New Safe Harbor for Reverse Exchanges
By James C. Griggs
SAALFELD GRIGGS PC
On September 15, 2000, the Internal Revenue Service finally issued some specific guidance for the completion of reverse, deferred like-kind exchanges. In Revenue Procedure 2000-37, the IRS provided a new safe harbor that allows taxpayers a workable, but short time frame to complete a reverse exchange.
When the deferred exchange rules were originally promulgated in 1991, they specifically excluded reverse Starker transactions from coverage by the new rules. Since that time, taxpayers have engaged in a variety of transactions to facilitate reverse like-kind exchanges, where replacement property is acquired prior to the disposition of the relinquished property. The most typical alternative would involve parking transactions. Under this structure, the replacement property is “parked” with an accommodator until the taxpayer arranges for the transfer of the relinquished property to the ultimate purchaser in a simultaneous or deferred exchange. When the subsequent sale of the relinquished property is arranged, the taxpayer often completes the exchange with the accommodator, and the accommodator then transfers the relinquished property to the ultimate purchaser. In a variation to this approach, an accommodator may acquire the replacement property and immediately exchange the property with the taxpayer for the relinquished property. The accommodator then holds the relinquished property until a buyer for the relinquished property can be found. Under the new Revenue Procedure, the IRS acknowledges that these parking transactions can still be accomplished outside the safe harbor offered by the new rules.
Under the newly published safe harbor rules, the accommodator can hold title to either the relinquished or replacement property. There are four key rules that must be followed:
- The exchanger must have a “genuine intent” to accomplish a like-kind exchange at the time that it enters into the agreement to acquire the replacement property. The documentation should clearly evidence this intent.
- Within five days after the property is transferred to the accommodator, the taxpayer and the accommodator have to enter into a written agreement as referred to by the new rules as the “qualified exchange accommodation agreement.” Specific provisions are required for this agreement.
- Within forty-five days after the replacement property is transferred to the accommodator, the relinquished property must be identified.
- Finally, the reverse exchange must be completed within 180 days after the transfer of ownership to the accommodator.
The new rules provide a great deal of flexibility in the types of agreements that can be entered into between the accommodator and the ex-changer. For instance, the exchanger or taxpayer can guarantee debt used to acquire the replacement property. In addition, the taxpayer can loan funds to the accommodator to facilitate the acquisition of the replacement property. Moreover, the exchanger can lease the replacement property or enter into an agreement to manage or supervise the improvement of the replacement property while it is held by the accommodator. Again, care should be taken in how these special agreements are drafted.
In conclusion, the newly issued safe harbor rules will surely make the use of reverse exchanges more popular. The primary shortcoming of the new rules relates to the limited time frame during which either the replacement or relinquished property can be held by the accommodator, 180 days. However, the other options which were previously used to afford a greater length of time to complete a reverse exchange, like option agreements or longer term parking arrangements, are still available if properly structured. The new rules simply provide for a higher degree of confidence in how to proceed with a short-term reverse exchange.