North Central Rental & Leasing, LLC v. United States , 779 F.3d 738 ( 2015 )

United States Court of Appeals
For the Eighth Circuit
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No. 13-3411
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North Central Rental & Leasing, LLC, by and through its Tax Matters Partner, M.
Daniel Butler
lllllllllllllllllllll Plaintiff - Appellant
v.
United States of America
lllllllllllllllllllll Defendant - Appellee
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Appeal from United States District Court
for the District of North Dakota - Fargo
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Submitted: October 7, 2014
Filed: March 2, 2015
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Before MURPHY, SMITH, and GRUENDER, Circuit Judges.
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SMITH, Circuit Judge.
The Internal Revenue Service (IRS) determined that North Central Rental &
Leasing, LLC ("North Central") had improperly claimed "nonrecognition treatment"1
1
"Nonrecognition treatment" of a gain generally means that the gain is not
included in the taxpayer's gross income at the time the taxpayer actually sells or
of gains from certain property exchanges. North Central filed suit against the United
States, seeking a determination that its gains from the exchanges were, in fact, entitled
to nonrecognition treatment. The district court2 entered judgment in favor of the
United States, and North Central appealed. We affirm.
I. Background
Butler Machinery Company ("Butler Machinery") sells agricultural, mining,
and construction equipment for manufacturers, primarily Caterpillar, Inc.
("Caterpillar"). Prior to 2002, Butler Machinery conducted a rental and leasing
business in conjunction with its retail sales business. In 2002, however, Butler
Machinery formed subsidiary North Central to take over Butler Machinery's rental and
leasing operations.
Although separate entities, Butler Machinery and North Central are closely
related and ultimately controlled by the same family. Indeed, Daniel Butler and certain
of his family members own Butler Machinery, which in turn owns a 99 percent
interest in North Central. Daniel Butler directly owns the remaining 1 percent of North
Central. Both Daniel Butler and his sister Twylah Blotsky are board members of both
Butler Machinery and North Central. Butler Machinery shares building space with
North Central, performs accounting and equipment-ordering functions for North
Central, and even initially pays the wages of North Central's employees.3 Caterpillar
assigned separate dealer codes to North Central and Butler Machinery, which enabled
exchanges the property giving rise to the gain. See 26 U.S.C. § 1031.
2
The Honorable Karen K. Klein, United States Magistrate Judge for the District
of North Dakota, sitting by designation and the parties' consent pursuant to 28 U.S.C.
§ 636(c).
3
North Central eventually reimburses Butler Machinery on an allocated basis
for the shared services given that North Central technically operates as a separate
financial entity.
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each entity to independently purchase its own equipment from Caterpillar; however,
Butler Machinery used its own dealer code to order equipment for both itself and
North Central.
A. LKE Program
At issue in this case is North Central's like-kind-exchange (LKE) program,
which commenced less than two months after Butler Machinery formed North Central.
In a nutshell, the LKE program allowed North Central to trade used equipment for
new equipment and, in the process, defer tax recognition of any gains or losses from
the transactions. Per the LKE program, North Central sold its used equipment to third
parties, and the third parties paid the sales proceeds to a qualified intermediary,
Accruit, LLC ("Accruit"). Accruit forwarded the sales proceeds to Butler Machinery,
and the proceeds "went into [Butler Machinery's] main bank account." At about the
same time, Butler Machinery purchased new Caterpillar equipment for North Central
and then transferred the equipment to North Central via Accruit. Butler Machinery
charged North Central the same amount that Butler Machinery paid for the equipment.
Butler Machinery's use of LKE transactions in this fashion facilitated favorable
financing terms from Caterpillar (referred to as "DRIS" financing terms). Caterpillar
advised Butler Machinery before it established either North Central or the LKE
program that such a transaction structure would enable Butler Machinery "to take full
advantage of [Caterpillar's] DRIS payment terms." The DRIS payment terms, among
other things, gave Butler Machinery up to six months from the date of the invoice to
pay Caterpillar for North Central's new equipment. During that time, Butler
Machinery could use the sales proceeds it received from Accruit for essentially
whatever business purposes it wanted, such as paying bills or payroll. In other words,
Butler Machinery essentially received an up-to-six-month, interest-free loan from each
exchange.
