At long last, the Internal Revenue Service (the “Service”) has provided taxpayers, qualified intermediaries (“QIs”), attorneys and accountants with guidance as to reverse exchanges. A reverse exchange is one in which the purchase of Replacement Property (i.e., the property being acquired by the taxpayer) occurs prior to the sale of the Relinquished Property (i.e., the property being disposed of by the taxpayer). This guidance comes in the form of a revenue procedure, Rev. Proc. 2000-37, issued on September 15, 2000, which sets out “safe harbor” guidelines for reverse exchanges.

Treasury regulations governing and providing safe harbors for standard deferred exchanges (i.e., exchanges in which the Relinquished Property is sold before the Replacement Property is purchased) were issued in 1991 (the “Deferred Exchange Regulations”). By their terms, the Deferred Exchange Regulations do not apply to reverse exchanges, but they do not specifically prohibit such exchanges.

The uncertainty with regard to the permissibility of reverse exchanges has not stopped taxpayers from structuring them in a number of different ways, including “parking” transactions. There are two types of parking transactions. In the more common type, the Replacement Property is purchased from its seller (the “Seller”) by an accommodation party, which holds title to it until the Taxpayer is ready to sell the Relinquished Property. At that time, the Taxpayer exchanges the Relinquished Property for the Replacement Property and the accommodation party sells the Relinquished Property to the intended buyer (the “Buyer”). In the other type, the accommodation party exchanges the Replacement Property with the Taxpayer immediately upon acquiring it. The accommodation party then holds the Relinquished Property until it can be sold to the Buyer.

Rev. Proc. 2000-37 governs both types of parking transactions but not other types of reverse exchanges. For example, it does not apply to reverse exchanges in which there is no accommodation party. In such exchanges, the taxpayer acquires the Replacement Property from the Seller, and, for some period of time, owns both the Relinquished Property and the Replacement Property. Thus, a reverse exchange must be structured as a parking transaction in order to qualify under the safe harbor.

This revenue procedure utilizes several new terms:

• “Qualified exchange accommodation arrangement” (“QEAA”) is defined as the structuring of a reverse exchange which meets certain requirements.
  
• “Qualified indicia of ownership” (“Ownership”) is defined as legal or equitable title as to either the Relinquished Property or the Replacement Property, or ownership of an entity disregarded for tax purposes which itself owns one of those properties. For example, beneficial ownership of a Replacement Property acquired pursuant to an installment land sale contract qualifies as Ownership.
  
• “Exchange accommodation titleholder” (“Titleholder”) is defined as a taxable person or entity which acquires Ownership and holds it in a QEAA.
  
• “Qualified exchange accommodation agreement” (“Accommodation Agreement”) is defined as a written agreement between the Taxpayer and the Titleholder containing certain terms, as set forth below.

Rev. Proc. 2000-37 provides that the Service will not challenge the qualification of property as Replacement Property or as Relinquished Property and will not challenge the tax treatment of the Titleholder if the property is held in a QEAA, the requirements of which are as follows:

1. The Titleholder must acquire Ownership of either the Relinquished Property or the Replacement Property. Most significantly in this regard, sole ownership of a single asset entity which is disregarded for tax purposes can constitute Ownership. Therefore, reverse exchanges generally should be structured such that a newly formed single asset limited liability company owned by the QI acquires the Relinquished Property or the Replacement Property, as the case may be. In this way, the taxpayer can be assured that pre-existing liabilities of the QI do not attach either to the Relinquished Property or to the Replacement Property and the QI, in turn, can be insulated from pre-existing liabilities of the properties it acquires.
   
2. At the time the Titleholder acquires Ownership, the taxpayer must have the bona fide intent to transact a tax-deferred exchange under IRC section 1031. This requirement should rarely, if ever, present a roadblock.
   
