Rev. Rul. 64-237

The Internal Revenue Service has reconsidered its position with respect to replacement property that is `similar or related in service or use' to involuntarily converted property within the meaning of section 112(f) of the Internal Revenue Code of 1939 and section 1033(a) of the Internal Revenue Code of 1954 in light of the decision of the United States Court of Appeals for the Second Circuit in the case of Liant Record, Inc. v. Commissioner , 303 Fed.(2d) 326 (1962), and other appellate court decisions.

In previous litigation, the Service has taken the position that the statutory phrase, `similar or related in service or use,' means that the property acquired must have a close `functional' similarity to the property converted. Under this test, property was not considered similar or related in service or use to the converted property unless the physical charateristics and end uses of the converted and replacement properties were closely similar. Although this `functional use test' has been upheld in the lower courts, it has not been sustained in the appellate courts with respect to investors in property, such as lessors.

In conformity with the appellate court decisions, in considering whether replacement property acquired by an investor is similar in service or use to the converted property, attention will be directed primarily to the similarity in the relationship of the services or uses which the original and replacement properties have to the taxpayer-owner. In applying this test, a determination will be made as to whether the properties are of a similar service to the taxpayer, the nature of the business risks connected with the properties, and what such properties demand of the taxpayer in the way of management, services and relations to his tenants.

For example, where the taxpayer is a lessor, who rented out the converted property for a light manufacturing plant and then rents out the replacement property for a wholesale grocery warehouse, the nature of the taxpayer-owner's service or use of the properties may be similar although that of the end users change. The two properties will be considered as similar or related in service or use where, for example, both are rented and where there is a similarity in the extent and type of the taxpayer's management activities, the amount and kind of services rendered by him to his tenants, and the nature of his business risks connected with the properties.

In modifying its position with respect to the involuntary conversion of property held for investment, the Service will continue to adhere to the functional test in the case of owner-users of property. Thus, if the taxpayer-owner operates a light manufacturing plant on the converted property and then operates a wholesale grocery warehouse on the replacement property, by changing his end use he has so changed the nature of his relationship to the property as to be outside the nonrecognition of gain provisions.

¹ Based on Technical Information Release 612, dated July 20, 1964.