Reverse Like-Kind Exchange Safe Harbor

The IRS issued Rev. Proc. 2000-37, providing a safe harbor for taxpayers entering into "parking" transactions to effectuate a reverse like-kind exchange ("reverse-Starker" transactions). Parking transactions involve an accommodation party that holds property in an exchange so that a taxpayer does not concurrently own both the relinquished and replacement exchange properties.

Under the boundaries of the safe harbor, the Service will not challenge:

• Qualification of a property as either replacement property or relinquished property for Sec. 1031 purposes; or
• Treatment of an exchange accommodation titleholder (EAT) as the beneficial owner of such property for Federal income tax purposes, if the property is held in a qualified exchange accommodation arrangement (QEAA), as defined in Section 4.02 of the revenue procedure.

Rev. Proc. 2000-37 sets specific time limits and adopts other requirements for completing parking transactions that qualify for the safe harbor. Importantly, however, in addition to sanctioned safe-harbor transactions, the IRS specifically states that non-safe-harbor transactions may be acceptable, and that the revenue procedure does not infer that transactions outside of its scope are invalid. Rev. Proc. 2000-37 is effective for transactions after Sept. 14, 2000.

Background

Sec. 1031(a)(1) provides that, in general, no gain or loss is recognized on the exchange of property:

• Held for productive use in a trade or business or for investment; and
• If such property is exchanged solely for like-kind property to be held either for productive use in a trade or business or for investment.

Sec. 1031(a)(3) allows a deferred exchange provided the replacement property is:

• Identified within 45 days after the date the taxpayer transfers the property relinquished in the exchange; and
• Received after the earlier of 180 days or by the due date of the transferor's return for the tax year in which the transfer of the relinquished property occurred.

In 1991, the Service issued Regs. Sec. 1.1031(k)-1, providing rules for deferred like-kind exchanges under Sec. 1031(a)(3). The preamble to the final regulations states that the deferred-exchange rules under Sec. 1031(a)(3) do not apply to reverse-Starker exchanges and consequently that the final regulations do not apply to such exchanges. Reverse-Starker exchanges are exchanges in which replacement property is acquired before the relinquished property is transferred; see Starker, 602 F2d 1341 (1979). Confusion arose because, theoretically, in a deferred like-kind exchange, at least one party is engaging in a reverse deferred exchange.

Since 1991, practitioners have often advised taxpayers to avoid using reverse-exchanges when actual ownership of the replacement property is acquired before the relinquished property is transferred, because no guidance existed in such circumstances. Instead, taxpayers often used parking transactions. These involve one of two formats. In the first, a taxpayer exchanges its relinquished property with an accommodator for the replacement property at the date of the replacement property purchase. The accommodator then holds the relinquished property until it is sold. In the second format, the accommodation party simply purchases the replacement property and holds it until the taxpayer sells the relinquished property. At that point, an exchange is made. The major tax issue with all parking arrangements has been whether the parking entity would be respected as the tax owner of the parked property.

QEAAs

Rev. Proc. 2000-37 adopts the parking arrangement model as the means to complete reverse like-kind exchanges. Property is held in a QEAA if all of the following requirements are met:

1. Qualified indicia of property ownership are held at all times from the acquisition date until the transfer date by an EAT that is not the taxpayer or a disqualified person. Either such person is subject to Federal income tax or, if the EAT is a partnership or S corporation, more than 90% of its owners are subject to Federal income tax.

2. At the time the qualified indicia of ownership are passed to the EAT, the taxpayer intends that the property held by the EAT represents either replacement property or relinquished property.

3. No later than five business days after the transfer of qualified indicia of ownership to the EAT, the taxpayer and the EAT enter into a written agreement that provides that the EAT is holding the property for the taxpayer's benefit to facilitate a Sec. 1031 exchange.

4. No later than 45 days after the transfer of qualified indicia of ownership of the replacement property to the EAT, the relinquished property is properly identified under principles equivalent to those applicable to deferred exchanges.

5. No later than 180 days after the transfer of qualified indicia of ownership to the EAT, either the property is transferred (directly or indirectly through a qualified intermediary) to the taxpayer as replacement property, or it is transferred as relinquished property to a person who is not the taxpayer or a disqualified person.

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

Property will not fail to be treated as being held in a QEAA as a result of any one or more of the following:

1. An EAT simultaneously serves as a qualified intermediary in the same transaction.

2. The taxpayer guarantees some or all of the EAT's obligations or indemnifies the EAT against costs and expenses.

3. The taxpayer loans or advances funds to the EAT or guarantees a loan or advance to the EAT.

4. The EAT leases the property to the taxpayer.

5. The taxpayer manages the property, supervises improvement of the property, acts as a contractor or otherwise provides services to the EAT for the property.

6. The taxpayer and the EAT enter into agreements or arrangements relating to the purchase or sale of the property (including puts and calls at fixed or formula prices) effective for a period not in excess of 185 days from the date that the EAT acquires the property.

7. The taxpayer and the EAT enter into agreements or arrangements providing that any variation in the value of a relinquished property from the estimated value on the date of the EAT's receipt of the property be taken into account on the EAT's disposition of the relinquished property through the taxpayer's advance of funds to (or receipt of funds from) the EAT.

Rev. Proc. 2000-37 is great news for deferred transactions intended for completion within 180 days. Provided the taxpayer follows the procedures set forth, the risk for the ownership of the parked property by the accommodating EAT is virtually eliminated. If, however, a transaction cannot be completed in the statutory 180 days, the taxpayer must rely on authority outside Rev. Proc. 2000-37. (See also Hamill, "Rev. Proc. 2000-37 Offers Long-Awaited Reverse Exchange Safe Harbor," p. 190, this issue.)

From Judi V. Bruce, CPA, Washington, DC, Glenn Mackles, J.D., Washington, DC, and Lou Weller, J.D., MPP, San Francisco, CA