3. Within five days after the Titleholder acquires Ownership, the taxpayer and the Titleholder must enter into an Accommodation Agreement, which must include the following provisions:

• The Titleholder acknowledges that it is holding the property for the benefit of the taxpayer to facilitate the taxpayer’s exchange;

• The Titleholder agrees to report the acquisition, holding and disposition of the property for federal income tax purposes; and

• The Titleholder agrees to be treated as the beneficial owner of the property for all federal income tax purposes.

If the QI serves as the Titleholder and sole ownership of a single asset LLC constitutes Ownership, the Accommodation Agreement can be incorporated into the exchange agreement. If a third party Titleholder is utilized, a separate Accommodation Agreement may well be required.

4. Within 45 days after the Titleholder acquires Ownership of the Replacement Property, the Relinquished Property must be properly identified.
   
5. Within 180 days after the Titleholder acquires Ownership, the property must be transferred through a QI to the taxpayer either as Replacement Property or it must be transferred to an unrelated third party as Relinquished Property.
   
6. The combined time periods that the Relinquished Property and the Replacement Property are held in a QEAA cannot exceed 180 days.

The Accommodation Agreement also may include any or all of the following terms even if they did not result from arm’s-length bargaining:

1. The Titleholder may act as QI, as usually will be the case if Ownership consists of a single member LLC.
   
2. The taxpayer may guarantee some or all of the obligations of the Titleholder or may indemnify the Titleholder against costs and expenses. This provision is critical in providing the Titleholder with reasonable and appropriate protections.
   
3. The taxpayer may advance funds to the Titleholder or guarantee a loan to the Titleholder. In virtually every reverse exchange, the taxpayer advances funds to the Titleholder, which otherwise does not have the wherewithal to acquire the Replacement Property.
   
4. The property held by the Titleholder may be leased to the taxpayer. Many reverse exchanges are structured utilizing triple net leases, and Rev. Proc. 2000-37 specifically approves this approach.
   
5. The taxpayer may manage the property, supervise construction of improvements, act as a contractor or otherwise provide services to the Titleholder. Reverse exchanges which do not utilize a triple net lease typically utilize a management agreement, and this revenue procedure puts its imprimatur on the use of such agreements.
   
6. The Accommodation Agreement may be effective for up to 185 days from the date the property is acquired by the Titleholder.
   
7. Any variation in value of the Relinquished Property from its estimated value on the date of the Titleholder acquires the Indicia may be taken into account upon its disposition of the Relinquished Property. This type of adjustment usually is necessary whenever the property being held is the Relinquished Property, since the price at which it ultimately sells frequently differs from the price anticipated.

Rev. Proc. 2000-37 is effective for all QEAAs in which the Titleholder acquires Ownership after September 14, 2000. As to reverse exchanges transacted before that date, it states that, “…no inference is intended with respect to the … treatment of ‘parking’ transactions that do not satisfy the terms of the safe harbor … whether entered into prior to or after the effective date of this revenue procedure.”

On September 29, 2000, after issuance of Rev. Proc. 2000-37 and without reference to it, the IRS released a technical advice memorandum (TAM 200039005) which disallowed a reverse exchange structured much like that approved in Rev. Proc. 2000-37, holding that the accommodation party was acting as the “agent” of the taxpayer! Since the facts in this technical advice memorandum arose prior to September 15, 2000, the new safe harbor rules do not apply to it. Nonetheless, its holding is so totally at odds with the policy enunciated in Rev. Proc. 2000-37 that the IRS should revoke or at least clarify it so as to minimize confusion.

Rev. Proc. 2000-37 does not answer all questions regarding reverse exchanges. For example, it does not explain how certain payments made to the Titleholder are to be handled in the exchange computation and it does not address whether the Titleholder is entitled to claim depreciation deductions. Even more important, it does not deal with reverse exchanges which are not structured as parking transactions.

However, Rev. Proc. 2000-37 does provide much needed stability and predictability to reverse exchanges. In spite of the unfamiliarity of its terminology and the complexity of its requirements, its issuance is a watershed event!