§1031 Exchanges- The Old and the New

Matthew J. Howard, J.D., LL.M.

Brian D. Smith, J.D.

MOORE INGRAM JOHNSON & STEELE, LLP

192 Anderson Street

Marietta, Georgia 30060

 

TABLE OF CONTENTS

I. Sales or Exchanges Generally
A. Internal Revenue Code Sections on Exchanges
1. IRC §1031
2. IRC §1033
3. IRC §121

II. Requirements for a §1031 Exchange
A. General Requirements
B. Holding Purpose Requirement
C. Exchange Requirement
D. Like Kind Requirement
E. Property Ineligible for Like Kind Treatment
1. Stock in Trade or Other Property Held Primarily for Sale
2. Stocks, Bonds, Notes, Etc.
3. Partnership Interests
4. Certificates and Trusts for Beneficial Ownership
5. Choses in Action

III. Multiple Party Exchanges
A. Two Party Exchanges
B. Three Party Exchanges
C. Four Party Exchanges

IV. Delayed Exchanges
A. Identification and Receipt Requirements
1. Identification
2. Receipt
B. Safe Harbors
1. Security or Guarantee Arrangement
2. Qualified Escrow or Qualified Trust
3. Qualified Intermediary
4. Allowable Payments from Escrow, Trust or Intermediary
5. Growth Factors and Interest

V. Realized Gain/ Recognized Gain/Boot/Liability/Basis
A. Realized Gain and Recognized Gain
B. Boot
1. Boot Offset Rules
2. Transfer of Property Other than Cash or Other Property
3. Financing Expenses
4. Allocation of Boot
C. Determining Basis of Property Received
D. Carry Over Holding Period
E. Example of Gain/Basis Allocation
F. Multiple Property Exchanges

VI. Mechanics/Documentation of Exchanges
A. Beginning the Exchange- Sale of Relinquished Property
1. Exchange Cooperation Clause
2. Exchange Agreement
3. Contract Assignment
4. Direct Deeding
5. Handling Earnest Money
6. Transfer of Relinquished Property- A Summary
B. Acquiring the Replacement Property
C. Closing Statements
D. Reporting the §1031 Exchange

VII. Special Issues
A. Related Party Rules
B. Reverse Exchanges
1. Introduction
2. Pre-Rev. Proc. 2000-37
3. Post Rev. Proc. 2000-37
4. DeCleene
C. Exchange Property to be Produced
D. Early Distribution from Escrow Account

APPENDICES:

Appendix A Agreement for the Deferred Exchange of Properties

Appendix B Qualified Exchange Accommodation Agreement

Appendix C Assignment of Purchase and Sale Agreement and Notice of Assignment

Appendix D Exchange Cooperation Clauses

§1031 Exchanges- The Old and the New

Matthew J. Howard, J.D., LL.M

Brian D. Smith, J.D.

MOORE INGRAM JOHNSON & STEELE, LLP

192 Anderson Street

Marietta, Georgia 30060

II.SALES OR EXCHANGES GENERALLY

INTERNAL REVENUE CODE ("I.R.C.") SECTIONS ON EXCHANGES

5.I.R.C. §1031

 

Section 1031 of the Internal Revenue Code of 1986, as amended (hereinafter referred to as the "I.R.C.") provides for the non-recognition of gain or loss on the exchange of certain types of property. The property exchanged and received in the exchange must be of like-kind and must be held for productive use in a trade or business or for investment. I.R.C. §1031(a)(1).

Section 1031 does not provide for the non-recognition of gain or loss on the exchange of stock in trade or other property held primarily for sale, partnership interests, stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest. I.R.C. §1031(a)(2).

 

Section 1031 only provides an exception from the current recognition of gain or loss. Upon the ultimate sale of property in a taxable transaction, all gain or loss is recognized.

6.I.R.C. §1033

 

I.R.C. § 1033 provides for the non-recognition of gain or loss on the theft, destruction, seizure, requisition or condemnation of property, or the threat or imminence of condemnation as long as the property is converted into property that is similar or related in service or use. I.R.C. §1033(a)(1).

 

In order for non-recognition treatment under §1033 to apply, the taxpayer must invest the conversion proceeds in similar property and the taxpayer must make an election to not recognize the gain. I.R.C. §1033(a)(2).

 

Under §1033(g), in order for non-recognition treatment to apply to the involuntary or compulsory conversion of real property held for productive use in a trade or business or for investment, the replacement property must also be real property held for productive use in a trade or business or for investment.

 

For §1033 to apply, the replacement property must be acquired by the taxpayer within a specified time period. The time period commences on the date of the disposition of the property, or the earliest date of the threat or imminence of condemnation , whichever is earlier, and ends on the date which is two years after the close of the first taxable year in which any part of the gain is realized or later, upon application to and acceptance by the Secretary. I.R.C. §1033(a)(2)(B).

 

7.I.R.C. §121

Under I.R.C. §121, an individual may exclude up to $250,000, and a married couple can exclude up to $500,000 from gain realized on the sale or exchange of a principal residence. To qualify for such non-recognition, the taxpayer must have owned and occupied the residence as a principal residence for an aggregate of at least two of the previous five years. I.R.C. §121(a). The exclusion of gain under §121 cannot be used more than one time in any two year period.

 

I.R.C. §121(b)(3).

 

II. REQUIREMENTS FOR A §1031 EXCHANGE

A. GENERAL REQUIREMENTS

§1031 provides that no gain or loss is recognized when property held for productive use in a trade or business or for investment is exchanged for like-kind property held for productive use in a trade or business or for investment. I.R.C. §1031(a)(1). Qualifying property under §1031(a)(2) does not include:

1. Stock in trade or property held primarily for sale (inventory);

2. Stocks, bonds, or notes;

3. Other securities or evidences of indebtedness or interest;

4. Partnership interests;

5. Certificates of trusts or other beneficial interests; or

6. Choses in action.

B. HOLDING PURPOSE REQUIREMENT

 

Qualifying property under §1031 must be held by the taxpayer for productive use in a trade or business or for investment. I.R.C. §1031(a)(1). The determination of whether property is held for productive use in a trade or business or for investment is made as of the time of the exchange.

A minimal amount of personal use may not disqualify the property from being trade or business or investment property. Additionally, the holding purpose may change while the taxpayer owns the property. Rev. Rul. 57-244, 1957-1 C.B. 247. For example, property held as a principal residence that later becomes rental property may qualify as investment property. The longer the property is held by the taxpayer as trade or business or investment property, however, the better. The more evidence showing the property is investment property, the better.

 

There is not a requirement that the property actually be used in a trade or business, or for investment. As long as the taxpayer intends to hold the property for use in a trade or business or for investment at the time of the exchange, then the holding purpose requirement is satisfied. Wagensen v. Commr, 74 T.C. 653 (1980).

 

The replacement property does not have to be held for the same purpose as the property transferred. Reg §1.1031(a)-1(a). For example, property held by a taxpayer for productive use in a trade or business can be exchanged for investment property.

 

The length of time that a taxpayer holds the property prior to or following the exchange is also an important factor. The longer the taxpayer holds the property before or after the exchange, the more likely it is that the property was held by the taxpayer for productive use in a trade or business or for investment. Unfortunately, the Service has not issued a clear rule in this area. Griffin v. Commr, 49 T.C. 253 (1967). It appears, however, that the shorter the holding period, the more important it is to have additional evidence indicating the existence of the requisite holding period. A sale or other disposition of the replacement property immediately after the exchange is evidence that the taxpayer did not have the requisite intent at the time of the exchange.

 

If, at the time of the exchange, the taxpayer intends to make a gift of the replacement property, the exchange may not qualify under §1031 because the taxpayer does not intend to hold the property for use in a trade or business or for investment. Click v. Commr, 78 T.C. 225 (1982), appeal dismissed 4th Cir. 1983.

 

As stated above, however, if at the time of the exchange, the taxpayer intends to hold the property for use in a trade or business or for investment but subsequently decides to give away the property, the exchange should qualified under §1031. Wagensen v. Commr, 74 T.C. 653 (1980).

 

It is not clear whether a taxpayer who acquires property from a related party succeeds to the rights of the taxpayer to qualify the subject property for §1031 non-recognition treatment. It is also unclear whether a person who acquires property from another taxpayer by gift or inheritance succeeds to the rights of the other taxpayer.

 

C. EXCHANGE REQUIREMENT

 

To qualify for non-recognition treatment under §1031, a transaction must constitute an exchange. Typically, a transaction constitutes an exchange if there is a reciprocal transfer of property, as opposed to a sale or transfer of property followed by a receipt of money or other like-kind property. Treas. Reg. §1.1002(d). Merely intending to effectuate an exchange is not sufficient. Bezdjian v. Commr, T.C. Memo 1987-140, aff'd. 88-1 USTC Para. 9306 (9th Cir. 1988). There must actually be an exchange of qualifying property. A sale and subsequent reinvestment is not a like-kind exchange under §1031 unless the substance of the transaction shows each step to be interdependent. Allen v. Commr, T.C. Memo 1982-188, 43 T.C.M. 1045.

As discussed above, in order for a transaction to qualify under §1031, there must be a reciprocal transfer of property. A transfer of property rather than cash does not automatically ensure non-recognition treatment.

 

A sale of property for money followed by a reinvestment of the money in like-kind property does not constitute an exchange under §1031. Treas. Reg. 1.1002(d); D'Onofrio v. Commr, T.C. Memo 1983-632, 47 T.C.M. 29.

 

Even if the sale of the relinquished property and the acquisition of the replacement property occur simultaneously, non-recognition treatment under §1031 will not be allowed if the two transactions are independent of one another. Allen v. Commr, T.C. Memo 1982-188, 43 T.C.M. 1045. To qualify for non-recognition treatment, the sale and subsequent reinvestment must be mutually dependent transactions. The sale of the relinquished property must be dependent upon the acquisition of the like-kind replacement property, and vice-versa. Even if the proceeds from the sale of the relinquished property are placed beyond the taxpayer's control, such as an escrow account for the purpose of completing the acquisition of the replacement property, the transaction will not qualify for non-recognition treatment under §1031 if the transactions are independent. Meadows v. Commr, T.C. Memo 1981-417, 42 TCM 611.

 

The taxpayer must never receive cash for the relinquished property, either actually or constructively. If the taxpayer does receive cash proceeds, like-kind exchange treatment will be denied to the extent of the cash proceeds received, even if the taxpayer holds like-kind property at the end of the transaction.

 

If a sale and subsequent reinvestment are dependent upon one another, the step transaction doctrine may be applied to cast the transaction as an exchange rather than a sale and reinvestment. Under the step transaction doctrine, the separate steps of a transaction could be viewed as interdependent transactions. Century Elec. Co. V. Commr, 15 T.C. 581 (1950), aff'd. 192 F 2d 155 (8th Cir 1951), cert denied 342 U.S. 954.

 

It is important in a §1031 exchange to fill the exchange agreement with intent language. It should be clear that the taxpayer intends to effect an exchange rather than a sale and reinvestment.

 

D. LIKE-KIND REQUIREMENT

 

To qualify for non-recognition treatment under §1031, the relinquished property must be of like-kind to the replacement property. I.R.C. §1031(a). "Like-kind" refers to the nature or character of a piece of property rather than the quality of the property. Treas. Reg. §1.1031(a)-1(b).

One piece of real property is like-kind with another piece of real property regardless of how dissimilar the properties may be. For example, an apartment complex could be of like-kind to a golf course.

 

Foreign real property is not like-kind with United States real property. I.R.C. §1031(h)(1).

 

Certain lease-hold interests can be of like-kind to fee simple interests. Although a lease-hold interest represents less than a fee interest in real estate, a lease-hold interest for a sufficiently long period of time vests in a taxpayer certain attributes which make the lease-hold interest and the fee simple interest like-kind. A lease-hold interest with 30 years or more to run on the lease and a fee simple interest are of like-kind. Treas. Reg. §1.1031(a)-1(c). In determining the length of a lease-hold, optional renewal periods may be included. Rev. Rul. 78-72, 1987-2 C.B. 258. Additionally, the Internal Revenue Service has ruled that a lease-hold for a period of less than 30 years is like-kind with another lease-hold of less than 30 years. Rev. Rul. 76-301, 1976-2 C.B. 241.

 

It is important to note that while properties may be of like-kind for federal tax purposes, they may not be of like-kind for state tax purposes. For example, relinquished property in Georgia is not like-kind to replacement property outside of Georgia. O.C.G.A. § § 48-7-21(b)(5) and 48-7-27(b)(6). In such transactions, non-recognition treatment is available for federal tax purposes, but gain must be recognized for state tax purposes.

 

Although this outline focuses primarily on exchanges of real property, it is important to note here that exchanges of personal property can also be conducted under §1031. Depreciable tangible personal property held for productive use in a trade or business or for an investment can be exchanged for other property of either like-kind or like class. Treas. Reg. §1.1031(a)-2(b).

 

Whether personal property is of like class under §1031 is determined by classifying the property among general asset classes and product classes as of the date of the exchange. Depreciable tangible personal property is of like-kind if the exchanged properties are either within the same general asset class or within the same product class. A single property may not be classified within more than one general asset class or within more than one product class. Treas. Reg. §1.1031(a)-2(b)(1).

 

Regulation §1.1031(a)-1(b)(2) provides a list of 13 general asset classes. These asset classes are based on asset classes listed in Rev. Proc. 87-56. These asset classes are as follows:

 

1. Office furniture, fixtures, and equipment (asset class 00.11);

2. Information systems (computers and peripheral equipment)(asset class 00.12);

3. Data handling equipment, except computers (asset class 00.13);

4. Airplanes (airframes and engines), except those used on commercial or contract-carrying of passengers and freight, and all helicopters (asset class 00.21);

5. Automobiles and taxis (asset class 00.22)

6. Buses (asset class 00.23);

7. Light general purpose trucks (asset class 00.241)

8. Heavy general purpose trucks (asset class 00.242);

9. Railroad cars and locomotives, except those owned by railroad transportation companies (asset class 00.25);

10. Tractor units for use over the road (asset class 00.26);

11. Trailers and trailer mounted containers (asset class 00.27);

12. Vessels, barges, tugs, and similar water transportation equipment, except those used on marine construction (asset class 00.28);

13. Industrial steam and electrical generation and/or distribution systems (asset class 00.4).

 

A product class consists of depreciable personal tangible property listed in a product class in the North American Industrial Classification System (NAICS) which has replaced the Standard Industrial Classification Codes. The NAICS is prepared by the Office of Management and Budget. The manual can be obtained at www.ntis.gov.