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B. Representative Transactions
The parties stipulated to two exchange transactions that they agree are
representative of the 398 LKE transactions at issue in this case. Because the two
stipulated transactions are essentially identical, the district court focused on only one
of them: the exchange of Truck 1 (North Central's relinquished property) for Truck
2, Skid Steer 1, and Skid Steer 2 (North Central's replacement property). So will we.
In the representative transaction, North Central agreed on or before June 30,
2004, to sell Truck 1 to a third party for $756,500. North Central's adjusted tax basis
in Truck 1 was $129,372.70 at the time. The third party paid Accruit the $756,500 in
sales proceeds, and North Central transferred to the third party legal ownership of
Truck 1.
On or about August 13, 2004, Butler Machinery identified and purchased the
replacement Caterpillar equipment, Truck 2 and Skid Steers 1 and 2. Butler
Machinery's total acquisition price for this new property was $761,065.60. Butler
Machinery then transferred legal ownership of the replacement property to North
Central through Accruit on August 27, 2004.
On September 10, 2004, Accruit transferred the $756,500 in proceeds from the
sale of Truck 1 to Butler Machinery. North Central and Butler Machinery then
adjusted a note between the two companies to compensate Butler Machinery for the
$4,565.60 difference between the $756,500 in sale proceeds and the $761,065.60 that
Butler Machinery paid for the replacement equipment.
Thus, in the immediate aftermath of the transaction, (1) a third party owned
Truck 1; (2) North Central held its replacement property (Truck 2 and Skid Steers 1
and 2) and an adjusted note reflecting its new $4,565.60 debt to Butler Machinery; and
(3) Butler Machinery possessed the $756,500 in sale proceeds from Truck 1 and an
adjusted note reflecting its new $4,565.60 credit to North Central. North Central
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deferred recognizing the $627,127.30 gain it realized from the transaction (the
difference between the $756,500 in sales proceeds from Truck 1 and North Central's
$129,372.70 adjusted tax basis in Truck 1), claiming the gain was entitled to
nonrecognition treatment under 26 U.S.C. § 1031. And Butler Machinery, per
Caterpillar's DRIS financing terms, had essentially unfettered use of the sales proceeds
from Truck 1 for nearly six months before it was obligated to pay Caterpillar for the
replacement equipment.
C. Procedural History
From 2004 to 2007 North Central claimed nonrecognition treatment of gains
from 398 LKE transactions pursuant to § 1031. The IRS issued final partnership
administrative adjustments for those taxable years, which declared that the
transactions were not entitled to nonrecognition treatment. The IRS concluded that
North Central structured the transactions to avoid the related-party exchange
restrictions provided under § 1031(f). North Central then brought an action against the
United States, alleging the LKE transactions were entitled to nonrecognition
treatment.
Following a three-day bench trial from April 2 to April 4, 2013, the district
court found, among other things, that the transactions were not entitled to
nonrecognition treatment and were "structured to avoid the purposes of § 1031(f)." In
so holding, the court analyzed Butler Machinery's "receipt of cash in exchange for
equipment, together with its unfettered access to the cash proceeds," as well as the
relative complexity of the transactions. The district court accordingly entered
judgment in favor of the United States, and North Central appealed.
II. Discussion
A. Statutory Framework
As a general rule, taxpayers must immediately recognize the gains or losses
they realize from the disposition of their property. See 26 U.S.C. § 1001(c). Taxpayers
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can defer recognizing such gains or losses, however, when they exchange "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." 26 U.S.C. § 1031(a)(1). This LKE exception
distinguishes a taxpayer who conducts an LKE from a taxpayer who liquidates or
"cashes in" on his or her original investment. With an LKE the taxpayer essentially
continues his or her original investment via the like-kind property. See Ocmulgee
Fields, Inc. v. C.I.R., 613 F.3d 1360, 1364 (11th Cir. 2010); Starker v. United States,
602 F.2d 1341, 1352 (9th Cir. 1979) ("The legislative history [of § 1031(a)] reveals
that the provision was designed to avoid the imposition of a tax on those who do not
'cash in' on their investments in trade or business property.").
