Going Past 180 Days

Non Safe Harbor Exchanges

Most investment property owners are familiar with the benefits provided by Section 1031 of the Internal Revenue Code regarding the deferral of capital gain and depreciation recapture taxes. They are also familiar with the limits associated with completing any exchange within the 180 day day exchange period.

But, can you go past the 180 days? Yes, provided you are well prepared.

2. An experienced Facilitator

1. A solid exchange plan

3. Accomplished legal representation

Rev. Proc. 200-37

The Rev. Proc. 2000-37 Safe-Harbor

IRC Section 1031 allows non-recognition of gain only to the extent that replacement property is “like-kind” to relinquished property. If all or part of the replacement property is not of a like-kind, gain will be recognized to the extent of that portion of consideration which is not of like-kind. Therefore, in order to fully defer the gain realized on the disposition of relinquished property, the taxpayer must acquire like-kind replacement property of equal or greater value to complete the exchange.

Improvements constructed on real property already owned by a taxpayer are not like-kind to other property and do not qualify as like-kind to relinquished property transferred by the taxpayer. Therefore, if a taxpayer uses proceeds from the sale of relinquished property for the construction of improvements on land already owned by the taxpayer, the amount used would be considered to be boot creating recognized gain, even if a qualified intermediary is used.

In order to complete these so-called “build-to-suit” exchanges, it is necessary to ensure that the taxpayer isn’t the owner of the replacement property until construction is complete. Rev. Proc. 2000-37 provides a safe harbor that allows a taxpayer to treat an accommodation party as the owner of the property for federal income tax purposes, thereby enabling the taxpayer to accomplish a qualifying like-kind exchange where proceeds from the sale of relinquished property will be used to fund construction of replacement property.

If the requirements of Rev. Proc. 2000-37 are satisfied, a taxpayer may complete a reverse section 1031 exchange regardless of whether the taxpayer has the various benefits and burdens of ownership with respect to the replacement property during construction and would otherwise be treated as the owner for federal tax purposes. Under the Revenue Procedure, a party that holds bare legal title to the property (referred to as an “exchange accommodation titleholder” or “EAT”) will be treated as the owner of the property for federal income tax purposes.1

Given the nature of a build-to-suit exchange transaction, it is often difficult to meet the 180-day time limit established in Rev. Proc. 2000-37. The Revenue Procedure, however, specifically provides that “the Service recognizes that ‘parking’ transactions can be accomplished outside of the safe harbor provided in this revenue procedure.” Unfortunately, the IRS has provided no guidance describing when such a non-safe harbor transaction could still qualify as a section 1031 like-kind exchange. Based on the Tax Court’s opinion in Bartell, taxpayers may be able to successfully complete a built-to-suit like-kind exchange transaction where the EAT holds bare title for a period exceeding 180 days.2

CASE STUDY 2 | Sam Reynolds

Situation

Sam has owned a retail property in Colorado for twelve years

He would like to trade up in value

He has located an ideal Replacement Property

Problem

His desirable Replacement Property has several interested Buyers

The property will likely be sold to another Buyer soon

There is not enough time to sell his existing property and 1031 exchange into the new property

CASE STUDY 2 | Sam Reynolds

Sam advances cash for Replacement Property purchase

New property is vested in an Exchange Accommodation Titleholder

Solution

Use a Reverse Exchange to acquire the Replacement with Fyntex on title before selling the Relinquished Property

Advantages

With Fyntex on title Sam avoids exchanging into property he already owns

Sam can advance the funds to acquire the new property and be repaid when the Relinquished Property sells

Relinquished Property sells. Funds got to Intermediary

Intermediary repays advanced cash and deeds property to Sam

The Warehousing Concept

Since you cannot technically exchange into property you already own, the IRS has approved the concept of warehousing or parking the title to a property in the name of an Exchange Accommodation Titleholder or EAT.

Replacement Property

Acquired

Replacement Title

in favor of EAT

Replacement Property

deed to Exchanger

Relinquished Property

Sells

Exchange Last

Exchange First

Parking the Replacement Property

This approach utilizes cash from the Exchanger to acquire the new property.

