Magneson v. C.I.R.

• Decision Date: 20 February 1985
• Docket Number: No. 84-7069,84-7069
• Citation: 753 F.2d 1490
• Parties: -911, 53 USLW 2439, 85-1 USTC P 9205 Norman J. and Beverly G. MAGNESON, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1490

753 F.2d 1490

55 A.F.T.R.2d 85-911, 53 USLW 2439, 85-1

USTC P 9205

Norman J. and Beverly G. MAGNESON, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 84-7069.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Dec. 7, 1984.

Decided Feb. 20, 1985.

Thomas W. Bettles, Post, Kirby, Noonan, Sweat, San Diego, Cal., for petitioner-appellee.

Raymond Hepper, Washington, D.C., for respondent-appellant.

On appeal from the United States Tax Court.

Before WALLACE and BOOCHEVER, Circuit Judges, and JAMESON, ^* District Judge.

BOOCHEVER, Circuit Judge:

We are faced in this case with an issue of first impression in the Courts of Appeals: whether property acquired in a like-kind exchange with the intention of contributing it to a partnership under Internal Revenue Code Sec. 721 is "held" for investment within the meaning of Internal Revenue Code Sec. 1031(a).

Petitioners Norman and Beverly Magneson exchanged a fee interest in one piece of real estate for a fee interest in another. The same day they contributed the acquired real estate to a limited partnership in return for a general partnership interest. The Magnesons claim nonrecognition of gain on both the exchange and the contribution under sections 1031(a) and 721 of the Internal Revenue Code. ¹ The Tax Court held that the taxpayers qualified for nonrecognition, 81 T.C. 767 (1983), and the Commissioner appeals. We affirm.

The Magnesons were the sole owners of an apartment building in San Diego, California (Iowa Street Property). They held the property for productive use in trade or business or for investment within the meaning of section 1031(a). N.E.R. Plaza, Ltd. (NER) was the sole owner of commercial property in San Diego, California, known as the Plaza Property (Plaza Property).

Pursuant to a prearranged transaction consummated on August 11, 1977, the Magnesons transferred their fee interest in the Iowa Street Property to NER in exchange for a ten-percent undivided fee interest in the Plaza Property. Thereafter, on the same day, both the Magnesons and NER transferred their interests in the Plaza Property to U.S. Trust, Ltd. (U.S. Trust), a limited partnership under California law. In exchange for cash and their ten-percent interest in the Plaza Property, the Magnesons received a general partnership interest in U.S. Trust consisting of a ten-percent equity interest and a nine-percent interest in net profits and losses. U.S. Trust was formed for the purpose of acquiring, holding, and operating the Plaza Property. The Magnesons paid no tax on the gain realized from their exchange of the Iowa Street Property for the Plaza Property, claiming nonrecognition treatment under section 1031(a). They also paid no tax on the gain realized from their contribution of the Plaza Property to U.S. Trust, claiming nonrecognition treatment under section 721.

The parties agree that the contribution of the Plaza Property to U.S. Trust qualifies for nonrecognition of gain under section 721, which provides that "[n]o gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership." The parties also agree that the Iowa Street Property and the Plaza Property are like-kind properties within the meaning of section 1031(a), which in 1977 provided:

No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.

For purposes of this opinion we will use the phrase "held for investment" when discussing the holding requirement of section 1031(a), because the distinction between productive use and investment is not at issue.

I. THE HOLDING REQUIREMENT OF SECTION 1031(a)

The Commissioner argues that the exchange of the Iowa Street Property for the Plaza Property cannot qualify for nonrecognition under section 1031(a) because the Magnesons did not "hold" the Plaza Property for investment. The Magnesons contend that holding the property to contribute to a partnership is "holding" the property for investment. The court found for the Magnesons. The majority concluded that the contribution of the Plaza Property to U.S. Trust was a continuation of the Magnesons' investment unliquidated but in a modified form, and that therefore the Magnesons did hold the Plaza Property for investment. 81 T.C. at 771-72. We review the Tax Court's conclusions of law de novo, noting however that its opinions are entitled to respect because of its special expertise in the field. California Federal Life Insurance Co. v. Commissioner, 680 F.2d 85, 87 (9th Cir.1982).

