I.
Introduction
A.
Reverse exchanges
B.
1.
Not covered by exchange regulations. A taxpayer may not engage in an exchange with itself, so the taxpayer cannot own its replacement property while still owning the relinquished property.
2.
Common reasons for using reverse exchanges include when acquisition of replacement property must precede disposition of relinquished property (e.g. because of a delay to sale, to construct improvements upon replacement property), or to avoid time limitations of § 1031.
Construction or “Build to Suit” exchanges
1.
Newly constructed property, or improvements to an existing property, may qualify as replacement property in a 1031 exchange. Treas. Regs. §
1.1031(k)-1(e) sets forth rules regarding identification and receipt of such property. a.
Only improvements that are completed prior to the Exchanger’s acquisition of the property qualify. b.
Partially completed real property still under construction may qualify as replacement property if local law considers the completed portion to be real property. c.
Improvements completed after the Exchanger has acquired the property do not qualify as “like kind” replacement property.
Bloomington Coca Cola Bottling Co. v. Commissioner, 189 F.2d
14 (7 th Cir. 1951). d.
Any additional improvements constructed after Exchanger’s receipt of the property will not be treated as like-kind. e.
Similarly, the Exchanger may not pre-pay for construction services to be completed after the exchange.
2.
Because of the unlikelihood of cooperation from a property seller to achieve construction of improvements prior to transfer of title to an Exchanger, it is often necessary to employ a third party to complete a build to suit exchange. a.
In a deferred exchange, the Qualified Intermediary may acquire and construct improvements upon property prior to transferring the property to an Exchanger.

II.
b.
A cooperative buyer or accommodation party may be engaged to acquire property and construct improvements (discussed further below).
Reverse Exchanges Prior to Rev. Proc. 2000-37
A.
Generally, exchange “parking” transactions are so-called “Exchange Last” format: a friendly accommodation party (“Accommodator”) purchases the
Exchanger’s intended replacement exchange property from a cash seller. The
Accommodator holds title to (or, “parks”) the replacement property (and often constructs improvements upon it) until the Exchanger sells the Relinquished
Property to a cash buyer. At that time, the Exchanger and Accommodator complete a simultaneous or deferred exchange, resulting in Exchanger’s ownership of the replacement property.
1.
In general, the Exchanger provides or arranges for financing to fund the
Accommodator’s purchase of the replacement property.
2.
The Exchanger usually will have an option or other agreement to purchase the replacement property from the Accommodator.
3.
Commonly, a cooperative buyer of the Exchanger’s Relinquished Property would serve as the Accommodator.
B.
4.
Various forms of this structure have been the subject of case law, and courts have largely been flexible in allowing parking arrangements in build-to-suit exchange transactions. See: a.
b.
J.H. Baird Publishing Company v. Commissioner, 39 T.C. 608
(1962)
Coastal Terminals Inc. v. U.S., 320 F.2d 333 (4 th Cir. 1963) c.
d.
Boise Cascade Corp. v. Commissioner, 33 TCM 1443 (1974)
Fredericks v. Commissioner, T.C. Memo 1994-27
5.
The IRS also approved an Exchange Last transaction in Rev. Rul. 75-291,
1975-2 C.B. 332; see also PLR 9428008, 9413006, 9149018, 9110007,
8701015, 8304022, 8217106, 8035049, 7929091, 7823035 for examples of allowed arrangements.
6.
For a contrary result, See DeCleene v. Commissioner, 115 T.C. No. 34 (Nov.
17, 2000), discussed further below.
Parking exchanges may also be structured in “Exchange First” format, in which the Accommodator acquires title to the Exchanger’s relinquished property, the
Exchanger acquires the replacement property, and Accommodator holds title to the relinquished property until a cash buyer can be found.
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C.
Since I.R.C. 1031 and the exchange regulations do not address “reverse” exchanges, planning techniques prior to the issuance of Rev. Proc. 2000-37 were largely concerned with structuring such exchanges so that the Accommodator
(rather than the taxpayer) could be considered the owner of the parked property:
1.
