IRS has issued a Rev. Proc. that provides a “safe-harbor” for acquisitions
of property on or after September 15, 2000. If followed, the acquisition of the
property will qualify for like-kind treatment. This material charts out the procedures
ISSUE 9: REVERSE EXCHANGES
Prior to Rev. Proc. 2000-37, exchangers and qualified intermediaries
were concerned about “reverse” exchanges, where the closing date for the purchase
of the replacement property occurred prior to the closing date for the sale of
the relinquished property. Rev. Proc. 2000-37 provides “safe harbors”, that,
if followed, will allow the acquisition of the replacement property prior to the
sale of the relinquished property.
Rev. Proc. 2000-37 is effective for acquisitions of property
on or after September 15, 2000.
Qualified intermediary (QI) Exchange accommodation titleholder (EAT)
agreement Qualified exchange accommodation
In order to better understand a reverse exchange, a review
of a regular exchangeis shown in Chart 1 below. The closing date of the
relinquished property triggers the 45-day identification period and the 180 day
exchange period for the replacement property. The 45-day and 180-day periods
start the day after the closing date for the sale of the relinquished property.
Practitioner Note.See pages 543–45 in the 2000 FarmIncomeTaxSchool Workbook for more details on the 45-day and 180-day rules specified
by I.R.C. §1031.
The fact that a contract has been negotiated for the purchase
of the replacement property prior to the sale of the relinquished property will
not preclude a tax-deferred exchange result. A seller who has entered into a contract
to sell the relinquished property may still enter into an exchange of that property,
if an exchange agreement is entered into prior to closing.On the
other side of the exchange, the seller of the relinquished property may enter
into a contract to purchase the replacement property prior to closing on the sale
of the relinquished property.
The most significant difference between a regular and reverse
exchange is that in the latter, the Exchange Accommodation Titleholder (EAT) musttake title to the replacement property.
Revenue Procedure 2000-37 defines the exchange accommodation
titleholder (EAT) as:
“a person who is not the taxpayer or
a disqualified person and either such person is subject to federal income tax
or, if such person is treated as a partnership or S corporation for federal income
tax purposes, more than 90% percent of its interests or stock are owned by partners
or shareholders who are subject to federal income tax.”
Chad, the seller, lends funds to the exchange accommodation titleholder
(EAT) for the purpose of the acquisition of the replacement property. In many
cases, unrelated LLCs are being used as the EAT. In
others, title companies or other facilitators are servings as the EAT.
The EAT then enters into a contract purchase, and subsequently
closes, on the purchase of Jane’s property. The EAT now owns the replacement property.
Rev. Proc. 2000-37 provides that no later than 5 business
days after the title to the replacement propertyhas passed to the EAT,
Chad, the seller, and the EAT must enter into a “qualified exchange
accommodation arrangement” (QEAA). Assuming a March 5, 2001, closing date for the purchase of Jane’s property, the QEAA
must be entered into by , March 12, 2001.
Rev. Proc. 2000-37 provides that no later than 45 days after
the title to the replacement property has passed to the EAT, the property to be relinquishedmust be identified.
Therefore Chad has until April 19, 2001, to identify the property he intends to sell.
Practitioner Note.The 5 business day and the 45-day identification requirements
In this example, Chad, by written notice to his EAT, identified the property to
be sold on April 1, 2001,
well within the 45-day period, which ended on April 19.
Rev. Proc. 2000-37 provides that no later than 180 days after
the title to the replacement property has passed to the EAT, the property to be
relinquished is transferred to a person (in this case, Ann) who is not the taxpayer
(Chad) or a disqualified person. In this example, the closing date for the sale
of Chad’s relinquished property to Ann occurred on June 01, 2001, well within the 180-day period. The 180-day period would
have expired at on September 1.
In the example, Chad, through the EAT, closed on the sale of his relinquished
property with Ann. At closing, the EAT directly deeded title to Chad’s relinquished property to Ann. In return, the EAT received
Ann’s purchase proceeds into escrow for the eventual benefit of Chad.
Practitioner Note.The combined time period that the relinquished property and
the replacement property can be held in a qualified exchange arrangement (QEAA)
by the EAT cannot exceed 180 days.
As of the closing date for the sale of Chad’s relinquished property to Ann, the EAT has possession of:
Title to the replacement property (acquired from Jane)
The escrowed net sales proceeds of the relinquished property
(acquired from Ann)
A note payable to Chad evidencing the original $300,000 loan Chad lent to the EAT
The final leg of the reverse exchange is the transfer by the
EAT of the three items above to Chad.As indicated previously,
the transfer of the replacement property by the EAT to Chad and the transfer of the relinquished property to Ann must
occur by September 1, in order to satisfy the 180-day requirement.
Regular exchanges continue to be the norm, with reverse exchanges
being utilized in exceptional situations. Due to financing issues, EAT’s
are not usually willing to take on the costs or liability issues of borrowing
large amounts of money in order to acquire the replacement property for the exchange.
As a result, reverse exchanges are more likely to occur when the exchanger is
a high income, high net worth individual who actually loans the needed acquisition
funds to the EAT.Reverse exchanges allow a property owner, who owns highly
appreciated real estate, to acquire the replacement property first, something
that was previously not possible under the regular exchange rules.
Practitioner Note.Rev. Proc. 2000-37 specifically states that no inference is
intended with respect to the federal income tax treatment of arrangements similar
to those described in the Rev. Proc. that were entered into priorto the
effective date September 15, 2000. The Rev. Proc. also indicates that certain
transactions can still be accomplished outside the “safe harbors,” and presumably
still qualify for reverse exchange treatment. Therefore, it is possible that reverse
exchanges that occurred prior to September 15, 2000, that do not specifically
follow the “safe harbor” guidelines mightstill be accepted by the IRS
in exam situations.