IRS Safe Harbor Reverse Exchange Guidance

Reverse Exchanges occur when a taxpayer arranges for a "exchange accommodation titleholder" (usually the Qualified Intermediary or a subsidiary organization) to take and hold title to Replacement Property before a taxpayer finds a buyer for his Exchange Property. Sometimes the exchange accommodation titleholder will take and hold title to the Exchange Property until a buyer can be found for it. Such exchanges have been considered risky because of the lack of guidance by the IRS in the form of regulations or otherwise for such exchanges. However, Reverse Exchanges have been common and have been preferred in circumstances where a taxpayer had to close on Replacement Property before an Exchange Property could be sold or where the taxpayer desired ample time to search for suitable Replacement Property before selling an Exchange Property which started the well-known 45 and 180-day clocks.

After promising to do so since 1991, the IRS issued safe-harbor guidance and recognition for Reverse Exchanges. Rev. Proc. 2000-37 officially sanctions Reverse Exchanges that are structured to comply with the procedures outlined in the Rev. Proc. The new safe-harbors are effective for Reverse Exchanges occurring on or after September 15, 2000.

Following is a summary of the basic requirements and provisions —

• The Reverse Exchange must be completed within 180-days or the property being held by the exchange accommodation titleholder must be deeded to the taxpayer.
• The property to be "relinquished" (the exchange property) must be identified within 45-days.
• A Qualified Intermediary (or a subsidiary) can hold title to either the Replacement Property or the Exchange Property pending completion of the exchange.
• A "Qualified Exchange Accommodation Agreement" (Reverse Exchange or title-holding agreement) must be entered into between the taxpayer and the exchange accommodation titleholder (qualified intermediary in most cases) within five business days after title to property is taken by the exchange accommodation titleholder in anticipation of a Reverse Exchange.

The Rev Proc makes it clear that these safe-harbor provisions are just that and are not mandatory. Reverse Exchange arrangements that do not meet these requirements will stand or fall on their own merits in the circumstances and will not be deemed to be disqualified merely because they do not comply with the safe-harbor provisions of this Rev. Proc. Reverse Exchanges entered into before September 15, 2000 will also stand or fall on their own merits.

Reverse Exchanges structured to take advantage of the new safe-harbors will permit the following procedures without challenge —

• Taxpayer indemnification of the exchange accommodation titleholder.
• Taxpayer guarantees of acquisition financing.
• Taxpayer lease-back of the property held by the exchange accommodation titleholder.
• Taxpayer management or construction supervision of the property held by the exchange accommodation titleholder.

Analysis —

Reverse Exchanges may very well become the preferred way to manage and transact 1031 Exchanges as a result of this official blessing by the IRS. The 45-Day identification period of delayed exchanges and related pressure to find suitable replacement property is often so burdensome that taxpayers are unable to successfully take advantage of the tax-deferral potential of a 1031 exchange.

Although Reverse Exchanges also contain similar time-clocks under the new safe-harbor procedures, such as pressure to find a buyer for the Exchange Property within the 180-days to complete the Reverse Exchange, failure to do so will not result in a taxable disqualification of the arrangement. The new safe-harbor procedures merely require that the exchange accommodation titleholder deed the property it is holding to the taxpayer on or before 180-days with no further tax consequences.

Reverse Exchanges are commonly used in connection with Improvement (Construction) Exchanges. The new 180-Day rule will be burdensome for completion of improvements in time to deed to the taxpayer.

Other issues will become self-evident as tax and exchange professionals study these new requirements.

No Reverse Exchange Safe-Harbor if Replacement Property Has Been Owned By Taxpayer in Past 180-Days

(Rev. Proc. 2004-51)

Rev. Proc. 2000-37 (a safe-harbor) provided that the IRS would not challenge a Reverse Exchange performed under the terms of the Rev. Proc. However, the IRS has become aware that some taxpayers have taken the position that Rev. Proc. 2000-37 allows a taxpayer to treat as a like-kind exchange a transaction in which the taxpayer transfers property to an Exchange Accommodation Titleholder (EAT) and receives that same property back as replacement property in an exchange of other property of the taxpayer.

A related Treasury Release dated July 20, 2004, explains that, in effect, these taxpayers are taking the position that the safe harbor permits the use of a parking transaction to reinvest the proceeds of the sale of one piece of realty in improvements to other realty that the taxpayer or a related person already owns.

Effective for transfers on or after 7/20/04, the safe harbor provisions of Rev. Proc. 2000-37 no longer apply to Reverse Exchanges when the intended replacement property has been owned by the taxpayer within the 180-day period ending on the date of transfer to the EAT.