Under general principles of tax law, which traditionally is based upon who holds the “benefits and burdens” of property ownership; and
2.
Without being considered an agent of the taxpayer under general principles of agency law.
3.
As discussed below, these concerns are still relevant to the planning of parking exchanges, when such exchanges do not qualify for the safe harbor of Rev. Proc. 2000-37.
III.
The Safe Harbor Under Rev. Proc. 2000-37
Significance A.
1.
Revenue Procedure 2000-37, 2000-2 CB 308 established a safe harbor for exchange parking arrangements used in reverse like-kind exchanges commenced on or after September 15, 2000.
2.
When the safe harbor requirements are met as provided in the revenue procedure, the IRS will not challenge an accommodation party’s ownership of parked property for federal income tax purposes.
3.
The revenue procedure states that no inference is intended regarding the tax treatment of parking arrangements that are outside the scope of the safe harbor requirements.
4.
Thus while complying with the safe harbor requirements can result in relative tax certainty for a reverse exchange, an arrangement that fails to so comply is not necessarily bound to be rejected by the IRS.
B.
Requirements / Conditions
1.
The parked property must be held by an Exchange Accommodation
Titleholder (“EAT”) as part of a Qualified Exchange Accommodation
Arrangement (“QEAA”). a.
The EAT cannot be a disqualified person (within the meaning of
Reg § 1.1031(k)-1(k)) with respect to the Exchanger, and must be subject to federal income tax. b.
A QI can act as the EAT. c.
The EAT may be designated as the agent of the Exchanger to avoid application of real estate transfer taxes in some jurisdictions. See PLR 200148042.
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C.
2.
The EAT must acquire “qualified indicia of ownership” (“QIO”) to the parked property, and continue to satisfy the QIO test at all times prior to the transfer of the parked property to the Exchanger. a.
QIO consists of either legal title or other indicia of ownership that are treated as beneficial ownership of the parked property under applicable principles of state commercial law. b.
Examples of QIO that should meet the test include a contract for deed in certain jurisdictions, or owner trust structures in commercial transactions involving creditors. c.
The EAT is permitted to hold the parked property through a disregarded entity, such as a single-member LLC.
3.
The Exchanger must have a “bona fide intent” that the parked property serve as relinquished or replacement property in a 1031 exchange.
4.
The QEAA must be reflected in a written “qualified exchange accommodation agreement” (“QEAAg”). a.
The EAT and Exchanger must enter into a QEAAg within five business days after the EAT acquires QIO of the parked property. b.
The QEAAg must state that the EAT is holding the parked property to facilitate a § 1031 exchange for the benefit of the
Exchanger under Rev. Proc. 2000-37; that the EAT will be treated as the beneficial owner of the parked property for all federal income tax purposes; and that both parties shall report the federal encome tax attributes of the parked property on their federal tax returns in a manner consistent with the QEAA.
5.
The EAT must report itself as the owner of the parked property for federal income tax purposes.
6.
In “exchange last” exchanges, the Exchanger must identify the property to be the relinquished property within 45 days of the EAT’s acquisition of QIO of the replacement property.
7.
The EAT may hold QIO of the parked property for a maximum of 180 days.
Allowable Arrangements Within a QEAA
1.
The Exchanger or a related party may advance funds to the EAT, or guarantee third party loans to the EAT, for the purpose of acquiring the parked property.
2.
The EAT may lease the parked property to the Exchanger, enter into a property management agreement with the Exchanger, or engage the
Exchanger as a contractor.
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3.
The Exchanger may agree to indemnify the EAT against various costs and expenses related to its ownership of the parked property.
4.
The EAT and Exchanger may enter into “put” or “call” options at fixed or formula prices, effective for a period not in excess of 185 days from the date the EAT acquires QIO of the parked property.
5.
All of the above arrangements may be entered into at terms that would not typically result from arm’s length bargaining.
D.
Modification by Rev. Proc. 2004-51
1.