Parking the Relinquished Property

This approach is most often used when the Exchanger needs to finance their Replacement Property purchase.

The Exchange Last Approach

Exchanger

Advances

Purchase Cash

Replacement

Property

Acquired

Advanced

Cash Refunded

to Exchanger

Replacement

Deeded

to Exchanger

Replacement

Deeded

to EAT

Relinquished

Property

Sells

The Exchange First Approach

Exchanger

Advances Cash

for Replacement

Equities Balanced

Relinquished &

Replacement

Relinquished

Property Deeded

to EAT

Relinquished

Property

Sells

Replacement

Property

Acquired

Exchange

Reported

on Form 8824

BARTELL DRUGS

Reverse exchange transactions offer taxpayers advantageous tax deferrals when structured correctly, particularly where the taxpayer wants to build or modify the replacement property. The findings in the Bartell case may allow taxpayers to take advantage of these tax deferrals even when they do not fall within the safe harbor limits of Rev. Proc. 2000-37.

While meeting the requirements of the revenue procedure ensure that the transaction will avoid IRS challenge, the Tax Court’s decision opens up the possibility that if an exchange facilitator who takes bare legal title of the replacement property is properly utilized, the taxpayer can manage the construction of replacement property, guaranty acquisition and construction loans, lend funds to facilitate completion of the project and make other necessary arrangements and still successfully complete a reverse like-kind exchange even without meeting the safe harbor requirements.

It is worth noting, however, that the Tax Court specifically stated that “we express no opinion with respect to the applicability of section 1031 to a reverse exchange transaction that extends beyond the period at issue in these cases. In view of the finite periods in which the exchange facilitator in these case could have held, and in fact did hold, title to the replacement property, we are satisfied that the transaction qualifies for section 1031 treatment under existing caselaw principles.” In light of this commentary, caution is warranted in structuring non-safe harbor exchange transactions that go beyond the facts of Bartell and the authorities described therein.

An attorney from the IRS Office of Associate Chief Counsel (Income Tax and Accounting) recently stated that the IRS considering appealing the Bartell decision to the Ninth Circuit. The IRS is considering the best strategy for supporting its legal analysis, which may or may not ultimately include an appeal. Regardless of its decision regarding an appeal, it appears the IRS is unlikely to give up on its position.

CASE STUDY 3 | Bill Smith

In this case, Bartell Drug entered into an agreement to purchase property in Lynnwood, WA, in 1999 and made periodic earnest money payments under the agreement. The sale agreement contained a clause stating that both the buyer and seller agreed to reasonably cooperate with each other to accomplish an exchange under section 1031. Bartell Drug ordered a commitment for title insurance, did due diligence on the property, applied for a building permit for the site and ordered a traffic study from a traffic engineering firm.

Bartell Drug engaged a facilitator for section 1031 exchanges, agreeing that EPC Two, a single member LLC formed for the exclusive purpose of providing services to Bartell Drug, would take title to the Lynnwood property in order to effect the section 1031 exchange. EPC Two obtained the title to the land as well as a title insurance policy. A loan was obtained in order to fund the acquisition of the Lynnwood land as well as the construction of a new drug store on the property. The loan was made to EPC Two, but was nonrecourse to the entity and was guaranteed by Bartell Drug. The commitment letter from the bank stated the purpose of the loan as “to finance the acquisition of land and construction of a new store in Lynnwood, WA under the benefits of 1031 tax-free exchange.”

Bartell Drug and EPC Two entered into an agreement where EPC Two was to construct a drug store on the Lynnwood property. Bartell Drug indemnified EPC Two for liabilities with respect to the project. After the bank loan proceeds were exhausted, the Bartell Drug funded the construction of the project. The agreement allowed Bartell Drug to manage the construction of the project and to lease the property once the construction was complete.

