Exelon quarrel with IRS could threaten tax-free exchange deals

By Patrick Temple-West

WASHINGTON, Jan 28 (Reuters) - Energy group Exelon Corp is fighting the U.S. Internal Revenue Service in court over a $517 million tax bill in a case that tax lawyers said could lead to new restrictions on businesses' ability to do tax-free property exchange deals.

Such exchanges are common legal strategies for avoiding capital gains tax. Thousands are carried out annually, though the Exelon deal at issue was unusually large.

If Exelon loses its case against the IRS in U.S. Tax Court, tax-free property exchange deals, even smaller ones, could be at risk of more often being labeled "abusive tax shelters," by the agency, tax lawyers said this week.

"People are already on edge ... it is going to put a crimp on this type of transaction," said Stefan Tucker, a lawyer with Venable LLP, who is not involved in the case. He said he thinks the case will likely be appealed regardless of the Tax Court's decision.

'LIKE-KIND' DEALS

Exelon is defending two tax-free property exchanges worth more than $1 billion combined. They were carried out by one of its units in 1999, according to a Tax Court filing.

The IRS contends that the exchanges were "a potentially abusive tax shelter," said Exelon, the largest U.S. nuclear power plant operator, in a November 2013 regulatory filing.

A spokesman for Chicago-based Exelon declined to comment and referred questions to the company's regulatory filings.

The IRS, which also declined to comment, has not yet filed a response to Exelon's Tax Court petition challenging the tax bill. The company does not have to pay the bill while litigation is ongoing. A trial has not yet been scheduled.

The dispute centers on a tax break that lets an individual or business sell an asset - often real estate - and pay no capital gains tax on any profit if the asset is replaced within a certain time period with a similar, or "like-kind," asset.

Tax-free exchanges must be done following strict rules on timing, intermediaries and any cash involved. Corporations filed more than 64,000 forms with the IRS in 2010 declaring so-called like-kind exchanges, while individuals filed more than 150,000 such forms that same year, the most recent year for which data was available.

In the Exelon case, the IRS is arguing that the company "did not acquire and retain significant and genuine attributes of a traditional owner," to satisfy the like-kind exchange rules, according to court documents.

'SILO' TAX SHELTER

The case traces back to 1999 when an Exelon subsidiary sold some of its fossil fuel power plants to comply with new regulations. With the sale proceeds, the subsidiary acquired three power plants in Georgia and Texas in what the company said it structured as a tax-free exchange.

The Exelon subsidiary then leased the Georgia and Texas properties back to the local governments that operated them. The governments paid advance rent to the Exelon unit totaling more than $1 billion, according to court filings.

The rent payments were part of a "sale in, lease out," or SILO, deal that was integral to the tax-free exchange.

The IRS contends that by leasing the properties, the Exelon unit did not take proper possession of the plants it got in the exchange. The IRS views some SILO deals as tax shelters and has won SILO disputes in court, including an unrelated one against Exelon last year in a federal appellate court.

"SILOs are old tax shelters and courts have ruled against them numerous times," said Bradley Borden, a Brooklyn Law School tax professor. He added that if the SILO portion of the power plants exchange does not hold up in court, Exelon could lose and its case could have "a chilling effect" on similar deals.

"Exelon is going to have a hard time winning," Borden said.

However, in court fights over like-kind exchanges, "the IRS has a pretty bad track record," said David Shechtman, a lawyer with Drinker Biddle & Reath LLP who is not involved in the case.

Exelon's transaction was not a typical SILO and that might help the company prove it was playing by the rules, he said.

The case is Exelon Corp, as successor by merger to Unicom Corp and Subsidiaries v. Commissioner of Internal Revenue; Tax Court docket No. 29183-13.