By Gene Aalseth
First American Title Insurance Company

Introduction

Your client wants to accomplish a tax deferred exchange pursuant to Internal Revenue Code Section 1031. Several months ago your client found an investment property and entered into a contract to acquire it. Since that time your client has been actively marketing five investment properties, but has had little success attracting buyers. The contract for the acquisition of the "replacement property" will expire soon and the seller has told your client that the contract will not be extended. Your client doesn't want to lose this "replacement property," but still wants to accomplish a tax deferred exchange. The solution is to enter into a "qualified exchange accommodation agreement (QEAA)" pursuant to IRS Revenue Procedure 2000-37 (Rev. Proc. 2000-37) in order to accomplish a "reverse exchange."

Under Rev. Proc. 2000-37 reverse exchanges are accomplished by "parking" either the "replacement property" or the "relinquished property" with a third party until the actual exchange of properties can take place. In the situation described above, your client would locate a third party willing to act as an "exchange accommodation titleholder" and assign the "replacement property" purchase contract to the "exchange accommodation titleholder." The "exchange accommodation titleholder," using funds advanced from your client or from a lender, would acquire title to the "replacement property" and would hold title to the "replacement property" until your client was able to sell one of the investment properties ("relinquished property"). The contract for the sale of the "relinquished property," would be assigned to a "qualified intermediary" and pursuant to that agreement title would be transferred to the "qualified intermediary" who would transfer it to the buyer. The "qualified intermediary" would then use the sale proceeds to acquire the "replacement property" from the "exchange accommodation titleholder" and would transfer the "replacement property" to your client to complete the exchange.

The Safe Harbor under Rev. Proc. 2000-37

Revenue Procedure 2000-37, which became effective September 15, 2000, provides a safe harbor under which the IRS will not challenge:

• " the qualification of property as either "replacement property" or "relinquished property" for purposes of § 1031 of the Internal Revenue Code and the regulations thereunder, or · treatment of the "exchange accommodation titleholder" as the beneficial owner of the "replacement property" or "relinquished property" for federal income tax purposes, if the property is held in a "qualified exchange accommodation arrangement," as defined in the revenue procedure.

Qualified Exchange Accommodation Arrangements

Section 4.02 of Rev. Proc. 2000-37 sets forth six requirements that must be met for property to be held in a Qualified Exchange Accommodation Arrangement. Those requirements can be summarized as follows:

1. The property is held by an "exchange accommodation titleholder" - a person who is not the taxpayer or a disqualified person and who is subject to federal income tax. (If this person is a partnership or an S corporation 90% of partners or shareholders must be subject to federal income tax.)
2. The taxpayer must have a bona fide intent that the property be held as either "replacement property" or "relinquished property" in a qualifying exchange when transferring it to the "exchange accommodation titleholder."
3. A written agreement must be entered into within five business days after the transfer of the property to the "exchange accommodation titleholder" that provides the:
• property is held for the benefit of the taxpayer in order to facilitate an exchange under § 1031 and Rev. Proc. 2000-37;
• taxpayer and "exchange accommodation titleholder" agree to report the acquisition, holding, and disposition of the property as provided in Rev. Proc. 2000-37; and
• exchange accommodation titleholder" will be treated as the beneficial owner of the property for all federal income tax purposes.
4. No later than 45 days after the transfer of the "replacement property" to the "exchange accommodation titleholder", "relinquished property" must be identified in a manner consistent with the principles for identifying "replacement property" found in § 1.1031(k)-1(c)(4) of the Treasury Regulations.
5. No later than 180 days after the transfer of the property to the "exchange accommodation titleholder" the property is transferred to the taxpayer as "replacement property" or to a person other than the taxpayer or a disqualified person as "relinquished property."
6. The combined time period that the "relinquished property" and the "replacement property" are held does not exceed 180 days.

As a consequence of requirement four, the client in the example must, within forty-five days, identify three potential "relinquished properties", or any number of potential "relinquished properties" so long as the aggregate fair market value of the identified "relinquished properties" does not exceed the two hundred percent of the value of the "replacement property," or any number of potential "relinquished properties" no matter what their value, provided ninety-five percent of the identified "relinquished properties" are transferred in connection with the exchange. If the client identifies three potential "relinquished properties," the client can transfer one, two or all three of the identified "relinquished properties" to complete the exchange.

