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Like-Kind Exchanges in Michigan

Author: LegalEase Solutions 


The Client sold real property lying in Michigan.  The proceeds of the sale were immediately held by Madison Exchange, LLC, pursuant to a Real Property Exchange Agreement.  Madison Exchange is acting as a § 1031 intermediary.  Specifically, Madison Exchange is in custody of $191,786.84 (consisting of $191,336.84 from the HUD-1 Statement and an additional $450.00 relating to a rent escrow). The Client now wishes to invest the $191,786.84 in like-kind property.

Question Presented

The issue is whether the client can invest the money in (1) a real estate investment partnership (eg. a limited partnership investing solely in real estate); or (2) buy shares in a REIT (Real Estate Investment Trust), and still have the transaction qualify as a 1031 exchange?


  1. The Client May Invest The Money Held In Escrow In A Real Estate Investment Partnership And Still Qualify As a Like-Kind Exchange.
  1. The Client must hold the property for investment.

26 USCS § 1031 states the following:

  • 1031.  Exchange of property held for productive use or investment.
    (a) Nonrecognition of gain or loss from exchanges solely in kind.
    (1) In general. No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.

(2) Exception. This subsection shall not apply to any exchange of

(A) stock in trade or other property held primarily for sale,
(B) stocks, bonds, or notes,

(C) other securities or evidences of indebtedness or interest,

(D) interests in a partnership,

(E) certificates of trust or beneficial interests, or

(F) choses in action.

Emphasis added.

 According to Meadows v. Commissioner, T.C. Memo 1981-417 (U.S. Tax Court Memos 1981), it is well settled that section 1031 does not apply when the proceeds of one piece of real property are used to purchase a second piece of real property in two separate and unrelated transactions.  Wheeler v. Commissioner, 58 T.C. 459, 462 (1972); Carlton v. United States, 385 F.2d 238, 241 (5th Cir. 1967); Rogers v. Commissioner, 44 T.C. 126, 133 (1965), affd. per curiam 377 F.2d 534 (9th Cir. 1967).

To qualify however, the Commissioner’s administrative position in Rev. Rul. 77-297 says that a like-kind exchange can be effected through an escrow account as long as the taxpayer cannot obtain use of the escrow money. Maxwell v. United States, 1988 U.S. Dist. LEXIS 16990, 11-12 (D. Fla. 1988). 

In a more vital case on point, Magneson v. Commissioner, 753 F.2d 1490 (9th Cir. 1985), the appellate court further discussed the meaning of “held for investment.”

In the Magneson case, the Magnesons had sold real estate property, and pursuant to a prearranged agreement, transferred their acquired interest for a share in a general partnership.  The Magnesons argued that their acquired interest was “held for investment” because they intended to invest it by trading it for a general partnership share.  The Commissioner disagreed and the Appellate Court affirmed for the Magnesons.

The Magneson Court at page 6 said that “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).”

The Court reasoned that the Magnesons’ intent when they acquired the interest was for investment.  This was evidenced by the prearranged agreement to transfer their interest for the general partnership share.  Thus, the court concluded that an acquired interest held for the exchange of a general partnership share is “held for investment” and qualifies as a like-kind exchange.

Importing the above principles to the facts of Mowafak and Fatina Asbahi, they have also satisfied the “held for investment” requirement.  They evidenced their intent to invest by placing the money immediately with Madison Exchange; Madison Exchange is serving as an escrow where the Asbahi’s do not have immediate access to the money; and also similar to the Magnesons’, the money was unliquidated.  Therefore, the Asbahi’s satisfy the first requirement of a like-kind exchange by holding the acquired asset for investment.

  1. Subsection 1031(a)(2)(d) “Interests In A Partnership” Exception Does Not Apply.

 The text of 1031(a)(2)(d) appears to except all exchanges for interests in property from qualifying as like-kind exchanges.  However, this is not true as evidenced in the Magneson case.  The Magnesons held an acquired interest and exchanged it for a general partnership share.  The Appellate Court held for the Magnesons without reference to 1031(a)(2)(d).

