Bartell v. Comm'r
| Decision Date | 10 August 2016 |
| Docket Number | Docket No. 22891-05.,147 T.C. No. 5,Docket No. 22829-05,Docket No. 22709-05 |
| Parties | ESTATE OF GEORGE H. BARTELL, JR. DECEASED, GEORGE DAVID BARTELL AND JEAN LOUISE BARTELL BARBER, CO-PERSONAL REPRESENTATIVES AND ESTATE OF ELIZABETH BARTELL, DECEASED, GEORGE DAVID BARTELL AND JEAN LOUISE BARTELL BARBER, CO-PERSONAL REPRESENTATIVES, ET AL., Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
In 1999, BD, a drugstore chain, entered into an agreement to purchase property L from a third party. In anticipation of structuring an exchange transaction under I.R.C. sec. 1031 to facilitate acquisition of L, BD later assigned its rights in the purchase agreement to third-party exchange facilitator EPC and entered a further agreement with EPC. That second agreement provided for EPC to purchase L and for BD to have a right to acquire L from EPC for a stated period and price. EPC so purchased L on August 1, 2000, with bankfinancing guaranteed by BD, acquiring title to L at that time. BD then managed the construction of a drugstore on L using proceeds from the aforementioned financing and, upon substantial completion of the construction in June 2001, leased the store from EPC from that time until title to L was transferred from EPC to BD on December 31, 2001.
In late 2001, BD contracted to sell its existing property E to a fourth party. BD next entered an exchange agreement with intermediary SS and assigned to SS its rights under the sale agreement and under the earlier agreement with EPC. SS sold E, applied the proceeds of that sale to the acquisition of L, and had the title to L transferred to BD on December 31, 2001.
Held: BD's disposition of E and acquisition of L in 2001 qualifies for nonrecognition treatment pursuant to I.R.C. sec. 1031 as a like-kind exchange, as EPC is treated as the owner of L during the period it held title to the property. Alderson v. Commissioner, 317 F.2d 790 (9th Cir. 1963), rev'g 38 T.C. 215 (1962), and Biggs v. Commissioner, 69 T.C. 905 (1978), aff'd, 632 F.2d 1171 (5th Cir. 1980), followed.
Robert J. Chicoine and John Mark Colvin, for petitioners.
Ilesa B. McAuliffe and William A. McCarthy, for respondent.
GALE, Judge: Respondent determined the following deficiencies and penalties with respect to petitioners' Federal income tax:
Petitioners Year Deficiency Estate of George H. Bartell, Jr., etc. 2001
$231,001 George D. and June M. Bartell
2001 2002 167,898 14,216 David H. and Jean B. Barber
2001 2002 2003 49,604 19,707 5,091
These cases have been consolidated for purposes of trial, briefing, and opinion. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended and in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
The principal issue for decision is whether a property transaction undertaken by the Bartell Drug Co. (Bartell Drug), an S corporation owned by petitioners, qualified for nonrecognition treatment pursuant to section 1031 as a like-kind exchange.2
Some of the facts have been stipulated and are so found. The stipulations, with accompanying exhibits, are incorporated herein by this reference. At the time the petitions were filed, all petitioners were residents of Washington State.
Bartell Drug owned and operated a chain of retail drugstores during the years at issue and had been doing so in Seattle, Washington, and surrounding areas for more than 100 years. Ownership of the company has remained in the Bartell family since its founding in 1890. During the years at issue, all shares in Bartell Drug were held by petitioners George H. Bartell, Jr.,3 and his two children George D. Bartell and Jean B. Barber.
The foregoing family members served on the company's board of directors in various capacities and as officers during the period under consideration. Jean B. Barber (sometimes Jean Barber) served as chief financial officer of Bartell Drug, as well as secretary and a director on the board throughout that period.
In conducting its retail business, Bartell Drug owned some of the properties in which its stores operated and leased others. Before the 1980s, most of Bartell Drug's stores were in shopping centers anchored by grocery stores, generally in a strip-mall format with the drugstore space sited between two other merchants. Developers of those centers would typically approach Bartell Drug, offering space in an already-planned complex.
