Forward Delayed Exchanges
In the most commonly executed exchange transaction, a Forward Delayed Exchange, property is sold (Relinquished Property), and the proceeds are then used to purchase another “like-kind” property (Replacement Property) In order for the exchange to qualify for tax-deferral under the safe harbor regulations, the sale proceeds must be held on behalf of the Taxpayer by a Qualified Intermediary (QI).
There are two versions of this exchange transaction. In the first version, two properties are “swapped” by two parties who want to simply trade properties. Taxpayer A gives his property to Taxpayer B, in return for Taxpayer B’s property. The other version of this exchange involves the sale of one property and the simultaneous acquisition of another. The Exchanger sells Relinquished Property to one party and then immediately acquires Replacement Property from a third-party. To ensure that this exchange qualifies for tax-deferral under the safe harbor regulations, the Taxpayer should engage the services of a Qualified Intermediary.
In a Reverse Exchange, the eventual Replacement Property is acquired before the sale of the Relinquished Property. Since the taxpayer has yet to sell Relinquished Property, the taxpayer may not hold the Replacement Property. Therefore, the eventual Replacement Property is “parked” by an unrelated third-party, referred to as an Accommodating Titleholder, until the Relinquished Property is sold. In order to qualify for tax-deferral under the safe-harbor regulations, the Parked Property must be acquired as Replacement Property within 180 days from the day the Accommodating Titleholder purchased it. The fees associated with these exchanges are higher due to the transactional complexity.
In a Construction Exchange (also known as a “Build-to-Suit” Exchange), the exchange proceeds from the Relinquished Property sale are used to acquire the Parked Property, and to construct improvements on the property. The property must be held by the Accommodating Titleholder until either the improvements are complete or the 180 day exchange deadline occurs. On or before the 180th day, the improved property must be transferred to the Exchanger as the Replacement Property, in completion of the exchange. These transactions may also be structured as Reverse Construction Exchanges. The fees associated with both of these exchanges are higher due to the transactional complexity.
In a Leasehold Exchange (also known as a Construction Leasehold Exchange), the exchange proceeds from the Relinquished Property sale are used to construct improvements on property owned by a related or unrelated taxpayer. Via the use of a ground lease, the improvements are held by the Accommodating Titleholder until either the improvements are complete or the 180 day exchange deadline occurs. On or before the 180th day, the improvements and the ground lease are transferred to the Exchanger as the Replacement Property, in completion of the exchange. These transactions may also be structured as Reverse Construction Exchanges. The fees associated with both of these exchanges are higher due to the transactional complexity.
Non-Safe Harbor Exchanges
The safe harbor regulations for a Reverse 1031 exchange were first outlined by the IRS in Revenue Procedure 2000-37. This Revenue Procedure specifically noted that the Reverse exchange transaction must be completed within 180 days in order for a taxpayer to qualify for safe harbor treatment. However, the Service also included “no inference” language in the Revenue Procedure whereby it stated that a taxpayer should not infer that the transaction will not qualify for deferral if the transaction varies from the safe harbor requirements. This language has led to much debate as to what flexibility a taxpayer has in structuring a Reverse exchange outside of the safe harbor requirements.
Shortly after the Revenue Procedure was published, a taxpayer approached the IRS for a Private Letter Ruling allowing deferral in a Reverse exchange transaction which required nearly nineteen months to complete. The IRS did grant deferral for this taxpayer, but since Private Letter Rulings are taxpayer specific, PLR200111025 can not be relied on by other taxpayers.
A Multi-Asset exchange involves the sale of more than one type of property; generally real property and personal property. The most common multi-asset exchange occurs when the taxpayer is selling a business. Generally, the sale of a business includes Real estate, Furniture, fixtures and equipment (FF & E), and Goodwill or going concern.
Because any depreciable asset can be exchanged, it is safe to include the real estate and personal property (FF & E); however, goodwill or going concern is not exchangeable and therefore is taxable. In real estate, the like-kind requirement is very broad; however, with personal property the like-kind requirement is very restrictive. The property that is being sold must be replaced with property within the same classification. Because goodwill is not exchangeable, it is important to allocate as much gain to the real estate and personal property as possible within a reasonable amount. With plenty of advanced planning and guidance from your tax professional these types of exchanges can be well executed and bring significant tax savings.