 

Even if depreciable tangible personal property is not of like class, it may still qualify for non-recognition treatment for §1031 if it is of like-kind. Treas. Reg. §1.1031(a)-2(a). To determine whether property is of like-kind, all facts and circumstances must be considered.

 

E. PROPERTY INELIGIBLE FOR LIKE-KIND TREATMENT.

 

As discussed above, certain types of property are ineligible for like-kind treatment under §1031. §1031(a)(2) provides that non-recognition treatment under §1031 does not apply to any exchange of the following assets:

 

1. Stock in trade or other property held primarily for sale;

2. Stocks, bonds, notes;

3. Other securities or evidences of indebtedness or interest;

4. Interests in a partnership;

5. Certificates of trust or beneficial interests; or

6. Choses in action.

 

1. STOCK IN TRADE OR OTHER PROPERTY HELD FOR SALE

The exclusion for stock in trade refers primarily to property that is included in the taxpayer's inventory. See I.R.C. §1221(a)(1).

 

Aside from inventory, other property held by the taxpayer primarily for sale is also excluded. I.R.C. §1031(a)(2)(A). Such property has always been outside the scope of §1031. The determination of whether property is "held primarily for sale" is a question of fact. The taxpayer's purpose for holding the property is to be determined at the time of the exchange. Brauer v. Commr, 74 T.C. 1134 (1980). The taxpayer has the burden of proving that the exchange property is held for productive use in a trade or business or for investment rather than primarily for sale.

 

2. STOCKS, BONDS, NOTES, SECURITIES, EVIDENCES OF INDEBTEDNESS, OR INTEREST

§1031(a)(2)(B) and (C) specifically exclude the exchange of stocks, bonds, notes, other securities and evidences of indebtedness or interest from non-recognition treatment under §1031.

 

3. PARTNERSHIP INTERESTS

§1031(a)(2)(D) specifically excludes the exchange of partnership interests from non-recognition treatment under §1031. This rule applies to all interests in partnerships regardless of whether the interests are general or limited partnership interests. Treas. Reg. 1.1031(a)-1(a)(1).

 

§1031(a)(2) does provide, however, that an interest in a partnership which has elected under §761(a) to not be treated as a partnership for federal tax purposes shall be treated as an interest in each of the assets of the partnership rather than as an interest in the partnership itself.

 

One possible way around this exclusion is to dissolve the Partnership and distribute its assets as tenants-in-common prior to the exchange of the property. Special care should be taken, however, to prevent the tenancy-in-common from being treated as a partnership. In such a transaction, the IRS may argue that the individual receiving the property from the dissolved partnership does not succeed to the partnership's holding purpose. See I.R.C. §1031(a). As with all exchange transactions, it must be the taxpayer's intent to hold the property for a productive use in a trade or business or for investment. I.R.C. §1031(a). The taxpayer cannot hold the property primarily for sale.

 

4. CERTIFICATES OF TRUSTS OR BENEFICIAL INTERESTS.

§1031(a)(2)(D) specifically excludes the exchange of certificates of trust or beneficial interest from non-recognition treatment under §1031.

 

5. CHOSES IN ACTION

§1031(a)(2)(F) specifically excludes the exchange of choses in action from non-recognition treatment under §1031. A chose in action represents the right to receive or recover some consideration or property from another.

 

III. MULTIPLE PARTY EXCHANGES

Exchanges of property under §1031 can be conducted with two parties, three parties, or even four parties.

 

A. TWO PARTY EXCHANGES

Two party exchanges are often very difficult to accomplish. In order to complete a two party exchange of property under §1031, the taxpayer would not only have to find a person who wanted to buy the taxpayer's property, but also owned property that the taxpayer wanted to purchase. Such exchanges occur simultaneously and involve a straight swap of property. These exchanges very rarely take place.

 

B. THREE PARTY EXCHANGES

Three party exchanges consist of a taxpayer who desires to exchange his property, a prospective purchaser of the taxpayer's property and a prospective seller of the replacement property. Typically, such exchanges involve two contracts and an exchange agreement. In structuring a three party exchange, special care must be taken to prevent the transaction from being viewed by the Internal Revenue Service as a sale and subsequent reinvestment rather than an exchange.

 

Three party exchanges do not involve an intermediary. These exchanges are either buyer facilitated or seller facilitated. In a buyer facilitated three-party exchange, the buyer of the taxpayer's property purchases the replacement property and then swaps with the taxpayer. In a seller facilitated three-party exchange, the taxpayer swaps properties with the seller of the replacement property and the seller then sells the relinquished property to the buyer of the relinquished property.

 

C. FOUR PARTY EXCHANGES

Multi-party exchanges under §1031 typically involve four parties. Four party exchanges usually involve an intermediary as the fourth party. There are usually two real estate contracts. One contract is for the sale of the relinquished property by the taxpayer. The other contract is for the acquisition of the replacement property by the taxpayer. There should also be an exchange agreement between the taxpayer and the intermediary. Both real estate contracts should be assigned to the intermediary. For reasons unrelated to §1031, direct deeding from the taxpayer to the buyer or from the taxpayer to the seller is allowed.

 

In a standard four party exchange, the taxpayer sells the relinquished property to the purchaser and the proceeds are paid directly to the intermediary. Pursuant the exchange agreement, the intermediary then acquires the replacement property. Since direct deeding is allowed, title to the replacement property passes directly from the seller to the taxpayer.

 

Four party exchanges can be accomplished either simultaneously or as delayed exchanges.

 

IV. DELAYED EXCHANGES

Although many exchanges can be conducted simultaneously, there are numerous reasons why a delayed exchange works better than a simultaneous exchange. For example, the taxpayer may not be able to find a suitable replacement property prior to the sale of the relinquished property. In such a situation, a simultaneous exchange is not possible.

 

Before the 1984 Act, the IRS took the position that a taxpayer could not achieve a delayed exchange. The IRS reasoned that either no exchange took place, or that the property received was a promise to acquire suitable replacement property, which is not like-kind to the relinquished property.

 

Starker v. U.S., 602 F2d. 1341 (9th Cir. 1979) was the first Circuit Court decision which considered the use of a delayed exchange under §1031. Prior to Starker, there was very little guidance in the area of delayed exchanges.

 

In Starker, A transferred property to B pursuant to a contract under which B agreed to acquire other real property in the future and convey it to A. B agreed to provide suitable replacement property to A within five years or pay any outstanding balance in cash. B also agreed to pay a growth factor of 6% per year on any outstanding balance. The 9th Circuit in Starker held that the transaction did, in fact, constitute an exchange under §1031 since the taxpayer intended to receive qualifying property and did not simply cash out his real estate investment.

 

Following Starker, there was widespread confusion regarding the use of delayed exchanges under §1031. In the 1984 Act, Congress took the 9th Circuit's lead and amended §1031(a) to permit delayed exchanges under certain circumstances.

 

§1031(a)(3) provides that the property received by a taxpayer will not be considered like-kind property if it is not properly identified by the taxpayer within 45 days of the closing of the sale of the relinquished property, or received by the taxpayer within 180 days of the closing of the sale of the relinquished property, or by the due date for the taxpayer's Federal Income Tax Return for the year in which the transfer of the relinquished property occurs, whichever is earlier.

 

The new rules promulgated by Congress in the 1984 Act were effective for all exchanges after July 18, and 1984. On April 25, 1991, Regulations were issued providing guidance on deferred exchanges. These Regulations begin with Treas. Reg. §1.1031(k)-1.

 

Treas. Reg. §1.1013(k)-1(a) defines a deferred exchange as,

"An exchange in which, pursuant to an agreement, the taxpayer transfers property held for productive use in a trade or business or for investment (the "relinquished property") and subsequently receives property to be held either for productive use in a trade or business or for investment (the "replacement property").

 

A. IDENTIFICATION AND RECEIPT REQUIREMENTS

As discussed above, property acquired in the exchange will not qualify as like-kind property if the property to be acquired is not identified, and the exchange is not completed, within certain specified time periods.

 

The time periods for both identification and acquisition of the replacement property begin on the date the taxpayer transfers the relinquished property. Treas. Reg. §1.1031(k)-1(b)(2). If the taxpayer transfers multiple relinquished properties as part of the same deferred exchange, and the relinquished properties are transferred on different dates, the periods begin on the date of the earliest transfer of relinquished property. Treas. Reg. §1.1031(k)-1(b)(2)(iii).

1. IDENTIFICATION

In order to comply with §1031, the taxpayer must identify the replacement property on or before the date which is 45 days after the transfer of the relinquished property. Treas. Reg. §1.1031(k)-1(b)(2)(i).

 

A taxpayer may identify up to three replacement properties without regard to the fair market values of the replacement properties. Treas. Reg. §1.1031(k)-1(c)(4)(A). If more than three properties are identified, the aggregate values of all identified replacement properties cannot exceed 200% of the fair market value of the relinquished properties in the transaction. Treas. Reg. §1.1031(k)-1(c)(4)(B).

 

A replacement property is properly identified only if it is unambiguously designated as replacement property in a written document signed by the taxpayer and delivered, mailed, telecopied, or otherwise sent before the end of the identification period to either the person obligated to transfer the replacement property to the taxpayer, or to any other person involved in the exchange other than the taxpayer or a disqualified person Treas. Reg. §1.1031(k)-1(c)(2).

 

Any property that is actually received by the taxpayer prior to the conclusion of the identification period is treated as properly identified. Treas. Reg. §1.1031(k)-1(c)(4)(ii)(A).

 

As mentioned above, the replacement property must be unambiguously identified in the identification document. This requirement can be satisfied with a legal description of the property, street address of the property, or by a distinguishable name. Treas. Reg. §1.1031(k)-1(c)(3). It is best to include as much information about the replacement property on the identification document as possible.

 

As discussed above, the maximum number of replacement properties that can be identified by the taxpayer is (a) three, without regard to fair market value, or (b) as many as the taxpayer wishes as long as the aggregate fair market value of all replacement properties does not exceed 200% of the aggregate fair market value of all relinquished properties as of the date the relinquished properties were transferred. Treas. Reg. §1.1031(k)-1(c)(4)(i). For purposes of the identification requirements, fair market value is the fair market value without regard to liabilities. Treas. Reg. §1.1031(k)-1(m).

 

If, as of the conclusion of the identification period, a taxpayer has identified more properties than are allowed, the taxpayer is deemed not to have made a valid identification of replacement property. Treas. Reg. §1.1031(k)-1(c)(4)(ii). This rule does not apply to any replacement properties actually received by the taxpayer prior to the end of the identification period or to any replacement properties identified by the taxpayer prior to the conclusion of the identification period and received before the end of the acquisition period, if the taxpayer actually receives replacement property constituting at least 95% of the aggregate fair market value of all identified replacement properties. Treas. Reg. §1.1031(k)-1(c)(4)(ii).

 

Under Treas. Reg. §1.1031(k)-1(c)(6), an identification of replacement property can be revoked at any time before the conclusion of the replacement period. A revocation of an identified property is only valid if it is made by a written document signed by the taxpayer and hand-delivered, mailed, telecopied, or otherwise sent before the end of the identification period to the person to whom the identification of replacement property was sent. Treas. Reg. §1.1031(k)-1(c)(6). If the identification of replacement property is made in the exchange agreement, then revocation can only be made by amending the exchange agreement or in a written document hand-delivered, mailed, telecopied, or otherwise sent to all parties to the exchange agreement. Treas. Reg. §1.1031(k)-1(c)(6).

 

One interesting issue regarding the identification and receipt of replacement property involves the identification of multiple legal parcels of property for purposes of the three property rule. Is legal title relevant for purposes of determining what constitutes "property" under the three property rule?

 

Example:

Taxpayer sells a warehouse and identifies as replacement property an office complex consisting of four (4) separate, but contiguous, lots. The four lots have one owner, but for reasons unrelated to the exchange, are each separate lots. Taxpayer acquires three (3) of the four lots, the cumulative value of which exceeds Two Hundred percent of the fair market value of the relinquished property as of the date of its sale. It is clear that the taxpayer has violated both the Two Hundred Percent Rule and the alternative Ninety-Five Percent Rule, but has taxpayer's §1031 Exchange failed?

 

The answer to the question presented in the above example depends on the definition of "property" under §1031. The taxpayer has a legitimate argument that the separate legal titles to the parcels should be irrelevant, and that the three property rule was satisfied. The following example may help clarify the issue.

 

Example:

Taxpayer sells a golf course and identifies as replacement property an entire city block. If one person owns the entire city block, it is clear that §1031 is satisfied. But what if the city block is actually owned by a number of different people?

 

In this example, §1031 treatment should apply because taxpayer has acquired substantially all of the property that he identified. Additionally, despite the fact that §1031 requires multiple relinquished property under the same exchange to be treated as one property, there is not a similar rule for replacement properties. Thus, by implication, it appears that separate legal title should not matter for purposes of the three property rule. The fact that taxpayer acquires substantially all of the identified replacement property should be the dispositive factor.

The above examples each deal with contiguous properties. It is clear that non-contiguous properties should be treated as separate properties for purposes of the identification rules under §1031.

 

2. RECEIPT

The property identified by the taxpayer must not only be identified within 45 days of the transfer of the relinquished property, but must be received by the taxpayer on or before the earlier of 180 days after the date of the transfer of the relinquished, or the due date, including extensions, of the taxpayer's tax return for the tax year in which the transfer of the relinquished property occurred. I.R.C. §1031(a)(3)(B). Additionally, the property acquired must be substantially the same as the identified property. Treas. Reg. §1.1031(k)-1(d)(1).

 

Strict adherence to the identification and receipt timing requirements must be followed. As stated above, the periods begin on the date the relinquished property is transferred. If multiple relinquished properties are transferred, the time periods begin on the date on which the first relinquished property is transferred. Treas. Reg. §1.1031(k)-1(b)(2).

 

In calculating the time period, the taxpayer should use a starting date that is the earlier of the date on which the deed to the relinquished property is delivered to the buyer, or the date on which the buyer releases the funds for the purchase.

 

Identification and receipt must be performed before midnight on the 45th and 180th days without regard to weekends or holidays. Treas. Reg. §1.1031(k)-1(b)(2)(i) and (ii). If the 45th day falls on a Sunday, identification must be made by midnight that Sunday.

 

The receipt time period may be cut short if the taxpayer's federal income tax return for the year in which the relinquished property is transferred falls before the conclusion of the 180 day period. Treas. Reg. §1.1031(k)-1(b)(2)(ii). In exchanges in which the due date for the taxpayer's tax return falls before the conclusion of the 180 day period, it might be wise to extend the due date for the taxpayer's tax return. The possibility of extending the due date for the filing of the federal tax return might be an issue for calendar year corporations which close the sale of the relinquished property on or after September 16 or 17 or for individuals who close the sale of the relinquished property on or after October 16 or 17.

