Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 68-394

1968-2 C.B. 338

Sec. 1031

Sec. 1033

IRS Headnote

The purchase of a leasehold of 30 or more years on property already owned by a taxpayer, immediately following the condemnation of unimproved real estate, qualifies as a `like kind' replacement of property for purposes of section 1033(g) of the Code.

Full Text

Rev. Rul. 68-394

Advice has been requested whether the investment of condemnation proceeds, under the circumstances set forth below, will qualify as replacement of involuntary converted property for purposes of section 1033 of the Internal Revenue Code of 1954.

In 1965, land held by the taxpayer for investment was condemned for a state freeway. The taxpayer owned adjacent land that he had leased to a second party to use and develop as a mobile trailer park site. For purposes of replacing the condemned property, the taxpayer used part of the condemnation proceeds to acquire by purchase the outstanding leasehold on the adjacent property. The lease still had 45 years to run at the time of purchase. After acquisition of the leasehold, the taxpayer used the land as a mobile trailer park site. His purchase of the outstanding leasehold was an arm's-length transaction.

Section 1033(a) of the Code provides that if property is compulsorily or involuntarily converted into money, the gain shall be recognized except, if the taxpayer so elects, to the extent that the taxpayer, during a specified period, for the purpose of replacing the property so converted, purchases other property similar or related in service or use to the property so converted. If qualified replacement property is purchased, gain shall be recognized only to the extent that the amount realized upon such conversion exceeds the cost of such replacement property.

Section 1033(g) of the Code provides that if real property not held primarily for sale, but held for productive use in trade or business or for investment, is compulsorily or involuntarily converted (as the result of its seizure, requisition, or condemnation, or threat or imminence thereof), property of a like kind to be held either for productive use in trade or business or for investment shall be treated as property similar or related in service or use to the property so converted. Section 1.1033(g)-1(a) of the Income Tax Regulations refers to section 1.1031(a)-1 of the regulations for guidance in determining whether the replacement property is property of like kind.

Section 1031(a) of the Code reads as follows:

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.

Section 1.1031(a)-1 of the regulations defines the words `like kind' as having reference to the nature or character of property and not to its grade or quality. It furhter provides, in part, as follows:

(b) * * * One kind or class of property may not * * * be exchanged for property of a different kind or class. The fact that any real estate involved is improved or unimproved is not material, for that act relates only to the grade or quality of the property and not to its kind or class. Unproductive real estate held by one other than a dealer for future use or future realization of the increment in value is held for investment and not primarily for sale.

(c) No gain or loss is recognized if * * * a taxpayer who is not a dealer in real estate exchanges city real estate for a ranch or farm, or exchanges a leasehold of a fee with 30 years or more to run for real estate, or exchanges improved real estate for unimproved real estate * * *.

Section 1.1031(a)-1 of the regulations is controlling for purposes of determining whether the replacement property is of like kind as required by section 1033(g) of the Code. In this regard, the regulations state that the exchange of a leasehold with 30 years or more to run for real estate qualifies as like kind of property for purposes of section 1031 of the Code. Therefore, since the exchange of a leasehold interest for real estate or vice versa constitutes a replacement of like kind of property for purposes of section 1031 of the Code, the acquisition of a leasehold interest with more than 30 years to run following the condemnation of unimproved real estate as in the instant case would likewise qualify as a replacement of property of like kind for purposes of section 1033(g) of the Code.

It is not material that the taxpayer acquired the leasehold on property already owned by him so long as he acquired it in an arm's-length transaction.

By purchasing the outstanding leasehold the taxpayer acquired the right to enjoy the possession of this land prior to the time he would have come into its possession under the terms of the lease. Therefore, the acquisition of this right constitutes a replacement of property of like kind for purposes of section 1033(g) of the Code.

Accordingly, under the facts of this case, the purchase of the leasehold by the taxpayer, immediately following the condemnation of unimproved real estate, represents the purchase of property of like kind for purposes of section 1033(g) of the Code.