Reverse Exchanges

The Reverse Exchange

Qualified Exchange Accommodation Arrangement (QEAA) Safe Harbor

Reverse-Starker transactions, in which the replacement property is acquired before the relinquished property is transferred, are not covered by the like-kind exchange regs under Reg § 1.1031(k)-1 , and thus do not qualify as tax-free exchanges (Rev Proc 2000-37). To circumvent that problem, taxpayers use parking arrangements, whereby a replacement property is parked with a third party until the taxpayer transfers the property the taxpayer wishes to relinquish, or the relinquished property is parked with the third party, who holds it until a transferee is identified. These transactions are arranged so that the third party or the accommodation party is treated as the owner of the replacement or relinquished property for federal income tax purposes. Safe harbor rules in an IRS revenue procedure allow these accommodation transactions to qualify as like-kind exchanges, although IRS recognizes that parking transactions outside of these safe harbor rules may still qualify. If these rules are not complied with, however, the safe harbor will not apply and determinations of who is the owner of the property for federal income tax purposes, as well as the proper treatment of any transactions by or between the parties to the exchange, are made without regard to the safe harbor. For example, if the property is not transferred within the time required in the safe harbor rules will not apply.

If property is held in a qualified exchange accommodation arrangement (QEAA), IRS will not challenge (1) whether the property qualifies as replacement property or relinquished property under Reg § 1.1031(k)-1(a) or (2) whether the exchange accommodation titleholder (“EAT”) qualifies as the beneficial owner of the property (Rev Proc 2000-37 , Sec. 1 , 2000-2 CB 308).

Definition of Qualified Exchange Accommodation Arrangement (QEAA).

Property is considered to be held in a qualified exchange accommodation arrangement (QEAA) if all of the following conditions are satisfied:

(1) An exchange accommodation titleholder (titleholder) must hold qualified indicia of ownership of the property at all times from the date the titleholder acquires the property until the property is transferred as described in (5), below.

(2) When the qualified indicia of ownership of the property are transferred to the titleholder, the taxpayer (the party seeking tax deferral treatment) must have the bona fide intent that the property held by the titleholder represents either replacement property or relinquished property in an exchange that is intended to qualify for nonrecognition of gain (in whole or in part) or loss under Code Sec. 1031.

(3) No more than five business days after the titleholder has been transferred the qualified indicia of ownership of the property, the taxpayer and the titleholder must enter into a written qualified exchange accommodation agreement that provides that (a) the titleholder is holding the property for the taxpayer's benefit to facilitate an exchange under Code Sec. 1031 and Rev Proc 2000-37, (b) the taxpayer and the titleholder agree to report the acquisition, holding, and disposition of the property as provided in Rev Proc 2000-37, and (c) the agreement must specify that the titleholder will be treated as the beneficial owner of the property for all federal income tax purposes. Both parties must report the federal income tax attributes of the property on their federal income tax returns in a manner consistent with the agreement. But property will not fail to be treated as being held in a QEAA merely because the accounting, regulatory, or state, local, or foreign tax treatment of the arrangement between the taxpayer and the titleholder is different from the treatment required by the rules at footnote 35 in this paragraph 3.

(4) No more than 45 days after the qualified indicia of ownership of the replacement property have been transferred to the titleholder, the relinquished property must be properly identified, as provided in Reg § 1.1031(k)-1(c). The taxpayer may also properly identify alternative and multiple properties, as described in Reg § 1.1031(k)-1(c)(4).

Observation: Reg § 1.1031(k)-1(c) (footnote 36) requires the identification of the replacement property, not the relinquished property, within 45 days of the transfer of the relinquished property, not within 45 days of the transfer of the replacement property. Presumably, the inversion of these terms in Rev Proc 2000-37 is deliberate in that the Rev Proc is intended to enable a taxpayer to accomplish a reverse exchange by “parking” the replacement property until it has acquired the property to relinquish in the exchange.

(5) No more than 180 days after qualified indicia of ownership of the property have been transferred to the titleholder (a) the property must be transferred (either directly or indirectly through a qualified intermediary (defined in Reg § 1.1031(k)-1(g)(4)) to the taxpayer as replacement property; or (b) the property must be transferred, as relinquished property, to a person who is not the taxpayer or a disqualified person; and

(6) The combined time period that the relinquished property and the replacement property are held in a QEAA must not exceed 180 days.³⁸

Exchange Accommodation Titleholder (EAT) of Property Held in a QEAA.

For purposes of the safe-harbor rules discussed at the exchange accommodation titleholder (EAT) is a person who is not the taxpayer (i.e. not the person seeking tax deferral for the exchange) or a disqualified person, and who is either subject to federal income tax or, if the EAT is treated as a partnership or S corporation for federal income tax purposes, more than 90% of its interests or stock are owned by partners or shareholders who are subject to federal income tax. Services for the taxpayer in connection with a person's role as the EAT in a qualified exchange accommodation arrangement (QEAA) are not taken into account in determining whether that person or a related person is a disqualified person under Reg § 1.1031(k)-1(c)(4).

For purposes of the rules relating to who is eligible to serve as an escrow holder of a qualified escrow account or a trustee of a qualified trust for purposes of the safe harbor rules a “disqualified person” is defined as: 5

(1) a person who is the agent of the taxpayer at the time of the transaction;

(2) certain persons related to the taxpayers; or

(3) certain persons related to the taxpayer's agent.

For more information on this matter or if we may be of further assistance please contact us for a free consultation by calling us at 1 (800) 781-1031 or (714) 939-1031 or by e-mail at info@cornerstoneexchange.com .

Security investments offered through Sandlapper Securities, LLC. (Member FINRA, SIPC)