After Congress enacted the LKE exception, however, sophisticated parties
exploited the exception in a manner inconsistent with its purpose. Some entities
agreed to structure transactions such that they could actually cash in on their
investments while nevertheless claiming nonrecognition treatment under § 1031. See
Ocmulgee Fields, 613 F.3d at 1365; Teruya Bros. v. C.I.R., 580 F.3d 1038, 1042 (9th
Cir. 2009). The following hypothetical illustrates how such transactions were
structured:
[A]ssume T owns Blackacre, which is worth $100 and has a basis of $20,
and her wholly owned corporation, C Corp., owns like kind property
(Whiteacre), which is also worth $100 but has a basis of $140; T and C
swap, and C immediately sells Blackacre to an unrelated person. If T had
sold Blackacre, she would have recognized gain of $80, but C, whose
$140 basis for Whiteacre becomes its basis for Blackacre, recognizes
loss of $40. . . . [T]he presale exchange . . . [has] the effect of deferring
recognition of T's potential gain and accelerating recognition of C's $40
loss.
Teruya Bros., 580 F.3d at 1042 (alternations in original; quotation omitted).
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Congress attempted to close this perceived loophole in 1989 when it passed
§ 1031(f). See Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101-239,
§ 7601, 103 Stat. 2106 (1989). Section 1031(f)(1) generally prohibits nonrecognition
treatment for exchanges in which a taxpayer exchanges like-kind property with a
"related person," and either party then disposes of the exchanged property within two
years of the exchange. Moreover, in an attempt to thwart the future use of more
complex transactions that technically avoid the provisions of § 1031(f) but
nevertheless run afoul of the purposes of the law, Congress also enacted
§ 1031(f)(4)—which broadly prohibits nonrecognition treatment for "any exchange
which is part of a transaction (or a series of transactions) structured to avoid the
purposes of" § 1031(f).
B. Purpose of the Transactions
"After a bench trial, this court reviews the district court's findings of fact for
clear error, and its legal conclusions de novo." Lisdahl v. Mayo Found., 633 F.3d 712,
717 (8th Cir. 2011). The core issue in this appeal is whether the district court erred in
determining that North Central structured the exchange transactions to avoid the
purposes of § 1031(f). This is a factual issue subject to clear error review. See Lisdahl,
633 F.3d at 717.
We begin by noting the comparative complexity of the transactions at issue. See
Ocmulgee Fields, 613 F.3d at 1369 (affirming a determination that an exchange was
structured to avoid the purposes of § 1031(f) in part because of the unnecessary
complexity and unnecessary parties involved in the transaction); Teruya Bros., 580
F.3d at 1046 (same). As discussed above, the transactions each involved an intricate
interplay between at least five parties: North Central, Accruit, Butler Machinery,
Caterpillar, and the third party who buys North Central's used equipment. Of course,
North Central, Caterpillar, and the third-party customer were indisputably necessary
for the sales and purchase transactions to occur. Butler Machinery and Accruit,
however, were not.
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As North Central acknowledges in its briefing, Butler Machinery functioned "as
a passthrough of both the cash and the property." This begs the question of why Butler
Machinery was involved at all in the transactions. Elsewhere in its briefing North
Central proffers several alternative reasons for Butler Machinery's involvement,
including that it made the transactions administratively easier and more efficient.
None of these arguments, however, convince us that the district court clearly erred in
reaching a different conclusion. After all, North Central already had its own dealer
code, and it could have placed the exact same equipment orders directly to Caterpillar.
Injecting Butler Machinery into the transactions added unnecessary inefficiencies and
complexities to the transactions, including, among other things, additional transfers
of payment and property.
An equally (if not more) plausible explanation for Butler Machinery's
involvement is that Butler Machinery financially benefitted from what amounted to
six-month, interest-free loans under the DRIS financing terms. See Ocmulgee Fields,
613 F.3d at 1369 (analyzing "the actual consequences" of the transactions to ascertain
the taxpayer's intent); Teruya Bros., 580 F.3d at 1045 ("[T]he taxpayer and the related
party should be treated as an economic unit in this inquiry."). As discussed above, the
DRIS financing gave Butler Machinery up to six months to pay its invoices to
Caterpillar. In the meantime, the sales proceeds from the relinquished equipment were
deposited into Butler Machinery's "main bank account," and Butler Machinery was
able to use the proceeds as it pleased. The value of Butler Machinery's interest-free
access to such money should not be underestimated.4
4
For instance, purely by way of illustration, assume that Butler Machinery could
have obtained DRIS financing terms for merely 350 of the exchanges at issue in this
case, and that the average sales proceeds received from the property relinquished in
the transactions was $600,000 (which is less than the sales proceeds received in each
of the stipulated transactions). In this scenario, Butler Machinery would have received
a total of $210,000,000 in de facto interest-free loans.
