Non-safe-harbor reverse-exchange guidance.
Tax advisers welcomed this guidance, even though reverse-exchange arrangements often cannot be consummated within 180 days. An open question is how the Service -will treat reverse-exchange parking arrangements that fail to comply with this requirement, or how it will view exchanges initiated before the effective date. Letter Ruling 200111025 provides insight into how the IRS might evaluate parking arrangements that fall outside the safe harbor.
In Letter Ruling 200111025, a taxpayer held a park for investment purposes. A tax-exempt organization wanted to purchase the park, but could not do so without first obtaining certain state approvals. As a result, the taxpayer received payment from the organization for an option to purchase the park. The taxpayer intended to complete a Sec. 1031 exchange when it sold the park, and the agreement with the organization clearly indicated the taxpayer's intent.
On the taxpayer's behalf, an accommodation party purchased property intended to be replacement property for the park property. It funded the purchase with proceeds of a bank loan and a loan from the taxpayer. The taxpayer guaranteed the bank loan and the accommodation party paid a fee for the guaranty. The taxpayer also indemnified the accommodation party against any environmental liability for the replacement property. The taxpayer then contracted to lease the property from the accommodation party for one year, with an option to extend the lease for an additional year. The lease was a triple-net lease, and the accommodation party also assigned other leases associated with the property. The taxpayer had the option to acquire the property for its fair market value, specified as the accommodation party's acquisition cost if the purchase occurred within 18 months.
The facts of Letter Ruling 200111025 fell outside of the Rev. Proc. 2000-37 safe harbor for two reasons. First, the accommodation party acquired title to the intended replacement property before the Sept. 15, 2000 safe-harbor effective date. Second, it held title for longer than 180 days. The IRS's analysis in the letter ruling is significant because many taxpayers had entered into reverse-exchange arrangements before the effective date. Also, many parking arrangements will require an accommodation party to hold title for longer than 180 days.
The Service reviewed many frequently cited cases in which exchanges did or did not qualify under Sec. 1031. In general, the "no-exchange" cases failed to support the purchase and sale of properties as an exchange. The IRS noted that an exchange requires three steps:
1. The taxpayer must show intent to qualify the transactions as an exchange and the properties in question must be of like-kind and held for a qualified use;
2. The transaction must be part of an integrated plan to exchange relinquished property for replacement property; and
3. The accommodation party holding title to the replacement property must not be the taxpayer's agent.
Practitioners have long worried that the typical parking arrangement created an agency relationship between the taxpayer and the accommodator. These concerns still exist for arrangements not covered under the new safe harbor, particularly in light of the failed parking arrangements in Letter Ruling (TAM) 200039005 and DeCleene, 115 TC No. 34 (2000).
Letter Ruling 2,00111025 notes that an agency analysis "underlies the determination of whether or not an exchange occurred." The factors of National Carbide Corp., 336 US 422 (1949), were used to analyze whether a relationship existed. The facts of the recent ruling suggest a more favorable fact pattern than existed in either TAM 200039005 or DeCleene. Under its own name, the accommodation party made the transaction, used its own bank accounts, did not act as a mere conduit for the transfer of money to the taxpayer, reported the parking arrangement consistent with its form on all tax filings, was independent of the taxpayer and held the property consistent with its normal business practices. The accommodation party could also realize a profit or suffer a loss from holding the property in certain circumstances. The Service concluded that there was no agency relationship and that the transaction qualified as an exchange.
Letter Ruling 200111025, like Rev. Proc. 2000-37, can be both a blessing and a curse. It demonstrates the IRS's willingness to favorably view parking arrangements not covered under the safe harbor. However, the arrangement in the ruling involved what was clearly a large, professional exchange accommodation company that took a variety of steps to properly "paper" the parking arrangement. Rev. Proc. 2000-37 provides a road map to success for those who can satisfy its requirements. Many exchange parking arrangements are conducted much less formally, and the less formal structures are factually distinguishable from both the safe harbor and the new ruling. Tax advisers must convince clients of the need for proper documentation for non-safe-harbor parking arrangements, including selecting a professional exchange accommodation party.
FROM JAMES R. HAMILL, PH. D., CPA, UNIVERSITY OF NEW MEXICO, ALBUQUERQUE, NM (NOT AFFILIATED WITH SUMMIT INTERNATIONAL ASSOCIATES, INC.)
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|Publication:||The Tax Adviser|
|Date:||Aug 1, 2001|
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