 

B. SAFE HARBORS

When a taxpayer transfers relinquished property and actually or constructively receives money or other property before receiving like-kind replacement property, gain may be recognized. Treas. Reg. §1.1031(k)-1(a). Additionally, where the full amount of the consideration for the relinquished property is received, actually or constructively, before the replacement property is received, the transaction will be considered a sale rather than an exchange. Treas. Reg. §1.1031(k)-1(f).

 

A taxpayer is considered to be in actual receipt of money or other property at the time he receives the money or other property, or receives the economic benefit of the money or other property. Treas. Reg. §1.1031(k)-1(f)(2). A taxpayer is considered to be in constructive receipt of money or other property at the time it is credited to his account, set aside for him, or otherwise made available to him. Treas. Reg. §1.1031(k)-1(f)(2). A taxpayer is neither in actual or constructive receipt of money or other property if his control over the money or other property is subject to substantial limitations or restrictions. Treas. Reg. §1.1031(k)-1(f)(2).

 

In an effort to clarify the rules for deferred exchange transactions under §1031, the Regulations provide several safe harbor arrangements which state that certain issues, such as agency and receipt, will be disregarded for purposes of determining whether the taxpayer is in actual or constructive receipt of money or other property.

Under Treas. Reg. §1.1031(k)-1(g) the taxpayer will not be considered to be in actual or constructive receipt of money or other property if the exchange satisfies one of the following safe harbor arrangements:

1. A security or guarantee arrangement;

2. A qualified escrow or qualified trust arrangement; or<

3. A qualified intermediary arrangement.

To satisfy a safe harbor arrangement, a taxpayer must satisfy all of the safe harbor's terms and conditions. See Treas. Reg. §1.1031(k)-1(g)(1). Additionally, the written agreement governing the safe harbor arrangement must specify that the taxpayer has no rights to receive, pledge, borrow, or otherwise obtain the benefits of the money or other property before the conclusion of the exchange. Treas. Reg. §1.1031(k)-1(g)(6). The agreement may allow the taxpayer to take actual or constructive receipt of the money or other property at the end of the identification period if no replacement properties are identified by the taxpayer, upon receipt of all identified replacement properties to which the taxpayer is entitled, or upon the occurrence after the conclusion of the identification period of a material or substantial contingency that relates to the exchange, is provided for in writing, and is beyond the taxpayer's control or of any disqualified person other than the person obligated to transfer the property to the taxpayer. Treas. Reg. §1.1031(k)-1(g)(6).

A taxpayer may receive money or other property from a party to the transaction, other than the safe harbor, without triggering actual or constructive receipt of the money or other property. Treas. Reg. §§1.1031(k)-1(g)(3)(b), 1.1031(k)-1(g)(4)(vii). However, if the taxpayer is allowed to receive money or other property from a party to the exchange other than the safe harbor, such as the buyer of the relinquished property, how can all rights to the relinquished property contract possibly be assigned to a qualified intermediary as required by the qualified intermediary safe harbor arrangement? This is just one of many unanswered questions in the §1031 arena.

Finally, it is important to note that more than one safe harbor arrangement can be used in any given transaction. Treas. Reg. §1.1031(k)-1(g)(1).

1. SECURITY OR GUARANTEE ARRANGEMENT

Regulation §1.1031(k)-1(g) provides for the security or guarantee arrangement safe harbor.

Under Treas. Reg. §1.1031(k)-1(g) a taxpayer will be considered to have actual or constructive receipt of money or other property before receiving replacement property if the obligation of the taxpayer's transferee (i.e., the Purchaser of the relinquished property) is, or may be, secured or guaranteed by one or more of the following:

1. A mortgage, deed of trust or other security interest (other than cash or a cash equivalent);

2. A stand-by letter of credit which satisfies all of the requirements of Treas. Reg. §15(a).453-1(b)(iii) and which does not allow the taxpayer to draw upon the stand-by letter of credit except on a default of the Transferee's obligation to transfer like-kind replacement property to the taxpayer; or

3. A guarantee of a third party.

This safe harbor arrangement is rarely utilized.

2. QUALIFIED ESCROW OR QUALIFIED TRUST

Treas. Reg. §1.1031(k)-1(g)(3) provides for the Qualified Escrow and Qualified Trust safe harbors. A taxpayer will not be considered to have actual or constructive receipt of money or other property simply because the obligation of the taxpayer's transferee to the transaction is or may be secured by cash held in a qualified escrow account or in a qualified trust.

To be qualified, the escrow holder or trustee must not be a disqualified person, and the taxpayer's ability to receive, pledge, borrow, or otherwise obtain the benefits of the cash or cash equivalent in escrow must be limited as provided in Regulation §1.1031(k)-1(g)(6).

A qualified escrow account is one in which the escrow account holder is not the taxpayer or a disqualified person. Treas. Reg. §1.1031(k)-1(g)(3)(ii)(A). A qualified trust is a trust in which the trustee is not the taxpayer or a disqualified person. Treas. Reg. §1.1031(k)-1(g)(3)(iii)(A). Although the fiduciary relationship created by a trust arrangement would ordinarily result in the trustee being considered a disqualified person, the relationship created by the qualified trust arrangement will be disregarded for this purpose. Treas. Reg. §1.1031(k)-1(g)(3)(iii)(A)

Qualified Escrow and Qualified Trust safe harbor arrangements cease to apply at the time the taxpayer has the immediate ability or an unrestricted right to receive, pledge, borrow, or otherwise obtain the benefits of the cash or cash equivalent held in escrow or in trust. Treas. Reg. §1.1031(k)-1(g)(3)(iv).

Like the security or guarantee arrangement discussed above, the qualified escrow or qualified trust is also a very rare §1031 safe harbor.

3. QUALIFIED INTERMEDIARY

The most common §1031 safe harbor is the Qualified Intermediary. The Qualified Intermediary safe harbor is easy to use, so it is usually preferred to the other safe harbor arrangements. Treas. Reg. §1.1031(k)-1(g)(4) provides that the Qualified Intermediary is not the agent of the taxpayer. Furthermore, Treas. Reg. §1.1031(k)-1(g)(4) provides that in exchanges in which a Qualified Intermediary is used as the safe harbor arrangement, the taxpayer's transfer of relinquished property and subsequent receipt of like-kind replacement property will be treated as an exchange, and the determination of whether the taxpayer is in actual or constructive receipt of money or other property before the taxpayer actually receives the like-kind replacement property is made as if the Qualified Intermediary is not the taxpayer's agent. Treas. Reg. §1.1031(k)-1(g)(4).

Like the other safe harbor arrangements discussed above, the Qualified Intermediary safe harbor arrangement is also subject to Treas. Reg. §1.1031(k)-1(g)(6) limitations. Very simply put, the limitations under Regulation §1.1031(k)-1(g)(6) limit, with few exceptions, the taxpayer's right to receive, pledge, borrow, or otherwise obtain the benefits of the money or other property before the end of the exchange period.

Under Treas. Reg. §1.1031(k)-1(g)(4)(iii), a Qualified Intermediary is any person who:

1. Is not the taxpayer or other disqualified person;

2. Enters into a written agreement with the taxpayer under which the taxpayer's rights to receive, pledge, borrow, or otherwise obtain the benefits of the money or other property held by the Qualified Intermediary are limited; and

3. Acquires the relinquished property from the taxpayer, transfers the relinquished property to the purchaser, acquires the replacement property from the seller and transfers the replacement property to the taxpayer as required by the written agreement.

A Qualified intermediary cannot be a disqualified person. Under Treas. Reg. §1.1031(k)-1(k)(2), a disqualified person is any person who has acted as the taxpayer's agent within the two-year period ending on the date of the transfer of the relinquished property. For this purpose, any person who has acted as the taxpayer's employee, attorney, accountant, investment banker, or broker, or real estate agent or broker is considered to be an agent of the taxpayer. Treas. Reg. §1.1031(k)-1(k)(2). For purposes of this paragraph, any person who has only conducted services for the taxpayer with respect to other §1031 exchanges, or routine financial, title insurance, escrow, or trusts services by a financial institution, title insurance company, or escrow company will not be considered a disqualified person for purposes of §1031. Treas. Reg. §1.1031(k)-1(k)(2)(ii).

Under Proposed Regulations issued by the IRS, bank members of a control group containing an investment banking or brokerage firm will not be a disqualified person merely because the investment bank or brokerage provided services to the taxpayer within two years of the transfer. 66 F.R. 3924-3925; Doc 2001-1778; 2001 TNT 11-18; H & D, Jan. 17, 2001, p. 1150. This change is the result of recent changes to federal banking law permitting banks and bank holding companies to become members of control groups that include investment banks and brokerage firms.

The definition of a disqualified person also includes any person who bears a relationship to the taxpayer, or bears a relationship to an agent of the taxpayer as described in either §267(b) or §707(b) of the Internal Revenue Code, determined by substituting in each section "10%" for "50%" in each place that it appears. Treas. Reg. §1.1031(k)-1(k)(3)(iv).

The persons or entities within §267(b) or §707(b) include the following:

1. Family members, including siblings, spouses, ancestors and lineal descendants;

2. An individual and a corporation, where more than 10% of the value of the stock is owned directly or indirectly by or for such persons;

3. Two corporations that are a part of the same control group;

4. A grantor and a fiduciary of the same trust;

5. A fiduciary and a beneficiary of the same trust;

6. A fiduciary of a trust and the fiduciary or beneficiary of another trust with the same person as Grantor of both trusts;

7. A fiduciary of a trust and a corporation more than 10% in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for the Grantor of the trust;

8. A person and a §501 organization if the organization is controlled by the person or his family;

9. A corporation and a partnership if the same person owns more than 10% in value of the outstanding stock of the corporation and more than 10% of the capital interest or profit interest in the partnership;

10. A S-corporation and another S-corporation or a C-corporation if the same person owns more than 10% of the value of the outstanding stock of each;

11. A partnership and a person owning, directly or indirectly, more than 10% of the capital interest, or profits interest, in such partnership; and

12. Two partnerships in which the same person owns, directly or indirectly, more than 10% of the capital interest or profit's interest.

4. ALLOWABLE PAYMENTS FROM A QUALIFIED ESCROW/TRUST INTERMEDIARY.

Treas. Reg. §1.1031(k)-1(g)(7) permits certain expenditures from a qualified escrow, qualified trust or qualified intermediary without destroying the respective safe harbor. The allowable expenditures under Treas. Reg. §1.1031(k)-1(g)(7) include items that a seller may receive as a consequence of the disposition of property and that are not included in the amount realized from the disposition of the property. These items include pro-rated rents, and other transactional items which relate to the taxpayer's side of the exchange and which appear as a responsibility of a buyer or seller under local standards in the typical closing statement (commissions, pro-rated taxes, recording fees, transfer taxes and title company fees). The qualified intermediary's fee can also be paid from the account.

5. GROWTH FACTORS AND INTEREST

The fourth category of safe harbor is found in Regulation §1.1031(k)-1(g)(5). Under this safe harbor, a taxpayer may receive interest or a growth factor with respect to the deferred exchange, provided the taxpayer's right to receive such interest or growth factor are limited to certain circumstances set forth in Treas. Reg. §1.1031(k)-1(g)(6). The taxpayer is treated as being entitled to receive interest or a growth factor if the amount of money or property the taxpayer is entitled to receive depends upon the length of time between the transfer of the relinquished property and the receipt of the replacement property. Treas. Reg. §1.1031(k)-1(h)(1). If, as part of the exchange, the taxpayer receives interest or a growth factor, then said amount will be treated as interest regardless of whether the interest or growth factor is paid by the taxpayer. The taxpayer must recognize the interest or growth factor on his tax return. Treas. Reg. §1.1031(k)1(h)(2).

V. REALIZED GAINS/RECOGNIZED GAINS/RECAPTURE/BOOT/LIABILITY/BASIS

A. REALIZED GAIN AND RECOGNIZED GAIN

§1031 allows the taxpayer to defer current taxation of the gain realized from an exchange of property. When the property is ultimately disposed of in a taxable transaction, however, all deferred gain is recognized. Complete tax-deferral can be achieved if the relinquished property is exchange solely for like-kind replacement property. The transfer of non like-kind property in a §1031 exchange results in recognition of gain or loss.

Non like-kind property, or boot, is often given an order to equalize the value of the like-kind properties. Boot may consist of cash, debt-relief, property that is not of like-kind, or other forms of excluded property.

The amount of gain realized in an exchange under §1031 is determined using the following formula:

Realized Gain=Amount Received- (Basis + Amount Paid)

RG=AR - (B +AP)

The amount received under the above formula is equal to the sum of the fair-market value of all qualifying property received by the taxpayer, the fair market value of other non-qualifying property received by the taxpayer, the fair market value of all cash received by the taxpayer, and the value of all liability boot received (liabilities encumbering the relinquished property immediately prior to the exchange) by the taxpayer.

 

The basis in the formula above is equal to the cost or other basis of all properties surrendered, less all depreciation on such properties.

 

The amount paid in the formula above is equal to the sum of all cash paid by the taxpayer for the replacement property, the amount of all liabilities encumbering the replacement property or incurred by the taxpayer in acquiring the replacement property and the fair market value of all like-kind property paid by the taxpayer for the replacement property.

 

The gain recognized by the taxpayer in an exchange under §1031 is recognized to the extent of all boot received.

 

B. BOOT

 

The non-qualifying money or property received by the taxpayer in an exchange under §1031 is commonly referred to as "boot". As mentioned above, realized gain is recognized by the taxpayer to the extent of all boot received. Since the determination of boot in an exchange is critical to the calculation of gain or loss recognized by the taxpayer, it is important to discuss boot in some detail.

 

§1031(b) states that gain is recognized in an exchange to the extent of money or other property received. Under §1031(d), where the relinquished property is transferred subject to a liability or the buyer of the relinquished property assumes debts of the taxpayer, the debt assumed or taken subject to is treated as money received by the taxpayer and thus constitutes boot received by the taxpayer.

 

In some cases, boot received by the taxpayer in an exchange can be offset by boot paid by the taxpayer.

 

1. BOOT OFFSET RULES

 

Liability boot received by the taxpayer can be offset by liability boot paid by the taxpayer. Treas. Reg. §1.1031(b)-1(c). Liability boot received by the taxpayer can also be offset by cash boot paid by the taxpayer. Treas. Reg. §1.1031(d)-2, Example 2.