In 2004, the IRS issued Revenue Procedure 2004-51, 2004-33 I.R.B. 294, which states that the safe harbor of Rev. Proc. 2000-37 will not apply if a would-be Exchanger owned the property intended to be a replacement property in an exchange within the 180-day period preceding the EAT’s acquisition of the property.
2.
This ruling is aimed at preventing taxpayers from circumventing the rule that one may not complete an exchange with oneself by transferring property to an EAT and re-acquiring the property via a § 1031 exchange.
IV.
Legal Authority Since Rev. Proc. 2000-37 Was Issued
A.
Some IRS rulings have taken a liberal approach to application of the safe harbor, or otherwise expanded the flexibility of its use, for example:
1.
PLR 200148042 provides hat the following language will not affect the safe harbor: “The EAT is acting solely as [Exchanger’s] agent for all purposes, except for federal income tax purposes.”
2.
PLR 200338001 clarified that the test of a disqualified person (applicable to
QI or EAT purposes) was based on ownership, not control; this allows an
Exchanger to have management control of an EAT without sacrificing the safe harbor of Rev. Proc. 2000-37.
B.
DeCleene v. Commissioner, 115 T.C. No. 34 (Nov. 17, 2000).
1.
The taxpayer in DeCleene attempted a planned, build-to-suit reverse exchange, and is the only truly thorough judicial examination of a parking exchange transaction.
2.
The exchange was structured such that the buyer of the taxpayer’s relinquished property acquired land that the taxpayer already owned, constructed improvements upon the property, and then conveyed the property and improvements back to the taxpayer in exchange for the relinquished property.
3.
The Tax Court concluded that the transfers failed to qualify under § 1031 under the basis that the taxpayer was the beneficial owner of the replacement
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property throughout the exchange process. The Court re-iterated the stance taken in the Code that a taxpayer may not accomplish an exchange with itself.
4.
The exchange in DeCleene was poorly structured, and some flaws peculiar to this case weighed against the taxpayer, such as: a.
The taxpayer owned title to the replacement property prior to engaging in the exchange. b.
An Accommodator was not used, and the documentation of the property transfers created ambiguity about whether any transfer of property ownership took place. c.
d.
All of the normal incidents of property ownership (e.g. payment of real estate taxes) remained the responsibility of the taxpayer during the exchange, and were never assumed by the cooperative buyer.
The cooperative buyer never had any equity risk or opportunity for profit in connection with owning the replacement property.
5.
Because of the poor structure of the exchange, the implication of the
DeCleene decision to other parking arrangements is uncertain. At the least, it indicates that the IRS will not “rubber stamp” transactions simply because an exchange of property takes place. In DeCleene, substance was stressed over form.
6.
Note that Rev. Proc. 2000-37 did not apply to the transaction, since it occurred prior to the September 15, 2000 effective date of the safe harbor ruling.
Leasehold Build-to-Suit Exchanges C.
The IRS has issued at least two letter rulings involving the use of a leasehold structure to accomplish a build-to-suit exchange within the safe harbor of Rev. Proc.
2000-37. As set forth in Regs. § 1.1031(a)-1(c)(2), a leasehold interest with a remaining term of at least 30 years is like-kind to a fee interest. These rulings involve situations in which an Accommodator acquired such a leasehold interest, constructed improvements to the leasehold estate, and transferred the remaining leasehold and improvements to an
Exchanger as replacement property in an exchange.
1.
PLR 200251008 a.
The Exchanger entered into a QEAA with an EAT, and an exchange agreement with a QI, satisfying all requirements of
Rev. Proc. 2000-37 and Reg. § 1.1031(k)-1. b.
The EAT leased land from an affiliate (related party) of the
Exchanger for a term of 32 years at a fair market value.
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c.
d.
The EAT constructed improvements to the land using funds borrowed from the Exchanger.
Through an assignment of rights to the QI, the Exchanger used exchange funds from the sale of Exchanger’s relinquished property to acquire the EAT’s interest in the leasehold interest and improvements. e.
