In the United States, a taxpayer normally incurs a capital gains tax obligation upon the sale of property if the taxpayer realizes a gain as a result of the sale. Because the capital gains tax rate is typically high taxpayers look for ways to reduce, or eliminate, paying capital gains taxes. One option is to enter into a Section 1031 Exchange transaction in lieu of a traditional sale. For transactions that qualify, any capital gains tax that would otherwise be incurred is deferred.
Like-Kind Requirement
There are a number of requirements that must be met for a transaction to be eligible for Section 1031 Exchange treatment including the requirement that the properties to be exchanged are of “like-kind”. Sometimes it is clear that the properties are of like-kind. For example, if a taxpayer relinquishes a ten unit apartment building for another ten unit apartment building it is likely that the properties involved are of “like-kind”. Other transactions clearly do not involve “like-kind” properties. Exchanging that same ten unit apartment building for a valuable coin collection will not pass muster as an exchange of “like-kind” property. As is often the case when it comes to tax law, there are some transactions that are difficult to evaluate. Exchanging a radio station for a television station, for example, is one of those.
Radio and TV Station Like-Kind Exchanges
The Internal Revenue Service, or IRS, recognizes that there are often complex and pervasive issues that need to be addressed in order to provide clarification and guidance for taxpayers. When the IRS identifies a set of issues that warrant attention it will often issue a “Coordinated Issue Paper” as a way to bring all of the related issues together and attempt to provide guidance to taxpayers. The inclusion of radio and television stations in Section 1031 Exchange transactions was the subject of an IRS Coordinated Issue Paper in recent years.
The issues discussed in the Coordinated Issue Paper pertinent to a taxpayer who is considering an exchange of a radio station for a television station include:
- Whether the exchange of a radio station for a television station qualifies as a “like-kind” exchange.
- Whether a network affiliation agreement and any claimed ability to affiliate should be valued separately from the FCC license under section 1031.
- Whether goodwill should be valued separately from the FCC license under section 1031.
In answering the first question, the IRS focused on the difference between nature and character of the properties versus quality or grade. Properties qualify as “like-kind” if they are of the same nature and character despite being of different quality or grade. The IRS found that the “only differences between the various FCC licenses are the specific operating parameters (such as frequency, operating hours, power, and antenna information) and geographic location” – all of which relate to quality or grade not nature and character. Therefore, the exchange of an FFC license for a radio station for an FCC license for a television station does involve an exchange of “like-kind” property qualifying for Section 1031 treatment.
With regard to the issue of affiliation, the IRS found that “If affiliation is an asset separate and distinct from an FCC broadcast license, there would be no logical basis for treating the ability to affiliate any differently.” This opinion is based on the historic treatment of affiliation as a separate and distinct asset.
The IRS also concluded that a station’s goodwill should be valued separately from the license itself for purposes of a Section 1031 exchange pointing out that only in very unusual circumstances does a station’s goodwill have no intrinsic value. Even if a purchaser plans to change the format of the station, thereby making the goodwill which exists at the time of purchase all but worthless to the taxpayer’s future plans that does not mean that the asset has no value at the time of purchase (or exchange). Instead, it simply means that the purchaser does not plan to make use of the asset’s value after the exchange transaction takes place.
To learn more about when a 1031 exchange makes sense, download a free three page eGuide to “Ten Reasons Why a 1031 Exchange Makes Sense,” by clicking on the button below.
