Recently, I was asked to consider accommodating a Non Safe Harbor reverse 1031 exchange. This type of 1031 exchange is used when the improvements or construction requires greater than 180 calendar days.
Reverse 1031 Exchange
Internal Revenue Service (IRS) Revenue Procedure 2000-37 recognizes reverse 1031 exchanges within the Safe Harbor of 180 calendar days and outside the Safe Harbor of 180 calendar days. The Safe Harbor means the Service will not challenge the treatment of the Exchange Accommodator Titleholder (EAT) as the beneficial owner of the replacement property. The EAT is an IRS requirement used to temporarily take title to or park the property under construction in a construction or leasehold improvement 1031 exchange. An EAT is typically a single member limited liability company (smllc) with the sole member, a parent company independent from the Qualified Intermediary.
Safe Harbor 1031 exchanges represent the majority of reverse exchanges. So why are Non Safe Harbor reverse 1031 exchanges not more popular?
IRS Non Safe Harbor Requirements
The challenge and expense is to demonstrate the EAT has adequate benefits and burdens to support the Service’s requirement for the EAT to be treated as the owner for Federal tax purposes. Eight critieria establish whether the EAT has sufficient benefits and burdens:
- whether legal title passes to the purchaser
- whether the parties treat the transaction as a sale
- whether the purchaser acquires an equity interest in the property
- whether the sales contract creates an obligation on the part of the seller to execute and deliver a deed, and an obligation of the purchaser on the purchaser to make payments
- whether the purchaser is vested with the right of possession
- whether the purhaser pays income and property taxes
- whether the purchaser bears the risk of economic loss or physical damage, and
- whether the purchaser receives a profit from the operation, retention and sale of the property.
See Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, at 1237-38 (1981).
Conclusion
Non Safe Harbor reverse 1031 exchanges are accomplished given the EAT bears the economic risk of loss and an opportunity for profit. This type of reverse exchange is expensive and not for the risk averse. Adequate planning is required inclusive of a long term lease with lessee purchase option and fair market rent.
To review your transaction and receive exchange tips, allow us to call by first completing the information once clicking on the button below.
Note: The picture above is of the Arthur Revenel Jr. Bridge in Charleston, South Carolina. Home to the annual 10K Cooper River Bridge Run held in early April. I ran it in 2008 with thirty thousand others in just over an hour.