Permitted Agreements

Several practical issues must be addressed in order for an "exchange accommodation titleholder" to be able to acquire, hold and manage property. For instance, a lender may not wish to lend money to the "exchange accommodation titleholder" without a guarantee from the taxpayer. The "exchange accommodation titleholder" may not be qualified to manage the property or to oversee construction if construction is to take place during the hold period. Section 4.03 of Rev. Proc. 2000-37 permits the taxpayers and "exchange accommodation titleholders" to enter into certain agreements to address these issues. In summary, these agreements may contain one or more of the following provisions:

1. An "exchange accommodation titleholder" may serve as "qualified intermediary;"
2. The taxpayer or a disqualified person may guarantee some or all of the obligations of the "exchange accommodation titleholder," including secured or unsecured debt incurred to acquire the property, or may indemnify the "exchange accommodation titleholder" against costs and expenses;
3. The taxpayer or a disqualified person may loan or advance funds to the "exchange accommodation titleholder" or guarantee a loan or advance to the "exchange accommodation titleholder;"
4. The property may be leased by the "exchange accommodation titleholder" to the taxpayer or a disqualified person;
5. The taxpayer or a disqualified person may manage the property, supervise improvement of the property, act as a contractor, or otherwise provide services to the "exchange accommodation titleholder" with respect to the property;
6. The taxpayer and "exchange accommodation titleholder" may enter into agreements or arrangements relating to the purchase or sale of the property, including puts and calls at fixed or formula prices, effective for a period not in excess of 185 days from the date the property is acquired by the "exchange accommodation titleholder;" and
7. The taxpayer and the "exchange accommodation titleholder" may enter into agreements or arrangements providing that any variation in the value of a "relinquished property" from the estimated value on the date of the "exchange accommodation titleholder's" receipt of the property be taken into account upon the "exchange accommodation titleholder's" disposition of the "relinquished property" through the taxpayer's advance of funds to, or receipt of funds from, the "exchange accommodation titleholder."

Exchange First and Exchange Last Transactions

Either the "relinquished property" or the "replacement property" can be parked in a QEAA. Transactions where the "relinquished property" is parked are known as "exchange first" transactions. In an "exchange first" transaction, the taxpayer transfers the "relinquished property" to the "qualified intermediary" who in turn transfers it to the "exchange accommodation titleholder." At the same time, the seller of the "replacement property" transfers it to the "qualified intermediary" who transfers it to the taxpayer to complete the exchange. The "exchange accommodation titleholder" holds title to the "relinquished property" until the taxpayer has found a buyer for it, and then transfers it to the buyer. The proceeds from the sale of the "relinquished property" are then used to repay the taxpayer or the lender who advanced the funds to acquire the "replacement property."

In the "exchange last" transaction, the seller of the "replacement property" transfers it to the "exchange accommodation titleholder" who holds it until the "relinquished property" has been sold, or, in the case of a reverse construction exchange, until construction has been completed, and then the exchange takes place.

Conclusion

Revenue Procedure 2000-37 provides a safe harbor for some, but not all "parking" transactions. It applies only to transactions after the effective date, September 15, 2000, and will not apply to an exchange that does not meet all six requirements found in Section 4.02. However, in Section 3.02 the IRS indicated that they recognize that "parking" transactions can be accomplished outside the safe harbor of Rev. Proc. 2000-37 and that those transactions may still qualify for tax deferred treatment. A transactions where improvements to be constructed on the "replacement property" will take longer than one hundred and eighty days to complete would be an example of an exchange that will need to be structured as a "parking" arrangement outside the safe harbor of Rev. Proc. 2000-37.

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All information contained herein is provided as a matter of courtesy to our clients. First American Exchange Company, its officers and agents make no representations as to the completeness and applicability of the information contained herein to each individual taxpayer. As a Qualified Intermediary, First American Exchange Company is precluded from providing tax or legal advice to its clients. Please consult your own independent tax or legal advisor regarding your specific circumstances.