A reverse exchange, the “flip side” of a deferred exchange, is where the taxpayer directly or indirectly acquires the replacement property before disposing of the relinquished property.
On October 2, 2000 the Internal Revenue Service (“IRS”) issued Revenue Procedure 2000-37 providing long awaited guidance on structuring reverse exchanges to avoid IRS challenge. This Revenue Procedure provides a safe harbor for reverse exchanges if certain requirements are met.
Beginning with the IRS’ acceptance of deferred like-kind exchanges, taxpayers have engaged in a wide variety of transactions, including so-called “parking” or “warehousing” transactions, to facilitate reverse like-kind exchanges. Parking transactions typically are designed to “park” the desired replacement property with a qualified intermediary until such time as the taxpayer arranges for the transfer of the relinquished property to the ultimate buyer in a simultaneous or deferred exchange. Once such a transfer is arranged, the taxpayer transfers the relinquished property to the qualified intermediary in exchange for the replacement property, and the qualified intermediary then transfers the relinquished property to the ultimate buyer. In other situations, a qualified intermediary may acquire the desired replacement property on behalf of the taxpayer and immediately exchange such property with the taxpayer for the relinquished property, thereafter holding the relinquished property until the taxpayer arranges for a transfer of such property to the ultimate buyer. In parking arrangements, taxpayers attempt to arrange the transaction so that the qualified intermediary has enough of the benefits and burdens relating to the property so that the qualified intermediary will be treated as the owner for federal income tax purposes.
Rev. Proc. 2000-37 provides that a reverse exchange will not be challenged if the taxpayer, who will be the ultimate owner of the parked property, satisfies two requirements: (i) the taxpayer enters into a written Qualified Exchange Accommodation Arrangement (“QEAA”), and (ii) the taxpayer engages the services of an exchange accommodation titleholder (“EAT”) which is typically a qualified intermediary such as All States 1031 X-Change Facilitator, LLC.
WHAT ARE THE REQUIREMENTS OF A QEAA?
WHAT ARE THE REQUIREMENTS OF AN EAT?
In addition to setting forth the requirements necessary to fall within the safe harbor, the Rev. Proc. listed permissible agreements that should provide most taxpayers and qualified intermediaries with the level of comfort necessary to effectuate a reverse exchange. A few of the more important types of permissible agreements are:
The new safe harbor under Rev. Proc. 2000-37 will provide tax certainty for reverse exchanges. The requirement that the EAT obtain legal title to the replacement property makes the transaction more costly and complicated than a traditional forward exchange; and, thus, exchangors should try to sell first and buy later. Reverse construction exchanges will inevitably require more than 180 days to complete, subjecting such transactions to the “burdens and benefits” test applicable to non safe harbor parking arrangements. Taxpayers who need to engage in non-safe harbor parking exchanges should not feel any greater sense of tax risk for their transactions after the issuance of the Rev. Proc., since the IRS acknowledges therein that parking arrangements can be accomplished outside the safe harbor. The key to a successful non-safe harbor reverse exchange will remain careful structuring to meet the benefits and burdens test.