 

It appears that only liability boot received can be offset by boot paid. Other forms of boot received cannot be offset by boot paid. Cash boot received cannot be offset by liability boot paid.

 

2. TRANSFER OF PROPERTY OTHER THAN CASH OR RELINQUISHED PROPERTY

 

The extent to which non-liability boot (cash or other property) can be offset by cash boot paid is unclear. In Revenue Ruling 71-456, 1971 C.B. 468, the IRS allowed the taxpayer to offset cash received from the disposition of the relinquished property with brokerage commissions paid by the taxpayer in connection with the exchange. Despite this Revenue Ruling, there is no clear authority allowing the netting of cash boot received with cash boot paid. Although the Revenue Ruling is limited to brokerage commissions, the Ruling should also apply to miscellaneous expenses associated with the transfer of the relinquished property and the acquisition of the replacement property.

 

The transfer of property other than cash or the relinquished property without receiving like-kind property will result in a taxable event to the taxpayer. For example, if taxpayer transfers real estate with a fair market value of $200 and a basis of $50, and a truck, with a fair market value of $50 and a basis of $0, and the taxpayer receives in exchange real estate with a fair market value of $250, then taxpayer is treated as having sold the truck for $50 and must realize and recognize gain on the sale of the truck in the amount of $50. In this transaction, no boot is received by the taxpayer since the taxpayer did not receive any property in the exchange other than like-kind property.

 

3. FINANCING EXPENSES

 

Expenses related to the financing of the replacement property, such as loan fees, mortgage insurance, recording fees, etc. are taxable boot to the extent that they are paid from the exchange balance since the expenses do not relate to the taxpayer's continuing investment in the property.

 

4. ALLOCATION OF BOOT

 

In multiple property exchanges, it becomes necessary to allocate boot received among the properties given to determine the amount and character of gain on the transfer.

 

C. DETERMINING BASIS OF PROPERTY RECEIVED

 

In an exchange under §1031, it is important to remember that unrecognized gain or loss is preserved through the basis rules of §1031(d).

The basis of property received in an exchange under §1031 is the basis of the relinquished property, increased by any additional consideration given, decreased by the amount of any money received, and increased by any gain or decreased by any loss recognized in the exchange. I.R.C. §1031(d).

 

In an exchange involving multiple properties, the basis must be calculated on an exchange group basis. Treas. Reg. §1.1031(j)-1(c). The aggregate basis of the properties in the exchange group is then allocated among each of the properties in the group. Treas. Reg. §1.1031(j)-1(c). The basis is allocated proportionately to each property received in the exchange group in accordance with its fair market value. Treas. Reg. §1.1031(j)-1(c).

 

D. CARRYOVER HOLDING PERIOD

 

The holding period of the replacement property received and exchanged under §1031 is the holding period of the relinquished property. I.R.C. §1223. The holding period for non like-kind property begins on the date of acquisition. There is no carryover holding period for non like-kind property.

 

E. EXAMPLE OF GAIN AND BASIS CALCULATION

 

The following example demonstrates the calculation of realized gain:

[ex] Taxpayer owns relinquished property with a fair market value of $1,000,000 and a tax basis of $200,000 and subject to a liability of $600,000. Taxpayer receives $100,000 cash and replacement property with a fair market value of $800,000, subject to a liability of $500,000. Transactional expenses charged to taxpayer total $20,000.

RG = AR - (B + AP)

AR= FMV of replacement property ($800,000)

Cash Boot Received ($100,000)

Liability Boot Received ($600,000)

Total AR= $1,500,000

B= Basis of relinquished property ($200,000)

AP= Transactional Expenses ($20,000)

Liability Boot Paid ($500,000)

Total AP= $520,000

RG= $1,500,000 - ($200,000 + $520,000)

RG= $780,000

So, Realized Gain in the transaction is $780,000.

Remember, Realized Gain is recognized to the extent of Boot Received. So, it is important to determine the value of all boot received.

Boot Received= $100,000 in cash boot received

$600,000 in liability boot received

Total Boot Received= $700,000

Net Liability Boot Received= $600,000 Liability Boot Received

($500,000) Liability Boot Paid

$100,000 Liability Boot Receive

($20,000) Cash Boot Paid

$80,000 Net Liability Boot Received

$100,000 Cash Boot Received

$180,000 Net Boot Received

 

Realized Gain is recognized to the extent of Boot received. If the Realized Gain is $780,000 and there is $180,000 in Net Boot Received, then $180,00 of the Realized Gain is recognized.

 

Basis of Replacement Property=

$200,000 Basis of Relinquished Property

$180,000 Gain Recognized

$520,000 Boot Paid

($700,000) Boot Received

$200,000 is the Basis of the Replacement Property

 

F. MULTIPLE PROPERTY EXCHANGES

 

Treas. Reg. §1.1031(j)-1 states that §1031 generally requires a property by property comparison for determining the gain recognized and the basis of property received in a like kind exchange. The Regulation section also provides an exception to the general rule for exchanges of multiple properties.

 

An exchange of multiple properties is one in which multiple exchange groups are created. A multiple property exchange also exists if only on exchange group is created but there are multiple properties within the one exchange group. Treas. Reg. §1.1031(j)-1(a)(1).

 

The amount of gain recognized in a multiple property exchange is computed by first separating the properties transferred and received into exchange groups. Treas. Reg. §1.1031(j)-1(b). This process involves matching up properties of a like kind or like class to the extent possible. Once exchange groups are created, liabilities assumed by the taxpayer are offset by liabilities relieved. Treas. Reg. §1.1031(j)-1(b)(2)(ii). Then the rules of §1031 are applied to each exchange group to determine the amount of gain recognized and basis.

 

VI. MECHANICS/DOCUMENTATION OF EXCHANGES

 

A. BEGINNING THE EXCHANGE-SALE OF RELINQUISHED PROPERTY

 

The easiest way to convert a sale of property into an exchange under §1031 is to use the Qualified Intermediary safe harbor. As discussed above, under the Qualified Intermediary safe harbor, the Qualified Intermediary must enter into a written agreement with the taxpayer which requires the Qualified Intermediary to acquire the relinquished property from the taxpayer, transfer the relinquished property to the buyer, acquire the replacement property from the seller, and transfer the replacement property to the taxpayer. Treas. Reg. §1.1031(k)-1(g)(4)(iii)(b).

The Qualified Intermediary is deemed to have acquired and transferred the relinquished property if the Qualified Intermediary enters into an agreement with a person other than the taxpayer for the transfer of the relinquished property to that person, and pursuant to that agreement, the relinquished property is actually transferred to that person. Treas. Reg. §1.1031(k)-1(g)(4)(iii)(B).

 

The Qualified Intermediary is deemed to have acquired and transferred the replacement property if the intermediary enters into an agreement with the owner of the replacement property for the transfer of that property and, pursuant to that agreement, transfers the replacement property to the taxpayer. Treas. Reg. §1.1031(K)-1(g)(4)(iv)(C).

 

Under the Qualified Intermediary safe harbor, the Qualified Intermediary is treated as having entered into the agreements under Treas. Reg. §1.1031.(k)-1(g)(4)(iv)(B) and (C) if the taxpayer's rights under the relinquished property contract and the replacement property contract are assigned to the intermediary and all parties are notified of the assignments before the date of the property transfer. Treas. Reg. §1.1031(k)-1(g)(4)(v).

 

1. EXCHANGE COOPERATION CLAUSE

 

Prior to beginning the exchange under §1031, the cooperation of the relinquished property buyer should be contractually arranged. To arrange the buyer's cooperation, an exchange cooperation clause should be included in the relinquished property contract. A sample exchange cooperation clause can be found at Appendix D.

2. EXCHANGE AGREEMENT

 

Treas. Reg. §1.1031(k)-1(g)(4)(iii)(B) requires that the Qualified Intermediary and the taxpayer enter into a written agreement. This written agreement sets forth the pertinent terms of the exchange.

 

Under Treas. Reg. §1.1031(k)-1(g)(6), the exchange agreement must provide that the taxpayer may not receive, pledge, borrow, or otherwise obtain the benefits of the money or other property held by the Qualified Intermediary prior to the end of the exchange period. The agreement may provide that the taxpayer may receive, pledge, borrow, or otherwise obtain the benefits of the money or other property upon the expiration of the identification period if the taxpayer fails to properly identify the replacement property. Treas. Reg. §1.1031(k)-1(g)(6). Furthermore, Treas. Reg. §1.1031(k)-1(g)(6) provides that the exchange agreement may allow the taxpayer to receive, pledge, borrow, or otherwise obtain the benefits of the money or other property after identifying replacement properties, upon or after:

 

1. The receipt by the taxpayer of all the replacement properties to which he is entitled under the agreement; or

 

2. The occurrence, after the end of the identification period, of a material and substantial contingency that relates to the exchange, is provided for in writing and is beyond the control of the taxpayer and of any disqualified person other than the person obligated to transfer the replacement property to the taxpayer. Treas. Reg. §1.1031(k)-1(g)(6).

The exchange agreement must also require that the Qualified Intermediary acquire the relinquished property from the taxpayer, transfer the relinquished property to the buyer, acquire the replacement property from the sell and transfer the replacement property to the taxpayer. Treas. Reg. §1.1031(k)-1(g)(4)(iii)(B).

An example of an exchange agreement can be found at Appendix A.

 

3. CONTRACT ASSIGNMENTS

 

As discussed above, the exchange agreement must require that the Qualified Intermediary acquire and transfer both the relinquished property and the replacement property. This requirement is met if the taxpayer assigns his rights under the relinquished property contract and the replacement property contract to the taxpayer prior to the respective transfer dates and gives notice of each assignment to all relevant parties. The contract assignments can be accomplished with very simple documents wherein all the taxpayer's rights, but not its obligations, under each contract are transferred and assigned to the Qualified Intermediary. All parties to the transaction must be given notice of the assignment and must acknowledge and consent to the assignment. Examples of contract assignments can be found in Appendix C.

 

4. DIRECT DEEDING

 

Under Treas. Reg. §1.1031(k)-1(g)(4)(i)(B), the relinquished property can be directly deeded from the taxpayer to the buyer. Title to the property does not have to pass through the Qualified Intermediary. This simplifies the closing process considerably.

 

5. HANDLING OF EARNEST MONEY

 

In a typical real estate transaction, the purchaser of the relinquished property will pay earnest money to the seller as a deposit on the property. In an exchange under §1031, the earnest money payment must be carefully structured to prevent the taxpayer from receiving taxable boot. It would seem that the taxpayer could transfer the earnest money payment to the Qualified Intermediary at any time prior to the closing and avoid the taxable boot issue altogether, since the escrow deposit would not be income to the taxpayer anyway until the property is purchased or the earnest money is forfeited. So, as a rule, the taxpayer should give all earnest money payments to the qualified intermediary prior to closing on the sale of the relinquished property.

5. TRANSFER OF RELINQUISHED PROPERTY - A SUMMARY

 

If the taxpayer wishes to conduct the transaction as an exchange under §1031, then several steps must be taken prior to the transfer of the relinquished property. These steps are as follows:

 

1. Negotiate a contract for the sale of the relinquished property;

2. Ensure that the relinquished property contract contains exchange cooperation language;

3. Hire a non-disqualified person to serve as the qualified intermediary;

4. Enter into an exchange agreement with the qualified intermediary;

5. Make sure the taxpayer's rights under the relinquished property contract are assigned to the qualified intermediary prior to the closing;

6. Make sure all earnest money paid to the taxpayer prior to the closing on the sale of the relinquished property is transfer to the qualified intermediary.

 

B. ACQUIRING THE REPLACEMENT PROPERTY

 

Under Treas. Reg. §1.1031(k)-1(g)(iv)(B) and (C), the Qualified Intermediary is deemed to have acquired the replacement property and transferred it to the taxpayer if the Qualified Intermediary is assigned all rights under the contract for the replacement property and all parties to the contract are notified of the assignment in writing.

 

The documents needed for the assignment of the replacement property contract to the Qualified Intermediary are very similar to those needed for the assignment of the relinquished property contract. A sample assignment document can be found at Appendix C.

 

As with the relinquished property contract, exchange cooperation language should be included in the replacement property contract. A sample exchange cooperation clause for a replacement property contract can be found at Appendix D.

 

As with the transfer of the relinquished property, direct deeding is allowed between the seller and the taxpayer. Treas. Reg. §1.1031(k)-1(g)(4)(iv)(C).

 

Again, special care must be taken with any earnest money deposit that must be made for the purchase of the replacement property. The safest way to handle the earnest money is to have the earnest money paid to the seller by the Qualified Intermediary after the contract is assigned to the Qualified Intermediary. Typically, however, the earnest money must be paid to the seller at the time the contract is signed. Another possibility is to have the taxpayer pay the earnest money from his own funds and then have the seller reimburse the earnest money at the closing and have the Qualified Intermediary pay the entire purchase price to the seller. Having the Qualified Intermediary reimburse the taxpayer for earnest money paid from the taxpayer's own funds risks violating the Treas. Reg. §1.1031(k)-1(g)(6) limitations.

 

C. CLOSING STATEMENTS

 

As discussed above, the relinquished property contract and the replacement property contract must be assigned to the Qualified Intermediary. Since both contracts must be assigned to the Qualified Intermediary, the Qualified Intermediary must be a party to the closings of each piece of property. Since the Qualified Intermediary must be a party to each closing, the Qualified Intermediary must be a party to each closing statement.

 

D. REPORTING THE §1031 EXCHANGE

 

I.R.C. §1031 exchanges must be reported to the IRS whether or not the taxpayer recognized any gain or loss on the transaction. Capital asset exchanges must be reported on Form 1040, Schedule D. Other exchanges must be reported on Form 4797. The parties to a §1031 exchange must also report the transaction on Form 8824. For §1031 exchanges where related parties are an issue, Form 8824 must be filed for the year of the exchange and for the following two(2) years.

 

VII. SPECIAL ISSUES

 

A. RELATED PARTY RULES

 

The §1031 non-recognition provisions do not apply to like-kind exchanges between a taxpayer and a related person, if before two years after the date of the last transfer that was a part of the exchange, either the taxpayer or the related party disposes of the property received in the exchange. I.R.C. §1031(f). This restriction exists to prevent basis shifting in non-recognition transactions. An example of a basis-shifting transaction is as follows:

 

Taxpayer owns an apartment complex with a low basis that he wants to sell for cash. Taxpayer's related party owns a high basis warehouse with a similar fair market value. Taxpayer exchanges property with his related party. The related party now has a high basis in the apartment complex. Taxpayer retains his low basis in the warehouse. Related party then sells the apartment complex with a high basis for little or no gain. In effect, the economic unit consisting of the taxpayer and the related party have cashed out of the apartment complex without paying tax.

