IRC §1031(a)(1) provides that no gain is recognized on an exchange of like kind properties if taxpayer holds each property for business or investment purposes. A recent tax case, Bartell, illustrates how “parking arrangements” may be used to, practically speaking, extend the timeframes in like-kind exchanges.
Typically, an exchange occurs as a deferred exchange. A deferred “exchange” occurs when a taxpayer sells relinquished property in one transaction and later buys a replacement property in an unrelated transaction, provided (1) the replacement property is identified within 45 days after relinquished property sale, (2) the replacement property is purchased within 180 days after relinquished property sale, and (3) taxpayer implements the transactions through a qualified intermediary (“QI”).
In 2000, IRS adopted Rev. Proc. 2000-37, safe harbor methods for 1031 exchange “parking arrangements,” providing for reverse exchanges and improvement exchanges. A “reverse” exchange occurs when taxpayer buys replacement property before selling the relinquished property. An “improvement” exchange occurs when taxpayer buys the replacement property and adds improvements to it as part of the replacement property received in the exchange.
Rev. Proc. 2000-37 allows an “exchange accommodation titleholder” (“EAT”) to hold legal title to the parked property, yet taxpayer retains all benefits and burdens of the parked property. The approved legal fiction requires EAT to hold title to the relinquished property or replacement property during the exchange. Absent the EAT, there is no exchange – the taxpayer can’t exchange with himself.
Illustration – Reverse Exchange:
On May 15, 2017, taxpayer transfers title of relinquished property to EAT and taxpayer buys replacement property. Provided EAT sells the relinquished property to a third-party buyer not later than November 11, 2017 (180 days). IRS will respect the exchange as 1031-qualified.
Illustration – Improvement Exchange:
On May 15, 2017, EAT buys the replacement property (with taxpayer’s money or debt). EAT appoints taxpayer as project manager. EAT transfers replacement property (as improved) to taxpayer not later than November 11, 2017. On or before June 29, 2017, taxpayer identifies a relinquished property. At any time between May 15, 2017, and November 11, 2017, taxpayer sells relinquished property to a third party.
Additional requirements apply: (1) The purchase price (including improvement costs) of the replacement property must equal or exceed the sale price of the relinquished property; (2) taxpayer must avoid receipt of net cash after the last property closes; and (3) the relationship among QI, EAT, and taxpayer must be documented properly.
Rev. Proc. 2000-37 limits reverse or improvement exchanges by a 180-day period, while IRC §1031 does not address such exchanges. Rev. Proc. 2000-37 provides a safe harbor but does not apply to parking arrangements over 180 days, instead providing that any non-safe harbor parking arrangement is governed by general tax principles. One court permitted a five year exchange period.
The Bartell decision permitted a parking arrangement of 24 months  and required no identification within 45 days of inception. Bartell hired EAT to buy and hold replacement property called “Lynnwood.” EAT bought Lynnwood on August 1, 2000. Bartell intended to buy Lynnwood from EAT by August 1, 2002. In April 2000, Bartell had designated property called “White Center” as the relinquished property in a 1031 exchange for Lynnwood.
The Bartell-EAT agreement provided that EAT would buy Lynnwood with Bartell’s money and a bank loan guaranteed by Bartell. Bartell retained a two-year option to buy Lynnwood from EAT for its original cost (plus improvement costs). Bartell also agreed to indemnify EAT for losses and expenses. Bartell retained benefits and burdens of ownership, though EAT held legal title.
Bartell did not exchange White Center for Lynnwood. Instead, Bartell sold relinquished property “Everett” on December 28, 2001, then bought Lynnwood from EAT on January 3, 2002. Thus, the exchange period was six days.
Note regarding identification: Rev. Proc. 2000-37 requires taxpayer to identify the relinquished property in a parking arrangement within 45 days after purchase of replacement property. Bartell did not identify Everett as relinquished property until December 1, 2001, 15 months after EAT’s purchase of Lynnwood. IRC §1031(a)(3) requires that the replacement property be identified within 45 days after sale of the relinquished property, but is silent as to identification of a relinquished property. Thus, the identification issue was not dispositive in Bartell.
In Bartell, IRS argued that EAT had no benefits and burdens of Lynnwood; thus, Bartell held Lynnwood through EAT’s mere bare legal title. Under that theory, IRS said Bartell could not exchange with himself.
Bartell argued the arrangement met the requirements of IRC §1031(a)(1): Lynnwood and Everett were properties of a like kind, both held for business or investment, and a deferred exchange had occurred within a 180-day period. Bartell sold Everett on December 28, 2001 and bought Lynnwood from EAT on January 3, 2002, a 6-day period. Bartell argued that EATs lack of benefits and burdens of ownership had no bearing on whether §1031 applied to the exchange.
Bartell prevailed. IRS may still appeal.
(1) An investor should consider a Bartell-like parking arrangement when buying a replacement property, whether or not improvements are contemplated, to make that property available as a replacement property for 24 months in case the investor later sells another investment property (i.e., parking a replacement property in case of a relinquished property sale not presently contemplated – think receipt of an unsolicited astronomical offer);
(2) an improvement exchange is limited to 180 days construction time under Rev. Proc. 2000-37, but Bartell appears to allow 24 months.
G. Scott Haislet is a 1031 qualified intermediary, CPA, and tax attorney (certified specialist) in Lafayette. Scott teaches courses for California CPA Society on Section 1031 and other real estate tax issues, and represents clients in 1031 exchanges and other tax and real estate matters. Scott is a CCCBA tax section member and past tax section president.
 Reg. §1.1031(k)-1 provides for deferred exchanges generally; Reg. §1.1031(k)-1(g)(4) provides for “qualified intermediaries” to implement a deferred exchange.
T. J. Starker v. United States, 602 F.2d 1341, 9th Cir., August 24, 1979. Starker inspired IRC §1031(a)(3), adopted in 1984; §1031(a)(3) significantly reduced the exchange period permitted under Starker.
Bartell v. Commissioner, U.S. Tax Court, 147 TC 5, August 10, 2016.
Bartell’s EAT bought the replacement property August 1, 2000 and transferred it to Bartell on January 3, 2002, but Bartell had the right to buy the replacement property until August 1, 2002.
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