Daily Development for
By: Patrick A.
Randolph, Jr.
Elmer F. Pierson Professor of
Of Counsel: Blackwell Sanders Peper Martin
Kansas City,
prandolph@cctr.umkc.edu
FEDERAL INCOME TAX; EXCHANGES; WATER RIGHTS: Transfer of
water rights that are not perpetual and subject to priority
limitations in exchange for a fee interest in land does not satisfy the
"like properties" requirement of Section 1031.
Wiechens v.
A partnership that owned land in an
irrigation district. The partnership obtained the right to receive
The IRS made assessments against the partners for their 1993
taxes, and the partners filed suit for a refund in district court. The partners
argued that water rights are an interest in real property, that the properties
exchanged were of like-kind, and that the exchange qualifies for nonrecognition treatment.
The court agreed with the partners that water rights in
general are an interest in real property, citing
Nevertheless, the court ruled that there was no like kind
exchange here because the water rights were not perpetual. The partners asserted that in fact the rights
were perpetual, arguing that they were grounded in the U.S. Supreme Court
decision in State of
The court rejected the partners' argument based upon the
Department of Interior opinion and concluded that under a 1984 subcontract the
partners were entitled to water rights only for a 50-year period, citing a
recent Tax Court opinion dealing with the water rights in question here:
Gladden v. Commissioner, 112 T.C. 209 (1999).
This court ruled that although the rights obtained by the State of
Arizona in Colorado River water were perpetual, the transfer of water rights
for distribution to the public authority involved in the partnership's water
rights was a subcontract that created limited right and only a for 50 year
term. The partnership could get only
what its grantor had, of course.
Although Gladden was reversed on appeal, the court concluded that the
reversal pertained to other issues, and that the Ninth Circuit had accepted the
court's analysis of the nature of the water rights in question. Consequently, the court concluded, the water rights were limited in quantity,
priority, and to a 50-year duration.
The court then accepted the government's position articulated
in Rev. Rul. 55-749, 1955-2 C.B. 295, which discussed
the exchange of water rights for a fee simple interest in land and concluded
that water rights limited in character and term are not sufficiently similar
under section 1031 to a fee simple interest in land. It rejected the partnerships argument that
the rights were at least similar to a thirty year
leasehold, an interest which has been held to qualify as the equivalent of a
fee for 1031 purposes:
"[A]pplication of 1031] requires a
comparison of the exchanged properties to ascertain whether the nature and
character of the transferred rights in and to the respective properties are
substantially alike. Factors to be
considered in this analysis include the respective interests in the physical
properties, the nature of the title conveyed, the rights of the parties, [and]
the duration [of the interests]. The
documentary evidence presented by the parties . . . establish that the
Partnership's water rights were narrowly restricted, unlike a fee simple
interest in land. . . . [T]he Court finds that the Partnership's water rights
were limited in priority, quantity, and duration, and they were not
sufficiently similar to the fee simple interest that it acquired in the Farm
Land to qualify as like-kind property.
Thus, the court held that an exchange of nonperpetual
water rights for a fee simple interest in land does not satisfy section 1031.
Comment: The vast bulk of land interests, particularly
leasehold interests, are subject to various limitations and conditions. It certainly would help if the court would
give more guidance as to exactly what characteristics of the water rights were
so foreign to the nature of property ownership that they destroyed their
characterization as "like" the interests exchanged.
For instance, would it have been possible to fashion a form of ownership of farmland that was sufficiently "like" the water rights to meet the test - or was the court simply concluding that the water rights were unique and could be traded for nothing other than, presumably, other water rights of similar character?
Readers are urged to respond, comment, and
argue with the daily development or the editor's comments about it.
Items in the Daily Development section
generally are extracted from the Quarterly Report on Developments in Real
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