 

A "related person" is any person bearing a relationship with the taxpayer as defined in §267(b) or §707(b). These are the same persons defined as disqualified persons for safe harbor purposes. Under §1031(f)(2), the related party rules do not apply to:

 

1. Dispositions of the property following the death of the taxpayer or the related party;

 

2. Disposition of the property in a compulsory or involuntary conversion, within the meaning of §1033; or

 

3. Dispositions of the property where it is established to the satisfaction of the Service that income tax avoidance was not a principal purpose of the transaction.

The IRS ruled in IRS Letter Ruling 9116009, that a subsequent disposition to a grantor trust, where either the taxpayer or the related party is the grantor, will not trigger §1031(f) treatment.

Exchanges between related parties which do not involve basis shifting should not be subject to the §1031(f) restrictions. If the taxpayer can prove to the satisfaction of the Secretary that the purpose of the related party transaction was not the avoidance of taxes, then §1031(f) will not apply. I.R.C. §1031(f)(2)(C).

 

An example of a transaction in which the exception under §1031(f)(2)(C) should apply is as follows:

 

Taxpayer has low basis property with high fair market value. Related party owns no like-kind property but pursuant to an exchange agreement entered into with taxpayer agrees to go out and buy like-kind property and sell it to taxpayer in exchange for taxpayer's property. Related party then sells the property received from taxpayer. In this transaction, tax avoidance is not the motive. Rather, the motive is to assist taxpayer with the deferral of taxes. Related party is simply reimbursed for the cash paid to acquire the like-kind property exchanged to taxpayer.

 

If a taxpayer exchanges property with a related party and either party to the exchange disposes of the property within two years, then any gain recognizable on the original exchange must be recognized on the date of the disqualifying disposition. I.R.C. §1031(f)(1). So, in the example above, when related party sells the apartment complex within the two year period, all taxes on the gain that would otherwise have been due, but for the exchange, come due.

 

Under §1031(f), the running of the two-year period is suspended for any period in which the holder's risk of loss for the exchanged property is substantially diminished by:

 

1. The holding of a put with respect to the property;

2. The holding by another person of the right to acquire the property; or

3. A short sale or any other transaction.

 

B. REVERSE EXCHANGES

 

1. INTRODUCTION

 

I.R.C. §1031 and the Regulations promulgated thereunder apply to exchanges in which the sale of the relinquished property precedes the acquisition of the replacement property. In some situations, however, for reasons unrelated to tax law, the taxpayer must acquire the replacement property prior to selling the relinquished property. Such exchanges are typically referred to as "reverse exchanges".

 

Reverse exchanges come about in situations in which it is not possible to sell the relinquished property prior to the acquisition of the replacement property. Typically, the need for a reverse exchange arises when the taxpayer cannot find a buyer for the relinquished property and there is a fear that someone else will buy the replacement property if it remains on the market.

Until recently, very little authority existed that directly addressed reverse exchanges. Neither §1031 nor the Regulations promulgated thereunder directly address reverse exchanges. Furthermore, cases and rulings on the topic seem to indicate that the IRS was opposed to reverse exchanges.

 

Despite the lack of guidance and the apparent opposition of the IRS, however, taxpayer's still found themselves in reverse exchange situations. Such situations forces taxpayers to improvise.

 

2. PRE-REV. PROC. 2000-37

 

Prior to September 15, 2000, the typical reverse exchange was conducted as a parking transaction. Parking transactions involve parking either the relinquished property or the replacement property with a third party until such time as a simultaneous exchange can be arranged. Parking transactions can be structured in two ways. The first method involves exchanging first and then parking the relinquished property with a non-disqualified person until a buyer is found. The second method involves parking the replacement property with a non-disqualified person until a simultaneous exchange is arranged.

 

Regardless of the method chosen, special care must be taken to insure that the taxpayer does not violate the constructive receipt rules under §1031. In other words, the parking entity is required to be a non-disqualified person under the same rules that apply for qualified intermediaries and other safe harbor arrangements.

 

The exchange-first arrangement is very uncommon and is usually only employed in situations where the lender insists the taxpayer take title to the replacement property right away in order to issue the replacement property loan. In such arrangements, the taxpayer and the parking entity first enter into an exchange agreement. Following execution of the exchange agreement, the taxpayer conducts a simultaneous exchange under §1031, using a new loan from the lender in order to acquire the replacement property. The parking entity then takes title to and holds the relinquished property until a buyer is found.

 

In a park-first transaction, the parking entity acquires the replacement property and holds it until the relinquished property can be sold. Typically, the taxpayer either loans the money to the parking entity or the taxpayer guarantees a loan to the parking entity. The sale of the relinquished property occurs at the end of the transaction and involves a simultaneous exchange. When the buyer for the relinquished is located, the parking entity sells the property in a simultaneous like-kind exchange under §1031.

 

In Pre-Rev. Proc. 2000-37 reverse exchanges, the taxpayer must be careful to insure that the parking entity is the true owner of the parked property for tax purposes prior to the exchange. In either form of parking transaction, the taxpayer is wise to complete the entire transaction prior to the expiration of the typical 180 day exchange period, although the statutory time limits under §1031 technically do not apply.

 

3. POST REV. PROC. 2000-37

 

As discussed above, prior to September 15, 2000, very little guidance existed in the area of reverse §1031 exchanges. On September 15, 2000, the Internal Revenue Service issued Rev Proc 2000-37, I.R.B. 2000-40 (Sep. 15, 2000) (hereinafter referred to as "Rev. Proc. 2000-37"). This new guidance from the IRS attempts to set forth a reverse exchange safe harbor under which the IRS will not challenge the qualification of property as relinquished property or replacement property for purposes of §1031 or the treatment of the Exchange Accommodation Titleholder as the beneficial owner of the property for federal income tax purposes as long as the property is held in a Qualified Exchange Accommodation Arrangement. With the Rev. Proc. 2000-37 arrangement in place, taxpayer's can finally conduct reverse §1031 exchanges without worrying about the IRS's apparent disdain for such transactions.

 

In order to accomplish a reverse §1031 exchange under Rev. Proc. 2000-37, the taxpayer must first enter into a Qualified Exchange Accommodation Arrangement with an Exchange Accommodation Titleholder under a Qualified Exchange Accommodation Agreement. Under Rev. Proc. 2000-37, the Qualified Exchange Accommodation Agreement must provide that the Exchange Accommodation Titleholder is holding the property for the taxpayer's benefit in order to facilitate an exchange under §1031 and Rev. Proc. 2000-37 and that the taxpayer and the Exchange Accommodation Titleholder agree to report the acquisition, holding and disposition of the property as provided in the Revenue Procedure. The Qualified Exchange Accommodation Agreement must also provide that the Exchange Accommodation Titleholder will be treated as the beneficial owner of the property for all federal income tax purposes. Rev. Proc. 2000-37, §4.02. The Qualified Exchange Accommodation Agreement must be entered into no later than five (5) business days after the qualified indicia of ownership of the property is transferred to the Exchange Accommodation Titleholder. Rev. Proc. 2000-37, §4.02(3).

 

Under the Revenue Procedure, the Exchange Accommodation Titleholder must possess all qualified indicia of ownership of the property from the date such property is acquired by the Exchange Accommodation Titleholder until it is ultimately transferred to the taxpayer. This means that the Exchange Accommodation titleholder must possess legal title to the property or other indicia of ownership that would be treated as beneficial ownership under applicable principals of commercial law. Rev. Proc. 2000-37, §4.02(1).

 

The Exchange Accommodation Titleholder can be any person who is not the taxpayer or a disqualified person. The rules for such qualification are the same rules set forth above under the Qualified Intermediary safe harbor. Additionally, the Exchange Accommodation Titleholder must be subject to federal income tax, or if the Exchange Accommodation Titleholder is a Partnership or S-corporation, more than 90% of it's interest or stock must be subject to federal income tax. Rev. Proc. 2000-37, §4.02(1).

 

Unlike the parking transactions conducted prior to Rev. Proc. 2000-37, strict time periods apply to the identification of relinquished property and the sale of the relinquished property under the Revenue Procedure. Within 45 days of the transfer of the qualified indicia of ownership of the replacement property to the Exchange Accommodation Titleholder, the taxpayer must properly identify his relinquished property. Rev. Proc. 2000-37, §4.02(4). Identification is properly made if the guidelines set forth in Treas. Reg. §1.1031(k)-1(c) for forward delayed exchanges are followed. Within 180 days of the transfer of the qualified indicia of ownership of the replacement property to the Exchange Accommodation Titleholder, the parked property must be transferred, either directly or indirectly through a Qualified Intermediary to the taxpayer as replacement property or must be transferred to someone other than the taxpayer or a disqualified person as relinquished property. Rev. Proc. 2000-37, §4.02(5).

 

The 45 and 180 day time periods set forth by the Revenue Procedure are clearly an effort by the Internal Revenue Service to provide symmetry between a reverse exchange and a forward delayed exchange. The time periods only apply to transactions structured under the Qualified Exchange Accommodation Arrangement safe harbor. The IRS specifically recognized in §3.02 of Rev. Proc. 2000-37 that reverse exchanges structured as parking transactions can be accomplished outside of the Qualified Exchange Accommodation Arrangement safe harbor. This statement seems to be an acknowledgment by the IRS that the Qualified Exchange Accommodation Arrangement will not work for all taxpayers. In situations such as large build-to-suit exchanges where it is not possible to complete construction within the 180 day time period, the Qualified Accommodation Arrangement safe harbor may not work.

 

The typical reverse exchange under Rev. Proc. 2000-37 should be structured as follows:

 

1. Taxpayer negotiates and enters into a Contract for the Purchase of Replacement property;

 

2. Taxpayer arranges financing for the acquisition of the replacement property;

 

3. Taxpayer shops for and hires a non-disqualified person or entity to serve as the Exchange Accommodation Titleholder;

 

4. Taxpayer and the Exchange Accommodation Titleholder enter into a Qualified Exchange Accommodation Agreement;

 

5. The Exchange Accommodation Titleholder acquires all of the Qualified Indicia of ownership of the replacement property with financing arranged by taxpayer;

 

6. Taxpayer identifies one or multiple relinquished properties within 45 days following the transfer of all Qualified Indicia of ownership of the replacement property to the Exchange Accommodation Titleholder;

 

7. Taxpayer locates a buyer for the relinquished property and negotiates a sales contract;

 

8. Taxpayer enters into an exchange agreement with a Qualified Intermediary and assigns all rights under the relinquished property contract to the Qualified Intermediary, and taxpayer assigns all rights to acquire the replacement property held by the Exchange Accommodation Titleholder to the Qualified Intermediary;

 

9. The Qualified Intermediary sells the relinquished property to the buyer via direct deed from taxpayer. Buyer delivers cash to Qualified Intermediary. Qualified Intermediary purchases replacement property from Exchange Accommodation Titleholder. Qualified Intermediary directs Exchange Accommodation Titleholder to convey replacement property directly to the taxpayer. Exchange Accommodation Titleholder uses proceeds from the sale of the replacement property to satisfy any acquisition indebtedness on the replacement property.

 

There are a number of arrangements that are allowed under §4.03 of Rev. Proc. 2000-37 without jeopardizing the Qualified Exchange Accommodation Arrangement safe harbor. The permissible arrangements include:

 

1. The Exchange Accommodation Titleholder may also serve as the Qualified Intermediary in a simultaneous or deferred exchange under §1031;

 

2. Taxpayer or some other disqualified person may guarantee some or all of the Exchange Accommodation Titleholder's obligations, including secured or unsecured debt incurred to acquire the replacement;

 

3. Taxpayer may indemnify the Exchange Accommodation Titleholder against costs and expenses;

 

4. Taxpayer or some other disqualified person may loan or advance funds to the Exchange Accommodation Titleholder or guarantee a loan or advance to the Exchange Accommodation Titleholder;

5. Exchange Accommodation Titleholder may lease replacement property to the taxpayer or some other disqualified;

 

6. Taxpayer may manage the property, supervise improvements on the property, act as contractor, or provide other services to the Exchange Accommodation Titleholder with regard to the replacement property;

 

7. Taxpayer and the Exchange Accommodation Titleholder may enter into agreements or arrangements relating to the purchase or sale of the replacement property; and

 

8. Taxpayer and Exchange Accommodation Titleholder may agree that any variations in the value of the relinquished property from the established value on the date of Exchange of Accommodation Titleholder's receipt of the property may be taken into account upon the Exchange Accommodation Titleholder's disposition of the relinquished property through the taxpayer's advance of funds to, or receipt of funds from the Exchange Accommodation Titleholder.

 

One of the most important requirements of Rev. Proc. 2000-37 is the requirement that the Exchange Accommodation Titleholder and the taxpayer respect the Exchange Accommodation Titleholder's beneficial ownership of the property for all federal income tax purposes. Revenue Procedure 2000-37, §4.02(3). The Exchange Accommodation Titleholder must show on its federal income tax return that it is the true owner of the property. The Exchange Accommodation Titleholder must report any operating income or loss from the property and must report any gain or loss on the eventual disposition of the replacement property.

 

While Revenue Procedure 2000-37 does appear to settle many issues that were previously unresolved in the reverse exchange arena, the new guidelines that it sets forth can add additional costs to the transaction. The taxpayer must pay additional settlement costs, escrow fees, transfer taxes, recording fees, and other transactional expenses not otherwise encountered in a forward transaction. There are additional title insurance expenses and issues that must be resolved. The financing of the replacement property by the Exchange Accommodation Titleholder may add additional expense to the transactions. Additional legal fees and accounting fees will necessarily be an issue. Also, the Exchange Accommodation Titleholder's fee will be somewhat larger than a typical Qualified Intermediary's fee.

 

An additional expense that must be incurred by the taxpayer is the cost associated with creating, registering, managing and dissolving a special purpose entity used by the Exchange Accommodation Titleholder to own the replacement property during the exchange period. Most sophisticated Exchange Accommodation Titleholders create special purpose entities to hold title to the parked replacement property. Creation of such special purpose entities insulates the Exchange Accommodation Titleholder and its other assets from liabilities. Some Exchange Accommodation Titleholders will create seven or eight different special purpose entities and then rotate them without allowing a special purpose entity to hold title to more than one replacement property at any time. In order to avoid potential liabilities from such problems as latent environmental defects, it is probably best to dissolve each special purpose entity after each transaction. If the exchange straddles two years, then additional fees, such as registration fees, income tax return preparation fees, etc. may be incurred.