Also, see FDIC v. Hish, 76 F.3d 620 (4th Cir. 1996).  In the Hish case, the court reasoned that the siblings in the case could not exchange their interests in the partnerships and qualify for a like-kind exchange.  The court said, “A similar exchange of the partnership interests was not possible, however, without severe tax consequences because partnership interests are explicitly excluded from the Internal Revenue Code’s tax-free exchange provisions, 26 U.S.C. § 1031(a)(2)(D).” FDIC v. Hish at 622.

In the Asbahi’s case, they are exchanging money for a general partnership interest.  They are not exchanging a partnership interest for a partnership interest.  Thus, the exception does not apply.

In the light of the above discussion, the Asbahi’s can exchange the money for an interest in a real estate investment partnership.

  1. The Client May Not Invest The Money Held In Escrow In A Real Estate Investment Trust And Still Qualify As a Like-Kind Exchange.
  1. Section 1031(a)(2)(f) clearly excepts exchanges with trusts from qualifying as a like-kind exchange.

A REIT is a trust and is thus excepted from qualifying as a like-kind exchange.  Section 856 of the IRC defines a REIT as follows:

  • 856.  Definition of real estate investment trust.
    (a) In general. For purposes of this title, the term ‘real estate investment trust’ means a corporation, trust, or association—
    (1) which is managed by one or more trustees or directors;
    (2) the beneficial ownership of which is evidenced by transferable shares, or by transferable certificates of beneficial interest;
    (3) which (but for the provisions of this part [26 USCS §§ 856 et seq.]) would be taxable as a domestic corporation;
    (4) which is neither (A) a financial institution referred to in section 582(c)(2) [26 USCS § 582(c)(2)], nor (B) an insurance company to which subchapter L applies [26 USCS §§ 801 et seq.];
    (5) the beneficial ownership of which is held by 100 or more persons;
    (6) subject to the provisions of subsection (k), which is not closely held (as determined under subsection (h)); and
    (7) which meets the requirements of subsection (c).

( c)  Limitations. A corporation, trust, or association shall not be considered a real estate investment trust for any taxable year unless—
(1) it files with its return for the taxable year an election to be a real estate investment trust or has made such election for a previous taxable year, and such election has not been terminated or revoked under subsection (g);
(2) at least 95 percent (90 percent for taxable years beginning before January 1, 1980) of its gross income (excluding gross income from prohibited transactions) is derived from–
(A) dividends;
(B) interest;
(C) rents from real property;
(D) gain from the sale or other

It can be gathered from the statute itself that REIT is an unincorporated business association receiving favorable tax treatment. Effectively, REIT is a trust managed by one of the trustees the beneficial ownership of which is evidenced by transferable shares, or by transferable certificates of beneficial interest and opts to derive its income from passive investments in real estate, rather than participating in active real estate business.

Therefore, through a plain reading of statutes 1031 and 856, the Asbahi’s may not invest their money in a REIT and still qualify as a like-kind exchange.

  1. An interest in real property does not have the same nature or character as an interest in a REIT.

The commissioner defines a like-kind exchange in Treas. Reg. §1.1031(a)-(1)(b) which reads as follows: “As used in 26 U.S.C.S. § 1031(a), the words ‘like kind’ have reference to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under that section, be exchanged for property of a different kind or class.” Ramey Inv. Corp. v. Commissioner, T.C. Memo 1967-4 (U.S. Tax Court Memos 1967).

In the Asbahi’s situation, they owned real estate property.  As described above, a REIT is a trust, thus making it different and placing it in a different class of property.  Thus, the Asbahi’s may not invest in a REIT and still qualify as a like-kind exchange.


The Asbahi’s may invest their money in a real estate investment partnership because they held it for investment with Madison Exchange, and the partnership exception does not apply in this case.

Secondly, the Asbahi’s may not invest the money in a REIT because 1031(a)(2)(f) facially excepts trusts and the REIT is clearly and effectively a trust.  Moreover, the REIT possesses a wholly different nature and character than the Michigan property formerly owned by the Asbahi’s.