WASHINGTON--The IRS has released an additional ruling addressing so-called "reverse" deferred or Starker exchanges under Code Section 1031.

The IRS ruled in Technical Advice Memorandum 200039005 that the acquisition of new property prior to the sale of the taxpayer's old property did not qualify as a Section 1031 exchange. However, this transaction was outside of the recently released "safe harbor" for reverse exchanges.

In this ruling, a taxpayer attempted to structure a deferred Section 1031 exchange using a qualified intermediary. When the sale of the taxpayer's property fell through, he completed the acquisition of the new replacement property anyway. The taxpayer negotiated the purchase, provided the funds, was personally liable on the mortgage, but gave title to the property to the qualified intermediary. When the sale of the taxpayer's old property was finally consummated, it was done through the intermediary, who then transferred title to the new property to the taxpayer. The IRS reiterated that a reverse deferred exchange, one in which replacement property is acquired before the original property is relinquished, does not qualify under the existing Section 1031 regulations established for "forward" deferred exchanges.

This transaction occurred prior to the Revenue Procedure that the IRS released on September 15, 2000 (see Arthur Andersen Real Estate and Hospitality Tax Alert of that date). The September 15th ruling established a mechanism to accomplish reverse exchanges. That Revenue Procedure provided that a taxpayer that complies with the following guidelines can accomplish a reverse deferred exchange:

(1) a third-party accommodator must hold legal title or similar ownership to the property;

(2) the taxpayer must have a bona fide intent to enter into a 1031 exchange with that property;

(3) the taxpayer must enter into a written agreement with the accommodator within 5 days after the accommodator acquires the property, pursuant to which the accommodator will be treated as the owner of the property for tax purposes;

(4) within 45 days after the transfer of the replacement property to the accommodator, the taxpayer must identify the property he intends to relinquish;

(5) no later than 180 days after the accommodator receives the replacement property, it must be transferred to the taxpayer; and

(6) the combined time period that the replacement and relinquished property are held by the accommodator cannot exceed 180 days. Moreover, the Revenue Procedure clarifies that the taxpayer may loan funds to or guarantee debt incurred by the accommodator to acquire the property.

This new ruling points out that reverse like kind exchanges that are not structured in strict compliance with the Revenue Procedure will probably not be respected by the IRS.

Published: October 12, 2000

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