Did you know you can Section 1031 to the US Virgin Islands? Now wait just a minute you say. IRS Code Section 1031 allows us to defer income tax on gains of our investment property sales, perhaps in many cases, forever, but the relinquished property and the replacement property have to both be located in the United States. Are you sure of that? Just about 15 years ago the IRS issued private letter ruling 200040017 (PLR) pronouncing that the US Virgin Islands were indeed property “in the United States” for purposes of Section 1031 tax free exchange. But dangerous waters lie ahead for the rest of us because PLRs cannot be cited or relied upon as precedent during an IRS audit. Indeed how you structure and contemporaneously document your unique sale and purchase to the Virgin Islands may determine if you win or lose in US Tax Court perhaps many years after your tax return has been filed. So if you are interested in a US Virgin Islands Section 1031 Tax Free Exchange (USVI 1031) stay with us here on TaxView with Chris Moss CPA to learn about the exciting new developments in these unchartered tropical waters of the US Virgin Islands and Section 1031.
The US Joint Committee on Taxation report published in 2013 says that the United States purchased the US Virgin Islands from Denmark in 1917 and codified the tax code there in 1954 to “mirror” the IRS Code in the United States. While the report goes out of its way to define on page 253 the term “bona fide resident” regarding the US Virgin Islands, the Joint Committee never mentions Section 1031. The report also makes clear that the US Virgin Islands is not part of the United States by defining the United States as the 50 States and the District of Columbia..
So how do we structure a USVI 1031 when the Joint Committee in 2013 never bothers to mention a USVI 1031? In order to create a bullet proof tax strategy for your USVI 1031 we then have to somehow overcome the simple fact that the US Virgin Islands is not part of the United States. We start with the PLR issued in 2000 about a taxpayer who acquired a 6 unit commercial building in the US held in a State land trust with a bank acting as trustee. Four years later the property was sold through a USVI 1031 which in the 5th year became income producing. The IRS is asked to comment on whether or not these facts qualify for Section 1031 tax free deferral.
PLR 200040017 ascertains the conflict between Section 1031, Section 932 and specifically gets the message of Section 1031(h) that investment property outside the United States is not “like kind” under section 1031. Furthermore, the IRS also establishes that the law of Section 7701(a)(9) is clear: The United States “when used in a geographical sense” includes only the 50 states and the District of Columbia. However, the IRS further reasons, in my view rather brilliantly, in PLR 200040017 that the legislative history of 1031(h) shows Congress did not want to override or otherwise modify Section 932 involving the tax treatment of the US and Virgin Island residents, citing Omnibus Budget Reconciliation Act of 1989 Report 101-386 dated November 21, 1989. Further research would seem to support the IRS PLR 200040017. According to the Conference Committee Report, the House in their original bill said “Foreign real property is treated as not similar or related in service or use to US real property for purposes of Section 1031”. The Senate amendment to the House bill had no provision for foreign real Section 1031 property. So how did this play out in Conference you ask?
In Joint Conference, perhaps behind close doors, the House and Senate decided to add the following provision: “No inference is intended to override or otherwise modify Section 932 of the Code (involving the tax treatment of US and Virgin Islands residents)”. See Page 614 of the Omnibus Budget Reconciliation Act of 1989, Conference Report dated November 21, 1989. Considering that the House reversed it's prior position on 1031 foreign real property that it had stated in the original House bill, one might ask how this new language could have been inserted into the Conference report without any explanation. Since neither the House Bill nor the Senate Amendment contained any of this new language, perhaps former House Ways Chairman Dan Rostenkowski or Senate Finance Chairman Lloyd Bentsen would have been able to explain what happened. Unfortunately as they have both since passed we will most likely never know what really happened.
In conclusion, since there does not appear to be any case law yet established to support USVI 1031 tax strategy, before you can file an income tax return with a USVI 1031 tax deferral your tax attorney has to have some ruling or IRS regulation, other than the PLR 200040017 that allows her to structure a legal USVI 1031 and bullet proof the tax return from adverse IRS audit action. In my view IRS regulations 1.932.1 perhaps might be all we need to support a USVI 1031 that connects to the Omnibus Budget Reconciliation Act of 1989 cited in PLR 200040017. Deep within Regulation 1.932.1 you will find Section (g)(1)(i) which says that the United States generally will be treated as including the Virgin Islands. Furthermore, section (g)(1)(ii)(E) says that application of the rule also includes property exchanged for 1031 property. This regulation clearly says USVI 1031 is legal, even though Section 1031(h) says it’s not and the 2013 Joint Committee Taxation Report never mentions it.
So what does all this mean for anyone who wants a USVI 1031 to the US Virgin Islands? First, make sure your qualified intermediary (QI), who will control all your funds from start to finish, is a Certified Exchange Specialist and a member of the Federation of Exchange Accommodators (FEA). Conference your QI, tax attorney and real estate agent making sure they are all familiar with structuring a USVI 1031. Second ask your tax attorney for a written opinion as to the soundness of the USVI 1031 structure she is creating for you all. Make sure your tax attorney cites IRS regulation 1.932.1 as support for your USVI 1031 structure and inserts that documentation into your tax return before filing along with her tax opinion which becomes part of any tax return you file that defers tax under Section 1031. Finally, enjoy your visits to inspect your new investment property in the US Virgin Islands. Perhaps I will meet up with you over at Island View Guesthouse. In the meantime make sure you join us next time with Chris Moss CPA on TaxView when we discuss related party 1031 tax free exchange strategy.
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Chris Moss CPA