The IRS held that the transaction qualified for non-recognition of gain under the exchange regulations and Rev. Proc. 2000-37.
2.
PLR 200329021: very similar to PLR 200251008 except that instead of leasing property from an affiliate of the Exchanger, the EAT acquired an existing long-term lease from an affiliate of the Exchanger (the land was owned by an unrelated third party).
3.
Positive Implications of These Rulings for Taxpayers: a.
They are taxpayer-friendly in that they took a ‘form over substance’ approach. The provisions of Rev. Proc. 2000-37 were applied like a simple checklist, and since there were no technical violations of those conditions, the exchanges were allowed. b.
c.
4.
Limitations of These Rulings for Taxpayers: a.
It is questionable whether such leasehold transactions would survive a “step transaction” attack as was used in the DeCleene case, discussed above. See also Smith v. Commissioner, 537
F.2d 972 (8 th Cir. 1976). b.
As noted above, it is arguable that related party restrictions could be interpreted to forbid such exchange structures. c.
Essentially creates a loophole around the restriction in
Bloomington Coca Cola and DeCleene that a taxpayer may not exchange real estate owned by the taxpayer for improvements upon land owned by the same taxpayer.
As private letter rulings, the two rulings have no precedential value. Further, informally the IRS has indicated displeasure with the rulings, which were apparently issued within a short time of each other by the same IRS attorney. d.
The rulings took the position that the related party restrictions of
§ 1031(f) did not present an obstacle to the validity of the exchanges (although this position is stated without analysis and may be considered dubious).
In light of these points (and the discussion of Rev. Proc. 2004-
51, below), it is highly unclear whether the IRS would continue to approve such parking transactions.
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D.
5.
Effect of Rev. Proc. 2004-51 Upon Leasehold Exchanges a.
Rev. Proc. 2004-51 provides that the safe harbor of Rev. Proc.
2000-37 does not apply to replacement property parked with an
EAT if the property is owned by the taxpayer within the 180-day period ending on the date of transfer of qualified indicia of ownership of the property to the EAT. b.
In the preamble to the Rev. Proc., the IRS cites DeCleene and
Bloomington Coca Cola for the proposition that “an exchange of real estate owned by a taxpayer for improvements on land owned by the same taxpayer does not meet the requirements of Section
1031. Rev. Rul. 67-255 1967-2 C.B. 270 is also cited for the idea that a building constructed on land owned by a taxpayer is not of like-kind to land of the same taxpayer. c.
The Rev. Proc. also contains the ominous statement that
The Service and Treasury Department are continuing to study parking transactions, including transactions in which a person related to the taxpayer transfers a leasehold in land to an accommodation party and the accommodation party makes improvements to the land and transfers the leasehold with the improvements to the taxpayer in exchange for other real estate. d.
These factors are generally taken by tax advisors at the very least to mean that such transactions should be approached with caution.
Recent Authority Concerning Non-Safe Harbor Parking Arrangements
1.
PLR 2000111025 (released March 19, 2001) is the only private letter ruling issued after Rev. Proc. 2000-37 to address a parking exchange structured outside the safe harbor provisions. a.
Facts: an Exchanger engaged an Accommodator to acquire replacement exchange property, and knew from the outset of the exchange that the Accommodator would hold title for more than
180 days. The Accommodator funded the acquisition with funds borrowed from a Bank (guaranteed by the Exchanger) and from the Exchanger; the Accommodator did not invest any of its own capital. The Exchanger had an option to acquire the parked replacement property at a cost that was fixed for 18 months. The
Exchanger also leased the parked property from the
Accommodator on a triple-net basis. b.
Based on an analysis of J.H. Baird, cited above, and Biggs v.
Commissioner, 69 TC 905 (1978), the IRS stated that three
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general requirements must be met for the Exchanger’s parking arrangement to qualify under § 1031: c.
d.
i. The taxpayer must demonstrate an intent to achieve an exchange and the properties to be exchanged must be of likekind and held for a qualified use; ii The steps in the various transfers must be part of an integrated plan to exchange the relinquished property for the replacement property; and iii The party holding the replacement property must not be the taxpayer’s agent.