In December 2001, Bartell Drug executed an exchange agreement for the exchange of relinquished property for the Lynnwood Drug Store using a qualified intermediary in a transaction intended to qualify for tax deferred treatment under section 1031. Because the length of time the property was held by EPC Two was greater than 180 days, the safe harbor rules under Rev. Proc. 2000-37 would not have applied even if Rev. Proc. 2000-37 had been effective prior to the initiation of the like-kind exchange.

The central issue between the taxpayer and the IRS in this case is whether Bartell Drug or EPC Two should be considered the owner of the Lynnwood property for Federal income tax purposes prior to EPC Two’s exchange of the Lynnwood Drug Store to the taxpayer. If it were to be ruled that Bartell Drug was the owner of the Lynnwood property prior to the exchange, then the taxpayer would have been engaged in a nonreciprocal exchange with himself.3

The IRS stated that under the benefits and burdens test, Bartell Drug already owned the Lynnwood property before December 2001, thereby precluding any exchange as of that date. The petitioners contended that EPC Two must be treated as the owner and that the agency analysis should be employed consist

Learn How to Include New Construction or Improvements to Your Replacement Property

Construction or

Improvements

Completed

Construction or

Improvements

Started

Property

located and

plans completed

Property deeded

or EAT assigned

to Exchanger

Property

vested in

EAT

Cash advanced

to acquire

property

IMPROVEMENT EXCHANGES DOS AND DONT'S

Ensure that the Exchange Accommodation Title is on title before commencing any improvements or construction activity

Ensure that all improvements are appropriately identified

Ensure that the Replacement Property with improvements is deeded to the Exchanger before the 180th day

Do not start a transaction without knowing you can complete enough for the exchange to work within the 180 day window.

If your construction will take you past 180 days, make sure you have experienced legal representation and a plan in place before starting.

Always buy as the same entity in which you sold or utilize a legitimate disregarded entity in your exchange

BE MINDFUL OF LOGISTICAL ISSUES

Always ensure that the exchange is setup prior to the closing of either the Relinquished or replacement Property.

If you need to finance the purchase of a Replacement Property in a Reverse Exchange, try to find a lender who understand the warehousing or parking concept before you get started. This is because the lender will be lending to the Exchange Accommodation Titleholder or EAT, not the Exchanger.. Some lenders will do this with a personal guarantee of the Exchanger.

Always try to buy as the same entity in which you sold. Changing your vesting from a relinquished Property to a Replacement Property, other than to a disregarded entity, can be dangerous. By changing vesting you are creating an opportunity for an argument that you don't meet the held for requirement of Section 1031.

If you expect for your exchange to exceed the 180 day Qualified Intermediary Safe Harbor, make sure your exchange documentation provides for an opportunity to extend the exchange with the payment of an extension stipend. Also, ensure that the case law upon which you are relying matches the circumstances of your exchange. Non Safe Harbor exchanges can be dangerous and expensive.

In certain jurisdictions Exchangers are at risk of a double transfer tax assessment when a property is deeded from the Exchange Accommodation Titleholder to the Exchanger. If you suspect the county or jurisdiction of your property intends to double tax you, have the Qualified Intermediary assign you the EAT LLC instead.

When planning a Reverse Exchange make sure your Facilitator or Qualified Intermediary is sufficiently experienced with the logistics and structuring of reverses. Also, ensure that your equities between your Relinquished and Replacement Properties are balanced in an Exchange First scenario.

1031 Expertise

While the concepts which underlie both a Reverse Exchange and an Improvement or Construction Exchange are simple, the logistics of many transactions can cause the water to get deep in a hurry. This is why you need to have a 1031 expert on your team to assist you.

Consider scheduling a Zoom video conference below with a Fyntex expert and your client.

We'll walk everyone through the operational logistics and ensure a smooth process.

https://fyntex.com/videconferencing.html

LET FYNTEX HELP ...

We're here to answer your questions

Tom Bottenberg

Phone

844-655-1031

Email

tbottenberg@fyntex.com

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https://1031resourcecenter.com/training/abtindex2.html