In VIP’s Industries Inc. (Tax Court, June 24, 2013), the taxpayer attempted to complete a tax-deferred likekind exchange under IRC Section 1031 by exchanging a leasehold interest in real property on which the taxpayer had constructed and operated a motel. The lease of the real property had another 21 years and four months remaining on its term. The taxpayer exchanged this leasehold interest for fee interests in two parcels of real property, one of which was improved with a motel and the other with an office building.

The question before the court was whether a leasehold in real property with a 21-year-and-four-month term was like-kind to a fee interest in real property. The Tax Court held that the leasehold was not like-kind with the fee interest and denied the taxpayer Section 1031 exchange treatment. The regulations under IRC Section 1031 provide that a leasehold interest in real property with 30 years or more remaining on its term is like-kind with a fee interest in real property. The question was whether this is an absolute minimum or merely a safe harbor.

It is surprising that the taxpayer attempted this exchange, at least if it obtained competent advice first. The Tax Court had previously held in May Department Stores v. Commissioner that a leasehold with 20 years remaining on its term was not like-kind with a fee interest. That case was decided in 1951, so its existence should not have come as a surprise. Perhaps the taxpayer thought that the extra one year and four months would make a difference?

The court did not say that a 30-years-remaining lease term is an absolute minimum. It left open the possibility that some remaining term less than 30 years might be like-kind with a fee interest. It will, however, take another adventurous taxpayer to find out what that term might be.