WHAT IS A REVERSE Exchange

One of the significant issues that remained unresolved, even after the enactment of the ExchangeRegulations of 1991 was the ability to perform a “reverse Exchange”. In the preamble to the Regulations promulgated under Code Section 1031(a)(3), the Treasury Department stated that, in its opinion, the deferred Exchangerules under Code Section 1031(a)(3) did not apply to reverse Exchanges, but that the Treasury and IRS would continue to study the applicability of the like-kind Exchangerules to such transactions.  

After nine years, on September 15,2000, the Internal Revenue Service enacted Revenue Procedure 2000-37 (Reverse Revenue Procedure) which was published as Internal Revenue Bulletin 2000-40 on October 2, 2000. 

For the first time property owners wanting to utilize the opportunity to PAY NO CAPITAL GAINS TAX benefit of IRC Section 1031, and needing to acquire the “replacement property” prior to conveying legal title of the “relinquished property”, can do so without fear of IRS scrutiny. They must, however, adhere to the rules set forth in the new Revenue Procedure.  

The Revenue Procedure provides: a safe harbor under Section 1031 for certain arrangements between taxpayers and Exchangeaccommodation titleholders; and
provides for the treatment of the Exchangeaccommodation titleholder as the beneficial owner of the property for federal tax purposes. 

Elements of the Revenue Procedure 

The safe harbor is available to all qualifying reverse Exchanges entered into on or after September 15, 2000. The relinquished property must be identified within 45 days from the transfer of the replacement property to the Exchangeaccommodation titleholder. Like a “deferred Exchange”, within 180 days from the date of the acquisition ofthe property by the Exchangeaccommodation titleholder, the property must be transferred to either: he taxpayer (when the replacement Property is held by the Exchangeaccommodation title holder); or a person who is not the taxpayer or a disqualified person (when the relinquished property is held by the Exchangeaccommodation titleholder). 

The IRS will not challenge the qualification of the property as either “relinquishedor “replacement property” or the treatment of the Exchangeaccommodation titleholder as the beneficial owner of such property for federal tax purposes if the property is held in a qualified Exchangeaccommodation arrangement (QEAA).Property is held in a QEAA if : legal title is held at all times by a person who is not the taxpayer or an agent of the taxpayer; at the time of the transfer of the property to the Exchangeaccommodation titleholder it is the taxpayer’s bona fide intent to perform a deferred Exchange;a written Exchangeagreement between the taxpayer and the Exchangeaccommodation titleholder has been entered into within five days from the date the property (either the relinquished or replacement property) is acquired by the Exchangeaccommodation titleholder; the written agreement specifies that the Exchangeaccommodation titleholder will be treated as the beneficial owner for all federal income tax purposes and both parties report the federal income tax attributes of the property on their federal income tax returns in a manner consistent with this agreement. The taxpayer is permitted to undertake certain activities and not violate the safe harbor. The taxpayer can: make and guaranty loans to the Exchangeaccommodation titleholder; lease the property from the Exchangeaccommodation titleholder; manage the property, supervise construction of improvements, or act as the contractor;
enter into option agreements with fixed or formula prices with the Exchangeaccommodation titleholder; enter into agreements with the Exchangeaccommodation titleholder that take into account a variation in the relinquished property’s value from the date it was acquired by the Exchangeaccommodation titleholder and the date it is ultimately sold to a buyer.