New IRS Ruling Sanctions "Reverse" like Kind Exchanges

New IRS Ruling Sanctions 'Reverse' like Kind Exchanges

Good news from the Internal Revenue Service: A great opportunity to defer paying taxes just got better.

Section 1031 of the U.S. Internal Revenue Code permits a property owner ("Taxpayer") to exchange one property for another, under certain circumstances, without recognizing any gain (or loss) on the exchange. This permits the Taxpayer to use tax-deferred dollars in another investment. To qualify for beneficial tax treatment, the Taxpayer must hold each property for productive use in a trade or business or for investment, and must exchange "like kind" properties. The Taxpayer has 45 days after closing on the sale of their current ("old") property to identify the replacement ("new") property, and 180 days to close on the purchase of the new property. This favorable tax treatment does not apply to an exchange of stock, partnership interests, securities, notes, or property held primarily for sale.

Historically the Taxpayer was expected to close on the sale of their old property first, then use the proceeds to purchase the new property. In other words, the Taxpayer had to sell, then buy; the Taxpayer could not buy, then sell.

On September 15, 2000, the Internal Revenue Service issued Revenue Procedure 2000-37 to provide a safe harbor for taxpayers engaged in a "reverse" exchange. If the transaction is structured properly, the Taxpayer can now acquire the new property before disposing of their old property, and still avoid recognizing any gain. To do so, the Taxpayer must enter into a qualified exchange accommodation arrangement with an exchange accommodation titleholder. The accommodator would then acquire the new property. The accommodator can either transfer the new property to the Taxpayer promptly, in exchange for the old property, then dispose of the old property later on; or transfer the new property to the Taxpayer after a period of time, once the ultimate purchaser of the old property is prepared to close.

In a reverse exchange, the Taxpayer has 45 days after the accommodator acquires the new property, to identify the old property. Usually this should not be an issue. The Taxpayer also has 180 days to receive title to the new property, and transfer title to the old property to the ultimate purchaser.

Not only does Revenue Procedure 2000-37 sanction reverse exchanges, it goes further, and provides a number of "kinder, gentler" safe harbors to facilitate these exchanges. For example, the Taxpayer may loan money to the accommodator, or guarantee a loan from a bank to the accommodator, to purchase the new property. In addition, during the time the accommodator holds title to the new property, the Taxpayer may lease the property; manage the property; supervise improvements; act as a contractor; and provide other property related services to the accommodator.

In sum, the new revenue procedure on reverse exchanges has made a valuable tax deferment opportunity even better.

Reprinted with permission from the ICLE Connection (January/February 2001)