In the ensuing decades, however, two key, and to some degree interrelated, developments affected the business model for retail drugstores. First, grocery stores began including pharmacies within their stores. That innovation both reduced the attractiveness of the grocery-anchored centers for competing drugstores and prompted grocery stores to have developers restrict leasing to such competitive merchants. Second, Walgreen Co. (Walgreens), a national drugstore chain, introduced on a massive scale and to notable success a store format that shifted the paradigm for drug retailing. The emphasis became freestanding corner locations with drive-through pharmacies. Walgreens entered the Seattle area market in the early to mid-1990s, at which point Bartell Drug came under increasing pressure. The national chains Walgreens, Rite Aid Corp., and Safeway, Inc., became increasingly influential and Bartell Drug's chief competitors in the market.
Given the foregoing, Bartell Drug management faced the prospect of the growing obsolescence of its retail locations and sought to formulate a strategy to update its portfolio of owned and leased properties. The changed business climate generally required Bartell Drug to undertake development of new sites itself in order to open freestanding stores. Such a project often necessitated a significantly greater financial commitment, frequently encompassing land acquisition and/or building construction costs, than that involved in merely occupying a space built by a third-party developer. Additionally, the properties owned by Bartell Drug at that juncture generally had very low bases, such that outright sale could produce significant taxable gain.
In the early to mid-1990s, Jean Barber was introduced to the concept of section 1031 exchanges through her husband, a real estate broker. Following further investigation and consultation with professional advisers, the Bartell Drug board of directors adopted as a policy and authorized management to pursue a strategy of employing section 1031 exchanges to update the company's real estate portfolio and acquire new store locations. That decision was made in 1998 and was followed by four such exchanges.
In executing the section 1031 exchanges, Bartell Drug worked with Section 1031 Services, Inc., a corporation that provided qualified intermediary services to taxpayers, and a related corporation, Exchange Structures, Inc. Exchange Structures, in turn, set up wholly owned limited liability companies to serve as exchange intermediaries in such transactions. One such limited liability company was EPC Two, LLC (EPC Two), a Washington State entity having Exchange Structures as its sole member. As discussed hereinafter, EPC Two served as the exchange intermediary in the transaction at issue.
Bartell Drug had operated a small store in Lynnwood, Washington, since the mid-1980s. That store was in a poorly maintained strip mall. By 1999 only a few years remained on the existing lease for the Lynnwood store, and Bartell Drug was interested in considering other properties. The company's real estate manager began looking into potential sites. At the time, it was rumored that Walgreens was also scouting locations in the Lynnwood area, one of which was likewise attractive to Bartell Drug.
That property was a recycling center, owned by Mildred M. Horton,4 across the street from Bartell Drug's existing Lynnwood store. On April 1, 1999, Bartell Drug's real estate manager had an initial meeting with Mildred Horton and her attorney regarding the property. Further negotiations followed, and as they proceeded Bartell Drug ordered a first commitment for title insurance for the site (hereinafter the Lynnwood property), effective April 21, 1999. The commitment identified Mildred Horton as "Seller" and Bartell Drug as "Buyer/Borrower" and "Proposed Insured". Bartell Drug also contacted an engineering firm aboutproviding a boundary and topographic survey of the Lynnwood property, and the firm responded with a proposal dated April 23, 1999.
The sale negotiations culminated on May 7, 1999, with the execution by Mildred Horton as "Seller" and Bartell Drug as "Buyer" of a Real Estate Purchase and Sale Agreement (sale agreement). The sale agreement recited a total purchase price of $1,898,640, payable in cash at closing, and set forth a closing date of August 1, 2000. In addition, the sale agreement specified a series of steps and deadlines to occur in the interim, relating to due diligence, title, survey, inspections, and environmental reports, as well as requirements for periodic earnest money payments totaling $100,000 to be deposited by Bartell Drug in escrow. The sale agreement also contained the following clause:
14.5 Section 1031 Exchange. Buyer and Seller agree to reasonably cooperate with each other to accomplish any exchange under Section 1031 of the Internal Revenue Code, including permitting assignment of this Agreement to an exchange facilitator; provided that the cooperating party is put to no liability or expense in connection therewith.
After execution of the sale agreement, Bartell Drug began to undertake the steps contemplated therein and related actions aimed at finalizing the acquisition and construction of a drugstore on the Lynnwood property. Bartell Drug ordered a second commitment for title insurance effective May 18, 1999, that modified certain listed exceptions not pertinent...
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