New Procedure on Taxation of Dual-Use Property Governs Interaction of Sections 121 and 1031

In Rev. Proc. 2005-14, 2005-7 IRB 528, the IRS set out to resolve the uncertainty that previously existed with respect to gain that qualifies for both exclusion under Section 121 and deferral under Section 1031. The Procedure establishes clear rules for an area of the tax law that previously lacked direct authority. Despite this progress, the reluctance of the IRS to resolve the 'held for' issue preserves the risk inherent in certain exchanges. Sections 121 and 1031 are not elective in the sense that they do not, by their plain language, allow a taxpayer to choose whether exclusion or deferral of gain should result. The mandatory nature of these provisions raised the question of how a transaction that qualifies for both exclusion under Section 121 and deferral under Section 1031 should be taxed. Even if a taxpayer were to prefer application of Section 1031 in order to avoid unrecaptured Section 1250 gain on the disposition of relinquished property, it was not clear, prior to Rev. Proc. 2005-14, whether the taxpayer's desired result would be the correct result. Accordingly, this guidance should be viewed as a positive development in that taxpayers who hold dual-use property, and who undertake tax planning with respect to such property, may achieve a desired and more certain result