The PLR used the agency test established in National Carbide
Corp. v. Commissioner, 336 U. S. 422 (1949) to conclude that the Accommodator was not the agent of the taxpayer.
Applying the facts to the other two requirements, the transaction was determined to qualify under section 1031. e.
The implications of this ruling are that perhaps the traditional test of beneficial ownership of parked property (a benefits-andburdens test) does not apply to an Accommodator in an exchange transaction, and that instead an agency test should be applied (as long as the Exchanger demonstrates an intent to an exchange via an integrated plan).
2.
FAA 20050203F: this field service advice employs an alternative approach to that used in PLR 200111025. Rather than an agency analysis, the Advice concludes that a non-safe harbor parking exchange could fail if the
Accommodator was not the tax owner of the parked property based on a benefits and burdens of ownership analysis. a.
The facts in the Advice were largely similar to that of PLR
200111025. The Accommodator acquired replacement property using a loan guaranteed by the Exchanger, and agreed to construct improvements. The Accommodator did not invest its own capital, and was not required to supply any funds beyond those provided by the Exchanger or available from the sale of the relinquished property. The Exchanger held an option to acquire the parked property from the Accommodator at a price that was fixed for 24 months. The Accommodator leased the parked property to the Exchanger at below-market terms. b.
The IRS applied a benefits and burdens test to the facts using factors set forth in Grodt & McKay Realty, Inc. v.
Commissioner, 77 T.C. 1221 (1981): i.
Whether legal title passes; ii.
Whether the transaction was treated as a sale;
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V.
c.
d.
iii.
Whether the purchaser acquires an equity interest in the property; iv.
Whether the sales contract obligates the seller to execute and deliver a deed and obligates the purchaser to make payments; v.
Whether the Accommodator is vested with the right of possession; vi.
Responsibility for property taxes; vii.
Risk of economic loss; viii.
Whether the Purchaser received profit from the property.
Informally, the IRS has announced that the FSA analysis will be applied in the future, rather than that of PLR 200111025.
The approach of the FSA clearly indicates that without the protection of the safe harbor, the Accommodator must have obligations and risk of loss in a parking exchange.
Conclusions
A.
Safe-Harbor Parking Transactions
1.
Given the straightforward checklist of conditions set forth in Rev. Proc.
2000-37, when transactions can be structured within its confines, it is possible to achieve a high level of comfort for a parking exchange.
2.
This structure can be used flexibly to complete construction exchanges as well.
B.
3.
IRS rulings issued after the Rev. Proc. have taken a liberal approach, and further expanded the flexibility of using an EAT as an exchange accommodation party.
4.
Leasehold transactions may or may not be viable going forward, and are at the least a risky strategy.
Parking Transactions Outside the Safe Harbor
1.
Non-safe harbor transactions are still valid if properly structured.
2.
However, there is considerable doubt about how to “properly structure” these transactions, and the IRS may be adopting a more constrictive approach to them.
3.
To minimize risk, such exchanges should be structured with a benefits-andburdens approach in mind. a.
The Accommodator should have some capital at risk; as for debt, non-recourse terms may not be sufficient.
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b.
c.
d.
The Accommodator should have opportunity to profit in the ownership of the parked property.
The Accommodator should have other ownership responsibilities
(e.g. payment of property taxes and debt service).
Any side agreements between the Exchanger and Accommodator
(e.g. management agreements, loans, or leases) should be at arms’ length or market terms.
4.
Because of the impracticality and difficulty of satisfying a benefits-andburdens analysis, such transactions will be available only to a select group of potential exchangers (commercial providers of qualified intermediary services will be hard-put to offer what is required).
5.
It is more important than ever that an Exchanger choose from the outset of the transaction whether to structure the exchange to comply with the safe harbor conditions of Rev. Proc. 2000-37 or to risk a non-safe harbor structure.
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