By David I. Kempler, Esq., Elizabeth Carrott
Minnigh, Esq. and Christine Bowers, Esq.

Buchanan Ingersoll & Rooney PC, Washington, DC

In Deseret Management Corp. v. United States, 112 AFTR
2d 2013-5530 (Fed Cl. 7/31/2013), the Court of Federal Claims held
that the taxpayer did not transfer appreciable goodwill as part of
an exchange of radio station assets under §1031 of the Internal
Revenue Code of 1986, as amended (the "Code").  In reaching
its conclusion, the Court of Federal Claims rejected alternative
contentions of the expert for the taxpayer that a radio station can
never possess goodwill because it would be based on audience
loyalty, which was subject to change, or because a financially
underperforming business cannot possess goodwill.

In general, §1031(a)(1), provides that no gain or loss is
recognized on the exchange of property held for productive use in a
trade or business or for investment if the property is exchanged
solely for property of a like kind that is to be held either for
productive use in a trade or business or for investment. 
Under §1031(b), if money or unqualified property is received in an
otherwise qualifying like-kind exchange, a taxpayer's realized gain
is recognized to the extent of the sum of such money and the fair
market value of such unqualified property. Under Regs.
§1.10131(a)-2(c)(2), the goodwill of one business is not of a like
kind to the goodwill of another business. Accordingly, to the
extent that the goodwill of a business has an appreciable value, it
will result in the realization of gain.

Taxpayer and its subsidiaries were in the business of owning and
operating radio stations. Taxpayer exchanged the country radio
station in Los Angeles, which included the station's Federal
Communications Commission (FCC) license, for four radio stations
located in St. Louis. The exchange contract provided that the
exchange value of the assets on both sides of the transaction was
$185 million.  As of the date of the exchange, the appraised
value of the Los Angeles radio station's tangible assets was
$3,384,637, its intangible assets other than the FCC license and
goodwill were valued at $4,858,317, and the residual assets were
valued at $176,757,046. Taxpayer took the position that the Los
Angeles radio station possessed no appreciable goodwill, that the
residual should be attributed solely to the radio station's FCC
license, and that the entire transaction was qualified for
tax-deferral as a §1031 exchange. Conversely, on audit, the IRS
determined that the Los Angeles radio station had $73.3 million of
goodwill on the date of the exchange. The IRS arrived at its
valuation by attempting to isolate the income attributable to the
FCC license, then discounted it to the present value, then
subtracted the result as well as the stipulated value of the
tangible assets and the other intangible assets, from the total
contract price of $185 million.  Regs. §1.197-2(b)(1) defines
goodwill as "the value of a trade or business attributable to the
expectancy of continued customer patronage," which may be due "to
the name or reputation of a trade or business or any other factor."
Moreover, the Supreme Court in Newark Morning Ledger Co. v.
United States¹ defined it as
"the expectation of continued patronage" and further described it
as the value "beyond the mere value of the capital, stock, funds,
or property employed therein" associated with continued patronage.
Goodwill is often described quantitatively as "the excess of cost
over the fair value of the identifiable assets acquired."²

The court rejected the idea that a radio station could never
possess goodwill because it would be based on audience loyalty,
which was subject to change. The court further rejected the
argument that a financially underperforming business cannot possess
goodwill. Rather the court concluded that the determination of
whether the radio station possessed any goodwill required an
examination of the quantitative evidence and adopted the "residual
cost over fair value of the net assets" as the standard for
quantifying the value of the goodwill.

After undertaking a detailed analysis of the methodologies used
to value the radio station's assets, the court concluded that the
FCC license was the "heart and backbone" of the radio station's
value and that the Los Angeles market placed a particularly high
value on FCC licenses of radio stations with strong signals. As
such, the court held that any goodwill possessed by the radio
station was negligible and insignificant and that no assets were
transferred in exchange for goodwill which would cause the
imposition of any tax under §1031.

Even though the court found for the taxpayers in this case, it
rejected arguments by the taxpayer that could have had the effect
of creating a bright line rule regarding when a radio station will
have goodwill. Accordingly, the value of a radio station goodwill
in any like-kind exchanges will have to be determined on a
case-by-case basis.

This commentary also appears in the October 2013 issue of
the  Real Estate Journal. For more information in the
Tax Management Portfolios, see Levine, 567 T.M., Taxfree
Exchanges Under Section 1031, and in Tax Practice Series, see
¶1510, Like-Kind Exchanges.