 

One other problem that must be addressed with regard to reverse exchanges under §1031 and Revenue Procedure 2000-37 involves financing the acquisition of the replacement property. Remember, it is the Exchange Accommodation Titleholder that must acquire the replacement property. The Exchange Accommodation Titleholder is not, however, required to have an equity investment in the parked replacement property during the exchange period. Rev. Proc. 2000-37, §4.02(1). In fact, the Exchange Accommodation Titleholder may borrow the entire purchase price of the replacement property. Coming up with the financing, however, can often be tricky.

First, it is critical to have a taxpayer with sufficient financial strengths or contacts with financial sources or lenders to arrange the financing of the replacement property. Since the Exchange Accommodation Titleholder must purchase the property, the loan must be made to the Exchange Accommodation Titleholder. For reverse exchanges that come about at the last minute, the financing issue can be a critical stumbling block. The taxpayer may think that the financing is arranged, but rearranging the financing so that the Exchange Accommodation Titleholder is the borrower may scare away the lender.

 

Under §4.03(3) of Rev. Proc. 2000-37, the taxpayer or another disqualified person can loan or advance the funds to the Exchange Accommodation Titleholder. If the taxpayer chooses to borrow from the lender and then loan money to the taxpayer, collateralizing the original loan with the lender can become an issue. In such cases, it is preferable to have the taxpayer use a property unrelated to the exchange as collateral.

 

As can be gathered from this outline, despite the issuance of Rev. Proc. 2000-37, reverse exchanges under §1031 are very complicated transactions. If at all possible, it is safest, and clearly less expensive to conduct the transaction as a forward exchange as originally contemplated by the Code and the Regulations. For reasons that are often beyond the taxpayer's control, however, the reverse exchange is sometimes the only way to go. In such situations, following the guidelines of the safe harbor provided by Rev. Proc. 2000-27 is the safest way. If time delays resulting from construction or a poor real estate market are an issue, however, it is still possible to conduct reverse exchanges as parking transactions.

 

4. DECLEENE

 

In a recent Tax Court decision, a Pre Rev. Proc. 2000-37 reverse exchange was disapproved. In Decleene v. Commr, 115 TC 34 (2000), the Tax Court held that, despite the taxpayer's efforts to structure a transaction as a reverse exchange, the taxpayer did not actually engage in a valid like-kind exchange under §1031.

 

In Decleene, taxpayer purchased real property to use as a new business location. Taxpayer then sold the property to an unrelated third party in exchange for a non-recourse promissory note. The following day, taxpayer and the unrelated party entered into an agreement which provided for the future exchange of the developed property owned by the unrelated party for the property owned by the taxpayer. The agreement also provided that the unrelated party would construct improvements on the property. Following the conclusion of the construction process, the parties engaged in a simultaneous exchange properties.

 

The IRS held that the transaction did not meet the exchange requirements of §1031. The Tax Court concluded in Decleene that the taxpayer remained the true owner of the replacement property between the time he sold it to the unrelated party and the time he re-purchased it from the unrelated party, thus, an exchange was impossible since the taxpayer owned both the relinquished property and the replacement property.

 

The Tax Court found that the taxpayer never, in fact, disposed of the replacement property. In finding that the taxpayer was the true owner of the replacement property throughout the exchange, the Court specifically pointed out the facts that a non-recourse note was used, the taxpayer guaranteed the construction loan. The taxpayer paid all related taxes and expenses and the unrelated party had any potential for gain or exposure to loss in connection with the property.

 

It is likely that Decleene will never be an issue with post Rev. Proc. 2000-37 reverse exchanges. In fact, Rev. Proc. 2000-37 addresses many of the problems with the Decleene transaction and allows them to occur. More importantly, though, Decleene provides insight on how non-Rev. Proc. 2000-37 exchanges conducted after September 15, 2000 should be conducted. For such transactions, it appears to be the Tax Court's opinion that the parking entity must bear some economic risk with respect to the parked property.

 

C. EXCHANGE PROPERTY TO BE PRODUCED

 

In some cases, the taxpayer may wish to construct improvements on the replacement property during the exchange period. Such transactions are provided for by §1.1031(k)-1(e). The property upon which the improvements are made cannot be property owned by the taxpayer prior to the exchange. The underlying real estate must actually be purchased by the taxpayer in order to maintain the like-kind nature of the exchange. Since the replacement property must be like-kind property, all qualifying improvements must be completed prior to the end of the exchange period or the improvements risk being classified as taxable boot to the taxpayer. See Bloomington Coca-Cola Bottling Company v. Commissioner, 189 F. 2d 14 (7th Cir. 1951), Smith V. Commissioner, 537 F. 2d 972 (8th Cir. 1976), and J. H. Baird Publishing Co. V. Commissioner, C.T. 608(1962) acquiesced 1963-2 C.B. 4.

 

The party owning the property during the construction phase cannot be the taxpayer's agent. Since the Qualified Intermediary is not considered the taxpayer's agent, provided all requirements of the Regulation §1.1031(k)-1(g)(4) safe harbor are met, the Qualified Intermediary could own the property during the construction period.

 

The identification requirements of Treas. Reg. §1.1031(k)-1(c)(3) are met if a legal description is provided for the underlying property and the taxpayer supplies as much information regarding construction of the improvements as is practicable at the time identification is made. Treas. Reg. §1.1031(k)-1(e)(2). It seems that a set of architects plans or information regarding the square footage of the improvements, the type of construction, etc. might be sufficient.

 

Since the exchange period only lasts for 180 days after the transfer of the relinquished property, the improvements must be completed prior to the 180th day. All improvements completed afterward are considered taxable boot to the taxpayer. Additionally, the replacement property received must be substantially the same as the replacement property identified. If the production of the property is not completed prior to the end of the exchange period, the replacement property will be considered to be substantially the same as that identified only if, had the construction been completed prior to the date the taxpayer received the property, the property would have been considered to be substantially the same property as that identified. Even so, however, the replacement property received will only be considered substantially the same property as identified to the extent the property received, constitutes real property under local law.

 

For purposes of determining whether the property received is substantially similar to that identified, minor variations due to usual or typical production changes are disregarded. If substantial changes are made, however, the property received will not be considered substantially the same as that identified.

 

As with reverse exchanges, there are a number of questions that must be resolved in build-to-suit exchanges. These questions include, but are not limited to:

 

1. How is construction financing arranged?

2. Who signs construction contracts?

3. What control over the construction can the taxpayer have?

4. How are construction defects handled?

5. How are potential environmental problems handled?

 

It appears that build-to-suit exchanges are contemplated in Revenue Procedure 2000-37. Section 4.03(5) of the Revenue Procedure provides that the taxpayer may supervise the construction of improvements on the replacement property or even act as contractor during the exchange period.

 

For reverse build-to-suit exchanges where there is a likelihood that the construction of improvements may take longer than 180 days, the Qualified Exchange Accommodation Arrangement safe harbor provided by Revenue Procedure 2000-37 is probably impractical. All is not lost, however, as §3.02 of Rev. Proc. 2000-37 states that the Service recognizes that parking transactions can be accomplished outside of the Safe harbor provided in the Revenue Procedure.

 

D. EARLY DISTRIBUTIONS FROM EXCHANGE ACCOUNT

 

An issue that has recently been addressed by the IRS involves the early distribution of exchange proceeds under a §1031 exchange. In a recent private letter ruling, the Service addressed this issue. Specifically, the Service discussed various circumstances under which the exchange proceeds could be distributed prior to the conclusion of the 180 period without poisoning the exchange from the beginning. Ltr Rul 200027028 (April 10, 2000).

Treas. Reg. §1.1031(k)-1(g)(6) provides that the exchange ends and proceeds can be distributed to the taxpayer upon the occurrence of four (4) events:

 

1. The end of the 180 day exchange period;

2. The end of the 45 day identification period if no replacement properties are identified;

3. The receipt of all properties to which taxpayer is entitled to receive under the agreement; or

4. The occurrence of a material contingency that is related to the exchange, is provided for in writing, and is beyond the control of the taxpayer or any other disqualified person.

 

In Florida Industries Investment Corporation T.C.M. 1999-346, the Qualified Intermediary allowed the taxpayer to receive portions of the exchange proceeds after the close of the identification period, but prior to the end of the exchange period. The Tax Court found that such distributions demonstrated a lack of independence on the Qualified Intermediary's part and that the taxpayer had too much control over the exchange proceeds. The Court ruled that the exchange failed completely, including all properties received prior to the distributions to the taxpayer.

 

In Florida Industries, the taxpayer claimed that the agreement provided for the release of funds that were not needed to acquire identified replacement properties. The Tax Court pointed out that the agreement did not specify which proceeds were to be applied to the acquisition of replacement property and which could be distributed. These arguments raised the question of whether an agreement can be drafted to provide for partial release of funds without jeopardizing §1031 treatment.

 

In the early distribution arena, there are two (2) basic fact patterns. The first fact pattern involves the taxpayer who begins a §1031 exchange but shortly thereafter changes his mind. The second fact pattern involves the taxpayer who identifies multiple properties, buys one, and decides he wants the rest of his money. Under either fact pattern, Qualified Intermediaries are concerned that if they ignore the §1.1031(k)-1(g)(6) limitations, the IRS will argue that the limitations are ineffective to all of the Qualified Intermediary's exchange agreements, thus taking them all outside of §1031.

 

As a result of these fact patterns, the Qualified Intermediary industry has wondered if it is possible to draft an exchange agreement that allows for the distribution of proceeds prior to the 45 or 180 day periods. It appears that the IRS has answered this question negatively.

 

In Ltr. Rul. 200027028, the IRS was essentially asked whether the taxpayer's failure to successfully negotiate a contract for the replacement property was sufficiently beyond the taxpayer's control to terminate the exchange. In response, the IRS said that language permitting early release on failure to negotiate contract terms is not within the Treas. Reg. §1.1031(k)-1(g)(6) limitations. Clearly, if the taxpayer wanted the property bad enough, he could successfully negotiate the terms of the contract. Therefore, the failure to negotiate terms is not beyond the taxpayers control.

 

The conclusion reached by the IRS in Ltr. Rul. 200027028 is that in order for a continency to be beyond the taxpayer's control, it should be beyond the control of anyone involved with the exchange.

 

While the Letter Ruling does answer some questions, many remain. It remains unclear whether problems with the property such as environmental defects, interest rates outside of a pre-stated range, or the seller's unwillingness to sell can be considered contingencies beyond the taxpayer's control.

 

As stated above, the Regulations under §1031 provide that taxpayer can receive the exchange proceeds once all properties to which the taxpayer is entitled are acquired. An agreement may, therefore, provide that the Qualified Intermediary is only obligated to convey one property to the taxpayer as replacement property. If the Qualified Intermediary is not obligated to purchase additional properties, then taxpayer is not entitled to additional properties. This appears to be an easy fix for the taxpayer who buys one of the multiple identified properties and then wants his money.

 

The above fix works great for the taxpayer who purchases one property and wants out, but what about the taxpayer who identifies replacement properties but decides to bail out without purchasing any? One possible answer might involve a contract amendment, supported by consideration, in which the taxpayer and the Qualified Intermediary agree that from the date of the amendment forward, Qualified Intermediary is not obligated to purchase any additional properties for taxpayer. It is possible that the Service might take the position that such a contract amendment was available from the beginning of the exchange, therefore the Treas. Reg. §1.1031(k)-1(g)(6) limitations fail.

 

The IRS has never before argued that a Qualified Intermediary should be required to hold a taxpayer's money even if the taxpayer completely changes his mind and decides he no longer wants to conduct an exchange. If the parties deal at arms length, consideration is paid, and a contract amendment is made, it seems that the IRS would have very little ammunition to fight with.

 

One additional possibility may be to have the taxpayer seek a Court order to compel the Qualified Intermediary to distribute the exchange funds prior to the termination of the Exchange. Such an order should clearly not taint a Qualified Intermediary's other exchanges. Another possibility may be to have the taxpayer indemnify the Qualified Intermediary for all damages resulting from post or future tainted exchanges resulting from the Qualified Intermediary's violation of the Treas. Reg. §1.1031(k)-1(g)(6) limitations. Such a request should be sufficient to scare away the taxpayer.

APPENDIX
E. Agreement for the Deferred Exchange of Properties

F. Qualified Exchange Accommodation Agreement

G. Assignment of Purchase and Sale Agreement and Notice of Assignment

H. Exchange Cooperation Clauses

______________________________________________________________________________

These sample documents are provided for the reference of the drafting attorney as an educational and informational aid ONLY. The author hereby expressly disclaims any liability for the use of the sample documents and expressly states that no express or implied warranty is made as to the effectiveness, validity or suitability of the sample documents for tax or legal purposes.

 

The drafting attorney is cautioned that the sample documents have been prepared with an emphasis on general federal tax law and that federal tax law changes constantly, requiring a current knowledge of federal tax law at the time a particular client's documents are drafted. As always, the drafting attorney is responsible for making all necessary modifications to sample documents to make the document's use appropriate to the client's situation and to assure compliance with both federal tax law and applicable local law.

APPENDIX A
STATE OF GEORGIA

COUNTY OF_________

AGREEMENT FOR THE DEFERRED

EXCHANGE OF PROPERTIES

THIS AGREEMENT FOR THE DEFERRED EXCHANGE OF PROPERTIES (the "Agreement") is made and entered into this day of , 2001, by and among_________________, (hereinafter referred to as "Transferor");________________, (hereinafter referred to as "Transferee"); and___________________, (hereinafter referred to as the "Qualified Intermediary").

W I T N E S S E T H :
WHEREAS, Transferor, as Seller, and Transferee, as Purchaser, entered into a_______________________________, dated __________, 2000 as amended (the "Purchase Agreement");

WHEREAS, Transferor and Transferee intended to effect the transactions contemplated in the Purchase Agreement by means of a deferred exchange of property of like-kind in accordance with §1031 of the Internal Revenue Code of 1986, as amended;

 

WHEREAS, Transferor desires to effectuate the sale of certain property more particularly described on Exhibit "A" attached hereto and incorporated herein by this reference (hereinafter referred to as the "Relinquished Property"), by means of a deferred exchange with "like-kind" property (hereinafter referred to as the "Exchange Property"), which is intended to qualify as such under Section 1031 of the Internal Revenue Code of 1986, as amended ("I.R.C."), and the Treasury Regulations promulgated thereunder (such exchange being hereinafter referred to as the "Exchange");

 

WHEREAS, Transferor desires to appoint the Qualified Intermediary to facilitate the Exchange and to provide for the establishment of a qualified escrow account, if deemed necessary by the Qualified Intermediary, to receive closing proceeds from the transfer of the Relinquished Property and to be used by the Qualified Intermediary to purchase the Exchange Property, all in a manner to comply with I.R.C. §1031, and the Treasury Regulations promulgated thereunder; and

 

WHEREAS, Qualified Intermediary is willing to assist Transferor in the Exchange of the Relinquished Property for the Exchange Property such that the Exchange will qualify as a deferred like-kind exchange under I.R.C. §1031, and the Treasury Regulations promulgated thereunder.

