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IRS Approves Like-Kind Exchange of Emission Reduction Credits

August 05, 2010

Like-Kind exchanges are valuable business tools.  Generally, if you exchange business or investment property solely for business or investment property of a like kind, no gain or loss is recognized under Code Sec. 1031.  The IRS recently approved the like-kind exchange of emission reduction credits between a taxpayer and its subsidiary.

Emissions
In this matter, the taxpayer's business generated air pollution in the form of nitrogen oxide (NOx) and volatile organic compounds (VOCs).  A government program awarded emission reduction credits for NOx and VOCs which qualified the holder to emit a certain quantity of the respective pollutant each year.

The taxpayer needed VOC credits.  One of its subsidiaries had credits for NOx but not VOCs.  The taxpayer proposed to have the subsidiary make a distribution of its NOx credits to the taxpayer.  After receiving the NOx credits, the taxpayer would exchange the NOx credits for VOC credits held by unrelated third parties.  The taxpayer would subsequently use the VOC credits to offset emissions from its trade or business.

Intangible property
The Tax Code has special rules for the like-kind exchange of intangible property.  Intangible personal property is of like kind to other intangible personal property if (1) the nature or character of the rights involved are of like kind and (2) the nature or character of the underlying property to which the intangible personal property relates is of like kind.

According to the IRS, the NOx credits and VOC credits are intangible personal property.  The NOx credits and VOC credits are of like kind if the nature or character of the rights involved and the nature or character of the underlying property to which the intangible personal property relates would be of like kind.

The IRS determined that the terms and conditions of the credits are the same.  They both allow a holder to emit a certain quantity of pollutant each year without penalty.  Although there are differences in the two chemical compounds, the differences were in grade or quality and not in nature or character.  Therefore, the credits were like kind.

 

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