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Improvement (build-to-suit or construction) exchanges allow an investor to use exchange proceeds to either (1) make improvements to a property the exchanger does not already own or (2) build a new replacement property. This variation is extremely popular because it provides the opportunity to purchase properties needing renovation or to acquire bare land and build to an investor’s exact specifications. The Qualified Intermediary makes improvements to the replacement property during the exchange period and transfers the improved property back to the Exchanger by the 180th day. Advance planning is essential; normal construction delays, inclement weather and obtaining government permits can make it a challenge to complete the needed improvements within the 180-day exchange period.

PARKING ARRANGEMENT” EXCHANGES: SAFE HARBOR FINALIZED ON SEPTEMBER 15, 2000

Revenue Procedure 2000-37 (finalized on September 15, 2000) provides the framework to safely perform a reverse exchange (purchasing a replacement property before selling the relinquished property) or an improvement exchange (making improvements or building a new replacement property).

BASIC POINTS OF CONCERN:
  • Issued on September 15, 2000 and also referred to as a Rev. Proc.
  • Effective September 15, 2000
  • Provides a safe harbor if transaction is within it’s parameters
  • IRS may amend the Rev. Proc. If necessary
  • “Reverse” exchanges may still be structured outside the Rev. Proc.
  • Transactions already completed or in progress are not affected

REVENUE PROCEDURE 2000-37 KEY TERMS:

  • Qualified Exchange Accommodation Arrangements = QEAA
  • Exchange Accommodation Titleholder = EAT

QEAA SUMMARY:

  1. Qualified indicia of ownership. The EAT must not be the taxpayer or a disqualified person and must be subject to federal income tax. Indicia of ownership must be maintained at all times until the property is transferred as described in section 4.02(5) of the Rev. Proc. Qualified indicia of ownership means legal title or other applicable principals of ownership under commercial law such as contract for deed.
  2. The taxpayer must have bonafide intent that the property held by the EAT must represent either the replacement or the relinquished property in an exchange that is intended to qualify for nonrecognition of gain (whole or in part) under section 1031.
  3. The taxpayer and the EAT must enter into an agreement (the qualified exchange accommodation agreement) no later than 5 days after the transfer of qualified indicia of ownership to the EAT. The agreement must state that the EAT is holding title for the benefit of the taxpayer in order to complete an IRC section 1031 and this Rev. Proc. And that the taxpayer and EAT agree to report the acquisition, holding and disposition of the property. In addition, the agreement must state that both parties will be treated as the beneficial owner for tax purposes and report it as such on it’s tax returns.
  4. In the event that the EAT holds the replacement property, the taxpayer must identify within 45 days, the relinquished property. This must be done in accordance with the multiple property identification rules in section 1.1031(k)-1(c)(4).
  5. The EAT must transfer the property held within 180 days from the date of acquisition to either the taxpayer (in the event EAT held the replacement property) or the buyer (in the event the EAT held the relinquished property).
  6. The combined time period that the relinquished property and the replacement property cannot exceed 180 days.

PERMISSIBLE AGREEMENTS:

The following agreements are permissible regardless of whether or not they contain terms, which may typically destroy an arms length relationship between the EAT and the taxpayer.

  1. The EAT may act as both the qualified intermediary and the EAT provided that they satisfy the qualified intermediary safe harbor provisions in section 1.1031(k)-1(g)(4).
  2. The taxpayer may guarantee all or part of the obligations of the EAT including debt and incurred expenses.
  3. Taxpayer may loan or advance funds to the EAT.
  4. The EAT may lease the property to the taxpayer.
  5. The EAT may enter into a management agreement with the taxpayer.
  6. The taxpayer may act as contractor and/or supervisor with respect to the property.
  7. EAT and taxpayer may enter into agreements using puts and calls at fixed or formula prices for subsequent dispositions.

REPLACEMENT PROPERTY PARKED

STEP 1 – EAT PURCHASE OF REPLACEMENT PROPERTY
  1. Exchanger advances/loans funds to the EAT.
  2. EAT purchases the replacement property.
  3. Seller deeds the replacement property to the EAT.
  4. EAT leases the replacement property to the Exchanger.
STEP 2 – SALE OF RELINQUISHED PROPERTY AND EXCHANGE OF THE REPLACEMENT PROPERTY TO THE EXCHANGER
  1. Relinquished property is deeded to the EAT in exchange for the replacement property to the Exchanger.
  2. Payoff of the original advance/loan from the Exchanger from sale proceeds.

RELINQUISHED PROPERTY PARKED

STEP 1 – EXCHANGE OF RELINQUISHED PROPERTY FOR THE REPLACEMENT PROPERTY
  1. Exchanger deeds the relinquished property to the EAT according to the QEAA.
  2. Simultaneously, the Exchanger and the EAT enter into an Exchange Agreement.
  3. Exchanger advances/loans funds to the EAT for the acquisition of the replacement property.
  4. The replacement property is deeded directly to the Exchanger in compliance with the Exchange Agreement.
  5. EAT leases the relinquished property to the Exchanger.
STEP 2 – SALE OF RELINQUISHED PROPERTY
  1. Exchanger locates purchaser for replacement property and enters into a contract.
  2. Exchanger assigns contract to EAT and EAT sells relinquished property to Buyer.
  3. EAT receives proceeds from sale and pays off advance/loan from Exchanger.