 

NOW, THEREFORE, for and in consideration of Ten Dollars ($10.00) in hand paid and of the mutual premises and covenants contained herein, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto covenant and agree as follows:

 

1. Appointment of Qualified Intermediary. Transferor hereby designates, constitutes and appoints the Qualified Intermediary to facilitate the Exchange under this Agreement and assigns all his rights, title and interest under the Purchase Agreement to the Qualified Intermediary; and the Qualified Intermediary hereby accepts such designation, appointment and assignment and agrees to act as the facilitator of the Exchange in accordance with the terms of this Agreement and the Purchase Agreement. The parties acknowledge and agree that the Qualified Intermediary shall serve as the facilitator of the Exchange only and not as the agent for Transferor. Transferor has no right, beneficial or otherwise, to receive or benefit from any funds or property of the Qualified Intermediary prior to the termination of this Agreement, in accordance with this Agreement. Transferee acknowledges and consents to the appointment of the Qualified Intermediary and agrees to abide by the terms and conditions of this Agreement.

 

2. The Qualified Escrow Account. The agreement of Transferee to effect the Exchange shall be secured by the deposit by Transferee in escrow with the Qualified Intermediary of DOLLARS ($ ) (the "Exchange Value"). The Qualified Intermediary shall acknowledge the receipt of cash in such amount. The Qualified Intermediary shall hold the funds solely for purposes of the Exchange in accordance with this Agreement. Transferor has no right, beneficial or otherwise, with respect to said funds prior to the termination of the Agreement, in accordance with the Agreement. Accordingly, prior to said termination, Transferor has no property interest in the funds whatsoever and may not receive, pledge, borrow, assign, hypothecate or otherwise use or obtain the benefits of the Qualified Escrow Account.

 

3. The Exchange. The Exchange shall be effected as follows:

 

(a) Transferor shall transfer the Relinquished Property to the Qualified Intermediary subject to the Transferee's right to purchase the Relinquished Property pursuant to the Purchase Agreement.

 

(b) The Qualified Intermediary shall transfer the Relinquished Property to the Transferee in accordance with the Purchase Agreement. For reasons unrelated to federal income tax, and because the exchanges provided for in the Purchase Agreement and this Agreement are part of an interdependent and integrated plan, legal title to the Relinquished Property may be conveyed directly from Transferor to Transferee.

 

(c) Simultaneously with (b) above, the Transferee shall deposit with the Qualified Intermediary the Exchange Value in accordance with Section 2 hereof.

 

(d) Transferor shall designate in writing to the Qualified Intermediary within forty-five (45) days of the closing (the "Identification Period") the Exchange Property. Upon written notice from the Transferor that the terms and conditions for the purchase of the Exchange Property have been negotiated, the Qualified Intermediary shall diligently pursue contracts on the Exchange Property in accordance with the directions of Transferor. The amount of any earnest money deposit required under the terms of the Exchange Property contracts shall be released from escrow hereunder and deposited by the Qualified Intermediary as such earnest money deposit.

 

(e) The Qualified Intermediary shall acquire the Exchange Property and convey the Exchange Property to Transferor within the earlier of one hundred eighty (180) days of the closing of the Relinquished Property or the due date (including extensions) for the tax return for the taxable year in which the transfer of the relinquished property occurs. For reasons unrelated to federal income tax and because the exchanges provided for in the Agreement and the Purchase Agreement are part of an interdependent and integrated plan, legal title to the Exchange Property may be conveyed directly from the owner of the Exchange Property to the Transferor.

 

4. Deposits and Disbursements from Qualified Escrow Fund.

 

(a) If the sum of the payments for which the Qualified Intermediary would become obligated under the Exchange Property contracts, plus the aggregate amount of payments which the Qualified Intermediary is obligated to make thereafter under the Exchange Property contracts previously executed by the Qualified Intermediary, exceeds the aggregate amount of cash held in escrow hereunder, then the Qualified Intermediary shall require, as a condition to entering into such additional Exchange Property contracts, that Transferor deposit in escrow hereunder, in cash, or a promissory note, if the seller of such Exchange Property is willing to accept a promissory note of the Transferor in lieu of cash, an amount equal to such excess.

 

(b) Except as otherwise expressly provided in this Agreement, monies held hereunder by the Qualified Intermediary may only be expended for the acquisition of the Exchange Property in accordance with Exchange Property contracts and for the payment of all other costs incurred by the Qualified Intermediary in connection with the acquisition of the Exchange Property and the conveyance thereof to Transferor as set forth herein. The Qualified Intermediary is hereby authorized and directed to make all payments required to be made under the Exchange Property contracts on or before the due dates for the payment thereof.

 

5. Investments. Any monies held in escrow hereunder shall be invested and reinvested by the Qualified Intermediary in (i) certificates of deposit; (ii) bonds, notes and other obligations of the United States, and securities unconditionally guaranteed as to payment of principal and interest by the United States or any agency thereof, or (iii) mutual funds, money markets, savings accounts or time deposits in any bank or savings and loan association whose deposits are insured by the Federal Deposit Insurance Corporation or the Federal Savings and Loan Insurance Corporation, except that monies may not be invested in obligations described in this clause (iii) in excess of the limits of Federal Deposit Insurance Corporation or Federal Savings and Loan Insurance Corporation insurance unless such bank or savings and loan association has a combined capital and surplus of not less than $50,000,000. Any such investments must mature within thirty (30) days from the date of purchase. Any such investments and reinvestments shall be held by or under the control of the Qualified Intermediary and shall be deemed at all times a part of monies from which made. The Qualified Intermediary is authorized and directed to sell and reduce to cash funds a sufficient amount of such investments whenever necessary to make any required payment. Notwithstanding any provision hereof to the contrary except for the compensation to be paid to the Qualified Intermediary as provided in Section 7, all proceeds of investments and reinvestments shall become a part of the escrow funds held hereunder and shall be treated as such for all purposes.

 

6. Termination. This Agreement shall terminate on the earliest of (i) the earlier of the date which is one hundred eighty (180) days after the closing and transfer of the Relinquished Property to the Transferee or the due date (including extensions) of the Transferor's federal income tax return for the taxable year in which the transfer of the Relinquished Property occurs; (ii) the first date on which the Exchange Property to which the Transferor is entitled has been conveyed by the Qualified Intermediary to Transferor in accordance with the provisions hereof; (iii) if there is no identification of Exchange Property under Section 3 hereof, the date which is forty-five (45) days after the closing and transfer of the Relinquished Property to the Transferee; or (iv) the date, following the end of the Identification Period, on which a material and substantial contingency arises that relates to the Exchange, is provided for in writing, and is beyond the control of the Transferor and of any disqualified person (as defined in Treas. Reg. Section 1.1031(k)-1(k)), other than the person obligated to transfer the Exchange Property to the Transferor. Except for the compensation to be paid to the Qualified Intermediary as provided in Section 7, the Qualified Intermediary shall distribute any monies and any other property held by him hereunder to Transferor as soon as practicable after termination hereof, but in no event more than one (1) business day thereafter.

 

7. Qualified Intermediary - Terms of Appointment. The Qualified Intermediary hereby accepts his appointment hereunder but only upon and subject to the following express terms and conditions:

 

(a) The Qualified Intermediary shall not be responsible or liable in any manner whatsoever for: (i) the sufficiency or correctness of the computation of the amount of the initial deposit; (ii) the physical condition of the Exchange Property; or (iii) any other matter or thing affecting the value or condition of the Exchange Property. It is expressly understood that the Qualified Intermediary shall act in good faith and only in accordance with written notice given in accordance with this Agreement, and shall have no discretionary power in the performance of his duties hereunder.

 

(b) The Qualified Intermediary shall be protected in acting upon any written notice, request, waiver, consent, certificate, receipt, authorization, power of attorney or other document, instrument or paper which the Qualified Intermediary in good faith believes to be genuine and to be what it purports to be.

 

(c) The Qualified Intermediary shall not be liable for anything which he may do or refrain from doing in connection herewith, except as provided in (d) below for any acts of gross negligence, willful misconduct or fraud.

 

(d) Notwithstanding anything herein to the contrary, the Qualified Intermediary shall not be liable, except with respect to acts of gross negligence, willful misconduct or fraud, for any liabilities, costs, expenses, or claims in connection with any act contemplated by or in any matter in any way connected with this Agreement, and Transferor agrees to indemnify and hold the Qualified Intermediary harmless from and against any such liabilities, costs, expenses or claims; nor shall the Qualified Intermediary be required to incur any liability in connection with the acquisition or conveyance of the Exchange Property.

 

(e) The Qualified Intermediary may consult with legal counsel in the event of any dispute or question as to the construction of any of the provisions hereof or the duties of the Qualified Intermediary hereunder, and the Qualified Intermediary shall incur no liability, and shall be protected, in acting in good faith and in accordance with the opinion and instructions of such counsel.

 

(f) In the event of any disagreement between Transferee and Transferor, or between them or any of them and any other person, resulting in adverse or inconsistent claims and/or demands upon the Qualified Intermediary, or in the event that the Qualified Intermediary is, in good faith, in doubt as to what action he should take hereunder, then, in any such event, and so long as such disagreement shall continue or such doubt shall exist, the Qualified Intermediary shall not be or become liable in any way to any person for the failure or refusal of the Qualified Intermediary to act under such circumstances.

 

(g) If the Qualified Intermediary is threatened with, or becomes involved in, litigation in connection herewith, the Qualified Intermediary is hereby authorized in good faith to interplead all interested parties in any court of competent jurisdiction, and to deposit all property held by him in escrow hereunder with the clerk of the court in which such litigation is pending, and, thereupon, shall stand relieved and discharged from any further duties hereunder.

 

(h) All charges for the Qualified Intermediary's services hereunder and all costs and expenses incurred by the Qualified Intermediary in connection with his acting as the Qualified Intermediary hereunder shall be paid from the funds held in this escrow. As compensation for the Qualified Intermediary's services hereunder, the Qualified Intermediary shall be entitled to receive the hourly rate agreed upon by Transferor and Qualified Intermediary prior to the execution of this Agreement, for services rendered as Qualified Intermediary.

 

8. Transferee. Neither Transferee nor the directors, officers, employees, shareholders nor partners of Transferee shall be personally liable for any obligation of Transferee arising by virtue of this Agreement or by virtue of the Exchange Property contracts, other than any liability which may result with respect to acts of willful misconduct or fraud of Transferee, and Transferor shall indemnify and hold Transferee harmless for any liability, damage, harm or cost (including reasonable attorneys' fees) with respect to such obligations other than any liability which may result with respect to acts of willful misconduct or fraud of Transferee. Nothing contained in this Agreement shall require Transferee to incur any additional obligation or liability, whether direct, contingent or otherwise, other than that set forth in the Agreement. Transferee shall incur no expense or liability of any nature in connection with the acquisition or subsequent conveyance of the Exchange Property or the execution of this Agreement, and Transferor shall indemnify and hold Transferee harmless for any such expense, liability, or damage in connection therewith, other than any which may result with respect to acts of willful misconduct or fraud of Transferee.

 

9. Inspection. All money or other property held in escrow hereunder shall at all times be clearly identified as being held by the Qualified Intermediary pursuant to this Agreement. The Transferee and/or Transferor may at any time during the Qualified Intermediary's normal business hours inspect the records of the Qualified Intermediary relating to the money or other property held in escrow hereunder.

 

10. Notices. Any and all notices, requests, demands or directions, and/or deliveries provided for herein shall be forwarded by certified mail, return receipt requested, postage prepaid, or personally delivered to the parties at their respective addresses set forth below:

 

To Transferor:

To Transferee:

To the Qualified

Intermediary:

 

11. Checks. The Qualified Intermediary shall deliver any sums to be disbursed pursuant to the terms hereof by check certified by, or cashier's check drawn on, or interbank wire transfer by, any FDIC lending institution.

 

12. Binding Effect. The terms and provisions of this Agreement are for the benefit of Transferee, Transferor and the Qualified Intermediary and their respective heirs, successors and assigns only. Nothing contained herein shall be deemed or construed to inure to the benefit of any other person or party, it being the express intent of Transferee, Transferor and the Qualified Intermediary that no such person or party shall be entitled to any of the benefits hereof, except as herein expressly provided for.

 

13. Time. Time is of the essence of this Agreement.

 

14. Governing Law. This Agreement is intended as a contract under the laws of the State of Georgia and shall be governed thereby and construed in accordance therewith.

 

15. Three Party Agreement. This Agreement shall not be valid and may not be modified or terminated unless signed by all three parties hereto.

 

16. Counterparts. This Agreement may be executed simultaneously in two or more counterparts, each of which shall be deemed an original, but all of which taken together shall constitute one and the same document.

 

17. Severability. If any provision of this Agreement shall be held, or deemed to be, or shall, in fact, be inoperative or unenforceable as applied in any particular case in any jurisdiction or jurisdictions or in all jurisdictions, or in cases because it conflicts with any other provision or provisions hereof or any constitution or statute or rule of public policy, or for any other reason, such circumstances shall not have the effect of rendering the provision in question inoperative or unenforceable in any other case or circumstance, or of rendering any other provision or provisions herein contained invalid, inoperative, or unenforceable to any extent whatever.

 

18. Tax Advice. Transferor acknowledges and agrees that it has relied solely upon the advice and judgment of its own independent tax advisors, tax attorneys, and/or certified public accountants as to the tax consequences and tax implications of the transfer, conveyance and exchange of the respective properties.

 

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed the date and year first above written.

"TRANSFEROR"

By:

Title:

(CORPORATE SEAL)

TRANSFEREE:

__________________________________

QUALIFIED INTERMEDIARY

By:

Title:

(CORPORATE SEAL)

APPENDIX B
STATE OF GEORGIA

COUNTY OF COBB

QUALIFIED EXCHANGE ACCOMMODATION AGREEMENT

THIS QUALIFIED EXCHANGE ACCOMMODATION AGREEMENT (the "Agreement") is made and entered into this _____ day of______, 2001, by and between _____________________,(hereinafter referred to as "Exchangor"), and _______________, an individual resident of Georgia (hereinafter referred to as "Exchange Accommodation Titleholder").