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Butler Machinery attempts to downplay the benefit it derived from these
de facto interest-free loans by asserting that North Central would have received the
same financing terms if it had ordered directly from Caterpillar. The President and
CEO of Accruit, however, testified at trial that Accruit would have paid the sales
proceeds from the relinquished property directly to Caterpillar if the new equipment
were not purchased via Butler Machinery. In other words, if Butler Machinery was not
involved in these transactions, neither Butler Machinery nor North Central would have
received the de facto interest-free loans.
In sum, Butler Machinery was not necessary to the transactions at issue yet
possessed significant, unearmarked cash proceeds as a result of the transactions. Both
the Eleventh Circuit and the Ninth Circuit have affirmed determinations that
transactions were structured to avoid the purposes of § 1031(f) when unnecessary
parties participated in the transactions and when a related party ended up receiving
cash proceeds. See Ocmulgee Fields, 613 F.3d at 1369; Teruya Bros., 580 F.3d at
1046. North Central argues that this case is unique because Butler Machinery did not
have indefinite access to the sales proceeds from each transaction. Even so, that fact
does not change our analysis, and we simply cannot ignore the significant and
continuous financial benefits Butler Machinery derived from these hundreds of de
facto interest-free loans. Indeed, as the Ninth Circuit noted in Starker v. United States,
"if . . . taxpayers sell their property for cash and reinvest that cash in like-kind
property, they cannot enjoy [§ 1031's] benefits, even if the reinvestment takes place
just a few days after the sale." 602 F.2d at 1352. This court reached a similar
conclusion in Coleman v. Commissioner of Revenue, in which we affirmed a
determination that $14,000 a taxpayer received as part of an exchange should be
recognized as taxable gain—even though the money was allegedly intended to apply
to a mortgage the taxpayer assumed in the exchange. 180 F.2d 758, 760 (8th Cir.
1950). Critically for purposes of our analysis, the taxpayer in Coleman "was at liberty
to use [the cash] as he pleased," id., just like Butler Machinery was in this case.
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Accruit was also an unnecessary party to these transactions. Butler Machinery
and North Central could have exchanged property directly with each other without
Accruit's involvement. This unnecessary layer of complexity lends support to a
finding that the exchanges were structured to sidestep § 1031(f). Indeed, the Eleventh
Circuit in Ocmulgee Fields affirmed a determination that exchanges were structured
to avoid the purposes of § 1031(f), in part, because the parties could have completed
the transactions without the involvement of a qualified intermediary. See 613 F.3d at
1370, 1373. Moreover, the Ninth Circuit reached the same conclusion in Teruya
Brothers and further held that a qualified intermediary's "involvement in [the
underlying] transactions thus served no purpose besides rendering simple—but tax
disadvantageous—transactions more complex in order to avoid § 1031(f)'s
restrictions." 580 F.3d at 1046 (footnote omitted). Notably, if Butler Machinery and
North Central exchanged the property directly with each other, they, as related parties,
would have to hold the exchanged-for property for two years before the exchanges
could qualify for nonrecognition treatment. See 26 U.S.C. § 1031.5 Hence, their need
for Accruit.
North Central argues that Accruit was nevertheless necessary for its LKE
program to qualify for certain "safe harbors" established under 26 C.F.R.
§§ 1.1031(k)–1 et seq. and Revenue Procedure 2003-39. North Central's safe harbor
argument is unavailing. It simply has not shown that the district court committed clear
error in finding the intent behind the transactions' structure. See F.D.I.C. v. Lee, 988
F.2d 838, 841–42 (8th Cir. 1993) ("[I]f a district court's factual determination 'falls
within a broad range of permissible conclusions,' then it must be upheld" under clear
error review) (quoting Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 400 (1990)).
Furthermore, the safe harbor rationale does not explain why Butler Machinery was
involved at all in these 398 exchange transactions. In short, because North Central
5
North Central does not dispute that it and Butler Machinery are "related"
parties under the statute.
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"could have achieved the same property dispositions" via a much "simpler means," it
appears "these transactions took their peculiar structure for no purpose except to avoid
§ 1031(f)." Teruya Bros., 580 F.3d at 1046.
The district court did not commit clear error by finding that the LKE
transactions were structured to avoid the purposes of § 1031(f).
III. Conclusion
Accordingly, we affirm the judgment of the district court.
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