership interest to a third party when the agency awarded a new contract to such third party. The taxpayer received payment for both sales of its beneficial ownership interests. At a later date, the agency awarded a new contract to the taxpayer to operate certain facilities at a different location and the taxpayer purchased existing buildings and improvements in order to satisfy its obligations under that new contract. Both the original contract and the new contract involved the operation of similar facilities.
If a taxpayer’s property is condemned by the government, Section 1033 of the Internal Revenue Code provides that such taxpayer can exclude any gain from the condemnation if such taxpayer purchases other similar or related property using the condemnation proceeds within a certain period of time. Property is similar or related if the “physical characteristics and end uses of the converted and replacement properties are closely similar.” If a taxpayer’s property is taken by the government for public use under the Fifth Amendment of the Constitution, then a condemnation has occurred for purposes of Section 1033.
The IRS determined that Congress, by virtue of its legislative activity, intended to provide the taxpayer in this case with the same property rights and protections as provided under the Fifth Amendment. Accordingly, the forced transfer by the taxpayer of its beneficial ownership interest constituted a condemnation of property. Further, because the taxpayer operated similar facilities at both locations, the newly-purchased buildings and improvements constituted similar or related property. Accordingly, the taxpayer was not required to recognize gain from the forced transfer of its beneficial ownership interests.
This ruling expands the scope of Section 1033 to include not only situations where a taxpayer has bare legal title to a piece of property, but also certain situations where a taxpayer has a more limited ownership interest in the property. Taxpayers who own or operate public facilities on behalf of a federal, state or local government or agency should be aware of this ruling in the event that such taxpayers are forced to transfer their limited ownership interests – if a taxpayer acquires replacement property that is substantially similar, such taxpayer may be able to defer recognition of gain from the forced transfer.
Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.
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