Safe-Harbor Procedure for Reverse Like-Kind Exchanges

In 1991, the IRS issued final regulations that allowed multiple-party like-kind exchanges using qualified intermediaries (QIs) (Regs. Sec. 1.1031(k)-1). As long as these QI requirements and the other Sec.1031 rules (such as the 45-day identification and 180-day acquisition requirements) were met, a taxpayer could rely on the nonrecognition treatment afforded under Sec. 1031.

However, the regulations did not address reverse exchanges, which involve a QI purchasing replacement property before selling the original asset. This frequently occurs when a taxpayer must act quickly to purchase specific replacement property before he can sell the original property. In the exchange industry, this is frequently called "parking," because the replacement property is "parked" with a third party while the original property is sold.

In Rev. Proc. 2000-37, the Service describes an arrangement under which a reverse exchange can be made. The IRS carefully clarifies that the safe harbor is not the only way to accomplish a reverse exchange. However, given that the new procedure establishes a safe harbor for the Service's recognition of like-kind treatment under Sec. 1031, taxpayers seeking a reverse exchange are well advised to follow this procedure if at all possible.

To receive safe-harbor treatment, Rev. Proc. 2000-27 introduces a new like-kind facilitator for reverse exchanges, known as the qualified exchange accommodation arrangement (QEAA), which is handled by the exchange accommodation titleholder (EAT). Taxpayers must meet the following requirements for the IRS to grant the safe harbor:

1. The EAT must hold the legal title or beneficial interest in the property. The EAT cannot be the taxpayer or a disqualified person (as defined in Regs. Sec. 1.1031(k)-1(k)). The EAT must also either be subject to Federal income tax, or if taxed as a partnership or S corporation, more than 90% of its ownership must be held by entities subject to Federal income tax.

2. The taxpayer must transfer either the original or replacement property to the EAT, with the purpose of effecting a Sec. 1031 exchange.

3. The taxpayer and the EAT must enter into a written QEAA no later than five business days after the initial transfer of property under the QEAA. The document must state that the property is being held to facilitate a Sec. 1031 exchange, and the parties agree to report the transactions consistent with this intent. The QEAA must state that the EAT is the beneficial owner for Federal income tax purposes, while it is titled in the QEAA. Finally, all parties must actually report the transaction for Federal tax purposes in accordance with these terms.

4. The replacement property must be identified within 45 days (as required under prior regulations).

5. The legal title to the property held by the EAT must actually be conveyed within 180 days in exchange for either (1) the replacement property being transferred to the taxpayer or (2) the relinquished property being transferred to an outside party.

6. The combined time that the replacement and the relinquished property are held in a QEAA must not exceed 180 days.

Transactions between the EAT and the taxpayer that will not cause the exchange to lose safe-harbor recognition include:

• The EAT is not prohibited from also functioning as a QI as provided under prior regulations.
• The taxpayer or a disqualified person may grant or guarantee debt for the EAT.
• The EAT may lease the property held to the taxpayer or a disqualified person. However, the procedure notes that the availability of depreciation deductions for the EAT, is not addressed at this time.
• The taxpayer may manage property held by the EAT or may oversee construction on the property.

The new safe harbor is effective for property acquired by an EAT under a QEAA as of Sept. 15, 2000.

From Milton Howell, CPA, Davenport, Marvin, Joyce & Co., Greensboro, NC