W I T N E S S E T H :

WHEREAS, Exchangor desires to effectuate the sale of certain property by means of a reverse exchange of "Like-Kind" property which is intended to qualify as such under Section 1031 of the Internal Revenue Code of 1986, as amended ("IRC"), the Treasury Regulations promulgated thereunder and Rev. Proc. 2000-37 (such exchange being hereinafter referred to as the "Exchange");

 

WHEREAS, Exchange Accommodation Titleholder desires to assist Exchangor in effectuating the Exchange by purchasing, on behalf of Exchangor, certain real property more particularly described on Exhibit "A" attached hereto and incorporated hereunder by this reference (the "Replacement Property");

 

WHEREAS, Exchange Accommodation Titleholder is not a disqualified person (as defined in Treas. Reg. Section 1.1031(k)-1(k)) and is subject to federal income tax;

 

WHEREAS, Exchangor entered into that certain CONTRACT OF SALE, dated January 16, 2001 (the "Replacement Property Contract") a copy of which is attached hereto as Exhibit "A" and is incorporated herein by this reference;

 

WHEREAS, Exchangor has assigned to Exchange Accommodation Titleholder all of its right, title and interest in and to the Replacement Property Contract, a copy of said assignment is attached hereto as Exhibit "B" and is incorporated herein by this reference; and WHEREAS, Exchangor may lend funds to Exchange Accommodation Titleholder necessary to purchase the Replacement Property under the Replacement Property Contract.

 

NOW, THEREFORE, for and in consideration of Ten Dollars ($10.00) in hand paid and of the mutual premises and covenants contained herein, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto covenant and agree as follows:

 

1. Cash Loan. Exchangor hereby agrees to loan to Exchange Accommodation Titleholder, the necessary funds in order for Exchange Accommodation Titleholder to close on the Replacement Property under the Replacement Property Contract. Exchange Accommodation Titleholder hereby agrees to cooperate with Exchangor with respect to any and all documentation necessary to provide for said funds, including, but not limited to, executing a deed to secure debt and promissory note with regard to the Replacement Property to Exchangor.

 

2. Purchase of Replacement Property. Exchange Accommodation Titleholder hereby agrees to Purchase the Replacement Property pursuant to the Replacement Property Contract. Exchange Accommodation Titleholder hereby agrees to comply with all the terms and conditions of the Replacement Property Contract.

 

3. The Exchange. The Exchange shall be effectuated as follows:

 

(a) Exchangor shall assign to Exchange Accommodation Titleholder all of its rights, title and interest in and to the Replacement Property Contract;

 

(b) Exchangor shall loan funds to Exchange Accommodation Titleholder necessary to purchase the Replacement Property under the Replacement Property Contract;

 

(c) Exchange Accommodation Titleholder shall purchase the Replacement Property and shall possess all qualified indicia of ownership (as defined in Rev. Proc. 2000-37) in and to the Replacement Property, including, but not limited to legal title to the Replacement Property;

 

(d) Within forty-five (45) days after the acquisition by the Exchange Accommodation Titleholder of the Replacement Property and the transfer of all qualified indicia of ownership in and to the Replacement Property to the Exchange Accommodation Titleholder (the "Identification Period"), the Exchangor shall designate in writing to the Exchange Accommodation Titleholder the identity of the Relinquished Property. Such identification must be made in a manner consistent with Treasury Regulation §1.1031(k)-1(c). Relinquished Property is properly identified only if it is unambiguously described in a written document signed by the Exchangor and hand delivered, mailed, telecopied, or otherwise sent to the Exchange Accommodation Titleholder before the end of the Identification Period.

 

(e) Within one hundred eighty (180) days after the acquisition by the Exchange Accommodation Titleholder of the Replacement Property and the transfer of all qualified indicia of ownership in and to the Replacement Property to the Exchange Accommodation Titleholder (the "Exchange Period"), the Exchange Accommodation Titleholder shall enter into a simultaneous exchange of like kind property with Exchange Accommodation Titleholder, the purchaser of the Relinquished Property, and Qualified Intermediary in accordance with Section 1031 of the Internal Revenue Code of 1986, as amended. and the Treasury Regulations promulgated thereunder.

 

4. Beneficial Ownership. During the Exchange Period, the Exchange Accommodation Titleholder shall be treated as the beneficial owner of the Replacement Property for all Federal Income Tax Purposes.

 

5. Termination. This Agreement shall terminate on the earliest of (i) the date which is one hundred eighty (180) days after the acquisition by the Exchange Accommodation Titleholder of the Replacement Property and the transfer of all qualified indicia of ownership in and to the Replacement Property to the Exchange Accommodation Titleholder, (ii) the first date on which the Replacement Property to which the Exchangor is entitled has been conveyed to Exchangor in accordance with the provisions hereof; or (iii) if there is no identification of Relinquished Property under Section 3(d) hereof, the date which is forty five (45) days after the acquisition by the Exchange Accommodation Titleholder of the Replacement Property and the transfer of all qualified indicia of ownership in and to the Replacement Property to the Exchange Accommodation Titleholder. Upon termination of this Agreement, the Exchange Accommodation Titleholder shall transfer title to all property held by him hereunder to Exchangor as soon as practicable after termination hereof, but in no event more than one (1) business day thereafter. Upon transfer of title to said property, any deed to secure debt and/or promissory note in favor of Exchangor shall be deemed satisfied.

 

6. Hold Harmless and Indemnification. The Exchangor shall hold harmless and indemnify Exchange Accommodation Titleholder from any and all liability, except acts of gross negligence and malfeasance by Exchange Accommodation Titleholder under the Replacement Property Contract, with respect to the transactions contemplated herein. Further, Exchange Accommodation Titleholder shall not be responsible or liable in any manner whatsoever for (1) the physical condition of the Replacement Property, (2) any other matter or thing affecting the value or condition of the Replacement Property (3) any liabilities, costs, expenses, or claims in connection with any act contemplated by or in any matter in any way connected with this Agreement, except with respect to acts of gross negligence, wilful misconduct or fraud, and (4) any liabilities, costs, expenses, including but not limited to legal fees, claims or causes of actions brought by a third party arising from any incident on the replacement property from which Exchangor shall hold harmless and indemnify Exchange Accommodation Titleholder. If Exchange Accommodation Titleholder is threatened with, or becomes involved in, litigation in connection herewith, Exchange Accommodation Titleholder is hereby authorized in good faith to interplead all interested parties in any court of competent jurisdiction, and to deposit the Replacement Property with the Clerk of the Court in which such litigation is pending, and, thereupon, shall stand relieved and discharged from any further duties hereunder. Exchange Accommodation Titleholder shall be protected in acting upon any written notice, request, waiver, consent, certificate, receipt, authorization, power of attorney or other document, instrument or paper which Exchange Accommodation Titleholder in good faith believes to be genuine to be what it purports to be. Exchange Accommodation Titleholder shall not be liable for anything which he may do or refrain from doing in connection herewith except as provided herein for any acts of gross negligence, wilful misconduct or fraud. Exchange Accommodation Titleholder may consult with legal counsel in the event of any dispute or question as to the construction of any of the provisions hereof with the duties of the Exchange Accommodation Titleholder hereunder, and the Exchange Accommodation Titleholder shall incur no liability, and shall be protected, in acting in good faith and in accordance with the opinion and instructions of such counsel. Exchangor shall hold harmless and indemnify Exchange Accommodation Titleholder from any and all obligations and liabilities arising out of the cash loan necessary to purchase the Replacement Property.

 

7. Notices. Any and all notices, requests, demands or directions, and/or deliveries provided for herein shall be forwarded by Certified Mail, Return Receipt Requested, postage pre-paid or personally delivered to the parties at the respective addresses set forth below:

 

To Exchangor:

To Exchange Accommodation Titleholder:

 

8. Binding effect. The terms and provisions of this Agreement are for the benefit of Exchangor and Exchange Accommodation Titleholder and their respective heirs, successors and assigns only. Nothing contained herein shall be deemed or construed to inure to the benefit of any other person or party, it being the express intent of Exchangor and Exchange Accommodation Titleholder that no such person or party shall be entitled to any of the benefits hereof, except as expressly provided for. Any and all of the obligations of Exchange Accommodation Titleholder and Exchangor hereunder shall remain the obligations of their respective heirs, successors, assigns, and estates.

 

9. Time. Time is of the essence of this Agreement.

 

10. Governing Law. This Agreement is intended as a contract under the laws of the State of Georgia, and shall be governed thereby and construed in accordance therewith.

 

11. Amendments. This Agreement shall not be valid and may not be modified or terminated unless signed by the Exchangor and Exchange Accommodation Titleholder.

 

12. Counterparts. This Agreement may be executed simultaneously in two or more counterparts, each of which shall be deemed an original, but all of which taken together shall constitute one and the same document.

 

13. Severability. If any provision of this Agreement shall be held, or deemed to be, or shall, in fact, be inoperative or unenforceable as applied in any particular case and any jurisdiction or jurisdictions or in all jurisdictions, or in cases because it conflicts with any other provision or provisions hereof or any constitution or statute or rule of public policy, or for any other reason, such circumstances shall not have the effect of rendering the provision in question inoperative or unenforceable in any other case or circumstance, or of rendering any other provision or provisions herein contained invalid, inoperative, or unenforceable to any extend whatever.

 

14. Legal Advice. Exchange Accommodation Titleholder acknowledges and agrees that it has relied solely upon the advice and judgement of its own independent advisors, tax attorneys, and/or certified public accountants as to the legal and tax consequences and implications of the execution and consummation of this Agreement.

 

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed the date and year first above written.

"EXCHANGOR"

_____________________________________

"Exchange Accommodation Titleholder"

APPENDIX C

ASSIGNMENT OF PURCHASE AND SALE AGREEMENT
THIS AGREEMENT is entered into by and between___________________ (hereinafter referred to as "Assignor") and __________, a Georgia corporation (hereinafter referred to as "Assignee");

W I T N E S S E T H
WHEREAS, Assignor as buyer, entered into that certain Purchase and Sale Agreement, dated_________, 2001 a copy of which is attached hereto as Exhibit "A" and is incorporated herein by this reference; and

WHEREAS, Assignor and Assignee have entered an Agreement for the Deferred Exchange of Properties dated___________, 2000 (hereinafter referred to as the "Exchange Agreement") in which Assignor has agreed to transfer a certain property to Assignee in consideration of Assignee's promise to acquire a suitable replacement property and transfer same to Assignor;

NOW, THEREFORE, the parties hereby agree as follows:

1.
Assignor hereby assigns to Assignee the Assignor's rights and interest, but not title in or Assignor's obligations under, the Purchase and Sale Agreement, a copy of which is attached hereto as Exhibit "A".

2.
Assignee hereby assumes the Assignor's rights and interest, but not title in or Assignor's obligations under the Purchase and Sale Agreement, a copy of which is attached hereto as Exhibit "A".

"ASSIGNOR"

__________________________________

"ASSIGNEE"

BY:

TITLE:________________________________

NOTICE OF ASSIGNMENT
DATE:

TO:

RE: ASSIGNMENT OF LOT/LAND PURCHASE AND SALE AGREEMENT dated effective___________, 2001

Dear Sir:

Please be advised that effective the day of ,2001,______________________ transferred and assigned all of his rights and interest, but not title in or obligations in and to the referenced LOT/LAND PURCHASE AND SALE AGREEMENT to ______________. _______________ is serving as Qualified Intermediary for the undersigned within the meaning of Internal Revenue Code Section 1031, and this assignment is given to permit the undersigned to acquire the property subject to this contract as replacement property.

This day of , 2001.

By:___________________________________

Acknowledged this ________ day of ________________, 2001.

____________________________________

APPENDIX D

EXCHANGE COOPERATION CLAUSE FOR RELINQUISHED PROPERTY CONTRACT
Seller and Purchaser acknowledge that it is the intention of the Seller to effect the transaction contemplated in this Agreement by means of an exchange of property of like-kind so as to qualify for the non-recognition of gain in accordance with the provisions of Section 1031 of the Internal Revenue Code of 1986, as amended, and the Treasury Regulations promulgated thereunder. Notwithstanding anything herein to the contrary, Seller shall have the right to assign Seller's interest in this Agreement without Purchaser's consent to such person or entity as Seller may designate to serve as a "Qualified Intermediary", within the meaning of Treasury Regulation §1.1031(k)-1(g)(4), for the sole purpose of enabling Seller to effect such an Exchange; provided, however, that notwithstanding any such assignment, Seller shall not be released from any of Seller's obligations, liabilities or indemnities under this Agreement. Purchaser shall cooperated in all reasonable respects with Seller to effect such an Exchange; provided, however, that Seller's ability to consummate such an Exchange shall not be a condition to the obligations of the Seller under this Agreement and Purchaser does not warrant and shall not be responsible for any of the tax consequences to Seller with respect to the transactions contemplated hereunder; and Purchaser shall not be required to incur any additional cost or expense as a result of such Exchange.

EXCHANGE COOPERATION CLAUSE FOR REPLACEMENT PROPERTY CONTRACT
Purchaser and Seller acknowledge that it is the intention of the Purchaser to effect the transaction contemplated in this Agreement by means of an exchange of property of like-kind so as to qualify for the non-recognition of gain in accordance with the provisions of Section 1031 of the Internal Revenue Code of 1986, as amended, and the Treasury Regulations promulgated thereunder. Notwithstanding anything herein to the contrary, Purchaser shall have the right to assign Purchaser's interest in this Agreement without Seller's consent to such person or entity as Purchaser may designate to serve as a "Qualified Intermediary", within the meaning of Treasury Regulation §1.1031(k)-1(g)(4), for the sole purpose of enabling Purchaser to effect such an Exchange; provided, however, that notwithstanding any such assignment, Purchaser shall not be released from any of Purchaser's obligations, liabilities or indemnities under this Agreement. Seller shall cooperate in all reasonable respects with Purchaser to effect such an Exchange; provided, however, that Purchaser's ability to consummate such an Exchange shall not be a condition to the obligations of the Purchaser under this Agreement and Seller does not warrant and shall not be responsible for any of the tax consequences to Purchaser with respect to the transactions contemplated hereunder; and Seller shall not be required to incur any additional cost or expense as a result of such Exchange.