To qualify for nonrecognition treatment under section 1031(a), the taxpayer must, at the time the exchange is consummated, intend to hold the property acquired for investment. Regals Realty Co. v. Commissioner, 127 F.2d 931, 934 (2d Cir.1942); see Margolis v. Commissioner, 337 F.2d 1001, 1003-05 (9th Cir.1964). Numerous cases have held that the taxpayers' intent at the time of the exchange to liquidate their interest in the property acquired disqualifies the exchange from nonrecognition under section 1031(a). See, e.g., Regals Realty, 127 F.2d at 933-34 (intent to sell); Click v. Commissioner, 78 T.C. 225, 233-34 (1982) (intent to give as gift); Lindsley v. Commissioner, T.C.M. (P-H) 1983-729, at 3047-48 (intent to give to charity); Land Dynamics v. Commissioner, T.C.M. (P-H) 1978-259, at 1107-08 (intent to sell). But see Wagensen v. Commissioner, 74 T.C. 653, 658-59 (1980) (intent at time of exchange to hold for productive use not negated by desire to give eventually to children). It is stipulated that the Magnesons intended at the time of the exchange to hold the property for contribution to U.S. Trust. Therefore, the Magnesons' exchange can only qualify under section 1031(a) if contributing property to a partnership in return for an interest in the partnership is "holding" the property for investment within the meaning of section 1031(a).

We have found no precedent on point at either the Tax Court or the circuit court level. Revenue Ruling 75-292, 1975-2 C.B. 333, relied on by the Commissioner, addresses a related question: whether a like-kind exchange followed by a transfer for stock under section 351 ² to a controlled corporation qualifies for nonrecognition under section 1031(a). The Service ruled that the property transferred to the corporation was no longer held by the taxpayer, and gain was recognized on the exchange. Id. at 334. Revenue rulings, however, are not binding on this court. Ricards v. United States, 683 F.2d 1219, 1224 & n. 12 (9th Cir.1981) (rulings not dispositive although entitled to consideration as "body of experience and informed judgment"). More significantly, transfer to a corporation in exchange for shares is distinguishable from transfer to a partnership for a general partnership interest in several important ways.

First, a corporation is a distinct entity, apart from its shareholders, whereas a partnership is an association of its partner-investors. Shareholders have no ownership interest in the assets of a corporation; partners own the assets of a partnership. Shareholders have no participation in daily management of corporate assets and very little participation in long-term management; general partners are the managers of the partnership. Thus when the owner of property transfers it to a corporation in exchange for shares, he relinquishes ownership and control of the property. In contrast, he retains both in a transfer to a partnership for a general partnership interest.

Second, a like-kind exchange followed by a section 351 transfer, viewed as a whole, results in the exchange of property for stock. The parenthetical clause of section 1031(a) expressly excludes stock as property eligible for exchange, but there is no such prohibition on exchange of partnership interests. Long v. Commissioner, 77 T.C. 1045, 1066-68 (1981) (rejecting Commissioner's argument that partnership interests fit within exclusionary clause as choses in action or evidences of interests). Revenue Ruling 75-292 is therefore inapplicable to this case.

The central purpose of both sections 721 and 1031(a), as stated by the Treasury Regulations, is to provide for nonrecognition of gain on a transfer of property in which the differences between the property parted with and the property acquired "are more formal than substantial," and "the new property is substantially a continuation of the old investment still unliquidated." Treas.Reg. 1.1002-1(c), T.D. 6500, 25 Fed.Reg. 11910 (1960). ³ The regulations reflect the legislative history of the predecessor of section 1031(a). See H.R.Rep. No. 704, 73d Cong., 2d Sess. 12, reprinted in 1939-1 C.B. (pt. 2) 554, 564; Starker v. United States, 602 F.2d 1341, 1352 (9th Cir.1979) (section 1031 "designed to avoid the imposition of a tax on those who do not 'cash in' their investments in trade or business property"). Furthermore, as the Tax Court noted, the regulations unequivocally describe section 721 as representing a continuation, not a liquidation, of the old investment. The case law, the regulations, and the legislative history are thus all in agreement that the basic reason for nonrecognition of gain or loss on transfers of property under sections 1031 and 721 is that the taxpayer's economic situation after the transfer is fundamentally the same as it was before the transfer: his money is still tied up in investment in the same kind of property. Koch v. Commissioner, 71 T.C. 54, 63-64 (1978); see Starker, 602 F.2d at 1352; Biggs v....