The Malulani Group, Limited v. Cir ( 2019 )

FILED
NOT FOR PUBLICATION
JUN 12 2019
UNITED STATES COURT OF APPEALS MOLLY C. DWYER, CLERK
U.S. COURT OF APPEALS
FOR THE NINTH CIRCUIT
THE MALULANI GROUP, LIMITED, No. 16-73959
AND SUBSIDIARY,
Tax Ct. No. 18128-12
Petitioner-Appellant,
v. MEMORANDUM*
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellee.
Appeal from a Decision of the
United States Tax Court
Argued and Submitted October 9, 2018
Honolulu, Hawaii
Before: WARDLAW, BERZON, and RAWLINSON, Circuit Judges.
The Malulani Group, Ltd. and Subsidiary (Malulani) appeal the decision
from the U.S. Tax Court (Tax Court) holding that a 2007 real estate exchange did
not qualify for nonrecognition under 26 U.S.C. § 1031 (§ 1031).
*
This disposition is not appropriate for publication and is not precedent
except as provided by Ninth Circuit Rule 36-3.
“We review the Tax Court’s conclusions of law and interpretations of the tax
code de novo.” Teruya Bros., Ltd. v. Comm’r, 580 F.3d 1038, 1043 (9th Cir. 2009)
(citation omitted).
Generally, a taxpayer must pay taxes on gain realized on the sale or
exchange of property. See 26 C.F.R. § 1.1002-1(a). Section 1031 is an exception
to this rule and is strictly construed. See 26 C.F.R. § 1.1002-1(b); see also Teruya
Bros., 580 F.3d at 1043. Under § 1031(f)(1), a party may benefit from
nonrecognition of the gain from an exchange of like-kind property with a related
party if the related party holds the property for at least 2 years after the last
transfer. See 26 U.S.C. § 1031(f)(1). However, any transaction or series of
transactions “structured to avoid the purposes” of § 1031(f) is ineligible for
nonrecognition. 26 U.S.C. § 1031(f)(4).
Malulani and Malulani Investments, Ltd. (MIL) are related entities.
Through a qualified intermediary, a Malulani wholly-owned subsidiary sold real
estate (the Maryland Property) to an unrelated third party and replaced it with real
estate owned by MIL (the Hawaii Property). The aggregate tax liability arising out
of the exchange was significantly less than the hypothetical tax that would have
arisen from a direct sale between the related parties.
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The outcome of this case is controlled by Teruya Bros. That case also
involved a like-kind exchange of real property between related entities and reliance
on § 1031 to defer recognition of the gain realized from the exchange. See 580
F.3d at 1040-41. After the Internal Revenue Service (IRS) issued a notice of
deficiency, Teruya Bros. appealed to the Tax Court. See id. at 1042. The Tax
Court affirmed the IRS’s determination that the like-kind exchange between the
related entities did not qualify for nonrecognition. See id. We affirmed the Tax
Court decision, explaining that the exchange was structured for “tax avoidance
purposes” because Teruya Bros. and its related entity “achieved far more
advantageous tax consequences by employing [a qualified intermediary to conduct
the like-kind exchanges] than it would have had Teruya simply sold its properties
to the third-party buyers itself.” Id. at 1047 (footnote reference omitted).
The same is true in this case. Rather than engaging in the intricate like-kind
exchanges that achieved favorable tax consequences for Malulani and MIL,
Malulani could have simply consummated the sales itself. Had it done so,
Malulani would have had to recognize a $1,888,040 gain. See id. Because the
aggregate tax liability arising out of the exchange was significantly less than the
hypothetical tax liability that would have arisen from a direct sale between the
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related parties, the like-kind exchange served tax-avoidance purposes. Therefore,
Malulani was not entitled to nonrecognition of gain under § 1031.
We also agree with the Tax Court that any argument regarding MIL’s use of
net operating losses to offset the gain realized was speculative. See The Malulani
Group Ltd. and Subsidiary v. Comm’r, T.C. Memo. 2016-209, 14 n.6 (November
16, 2016).
AFFIRMED.
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