A “reverse” exchange occurs when the taxpayer acquires the replacement property before transferring the relinquished property. A “pure” reverse exchange, where the taxpayer owns both the relinquished and replacement properties at the same time, is not permitted. As a workaround, enterprising taxpayers structure “parking” transactions. An accommodation party (“AP”) would acquire and hold the replacement property until the taxpayer could transfer the relinquished property in a customary forward exchange. A major challenge of the parking arrangement was to give the AP enough benefits and burdens of the parked property to be treated as the owner for federal income tax purposes.
Revenue Procedure 2000-37 was issued by the IRS to provide taxpayers with a “safe harbor” to qualify their parking transactions under §1031. If the conditions of the safe harbor are met, the IRS will treat the AP as the owner of the parked property.
One condition of the safe harbor is that the AP can only hold the parked property for 180 days. That time requirement is an impediment to transactions where the replacement property needs improvements that will take more than six months to complete, or where the relinquished property takes longer to sell. As a result, many taxpayers choose to stay outside the safe harbor, in a “non-safe harbor exchange”.
The recent Tax Court decision in Estate of George H. Bartell, Jr. v. Commissioner, 147 T.C. No. 5 (2016), offers new hope to a taxpayer who’s parking arrangement will exceed 180 days. This case involved a reverse construction exchange that was started prior to the issuance of Rev. Proc. 2000‐37. The AP held the property for 17 months, and had no appreciable benefits or burdens of ownership.
The IRS argued that a benefits and burdens test must be applied to determine the true owner of the parked property, and under that test the taxpayer was the true owner, not the AP. The Court disagreed. It held that the AP may hold title solely for the purpose of an exchange. The AP was not required to have the benefits and burdens of ownership of the parked property to have a valid exchange. An important factor in the Court’s decision was that the AP was not the agent of the taxpayer.
The IRS chose not to file an appeal, but has indicated it will not follow Bartell outside of the 9th Circuit. The case may be cited as precedent, but Taxpayers should consult their tax professionals before relying on Bartell (especially those outside the 9th Circuit). The agreement between the taxpayer and the AP should not contain express agency language.
Under the right circumstances, the Bartell decision should bring a new level of confidence to taxpayers who need to structure a non-safe harbor exchange. For a better understanding of how this case may benefit you, please contact your IPX1031 expert. We will be happy to work with you and your tax professionals to craft a solution that will best fit your needs.
