IRS Releases Guidance on Combination Reverse and Deferred Exchange
In a recently released Legal Memorandum (ILM 200836024) the IRS held that a single asset could
be relinquished property in both a Rev. Proc. 2000-37 safe-harbor reverse exchange and a deferred
exchange under IRC §1031(a).
On date 1, pursuant to a qualified exchange accommodation agreement between the exchanger and
an EAT, the EAT acquired reverse exchange replacement property (the Reverse RP) using funds lent
to it by the exchanger. On date 2, the exchanger identified three potential relinquished properties
(RQ’s). On date 3, which was 180 days from the acquisition of the Reverse RP by the EAT, the exchanger
sold one of the identified RQs through a QI, pursuant to a deferred exchange agreement. Also on date
3, QI used a portion of the RQ proceeds to acquire the Reverse RP for the exchanger from the EAT.
Upon receipt of the proceeds, EAT transferred the RP to the exchanger and then immediately repaid
the loan used to purchase the parked property, completing the reverse exchange. Within 45 days of
date 3, exchanger identified three deferred exchange replacement properties (Deferred RPs), utilizing
the 200% rule. The exchanger failed to acquire any of the Deferred RPs. After the deferred exchange
period ended, the QI released the remainder of the exchanger’s RQ proceeds on date 5, which was in
tax year subsequent to the start of the deferred exchange. Because the deferred exchange transaction
straddled tax years, the exchanger reported a portion of the gain in year two as an installment sale
under §453.
The central question addressed by ILM 200836024 is whether, having received the Reverse RP from
EAT on date 3, the exchanger was entitled to receive additional replacement properties during the
subsequent 180 day deferred exchange period. Although the deferred exchange had failed, at issue
was the potential for penalties and interest on the taxes paid.
The IRS ruled in favor of the Exchanger. In doing so, the IRS recognized that the time periods prescribed
by the §1031(a) deferred exchange rules and the Rev. Proc. 2000-37 reverse exchange safe harbor are
in fact different. IRS held there is no abuse in allowing an exchanger to utilize separately both 180 day
periods. The memorandum cites the fact that courts have afforded “significant latitude” to exchangers
structuring like-kind exchanges. Further, Rev. Proc. 2000-37 itself seems to contemplate such a
transaction by expressly permitting the EAT to also act as the exchanger’s QI in a deferred exchange.
The ruling also implies (although without analysis) that an exchanger can be repaid the loan made to the EAT to purchase the parked property during the pendency of a deferred exchange without the
payment being characterized as boot. This feature of the ruling may be very useful when planning a
transaction that contemplates both a safe harbor reverse exchange and a deferred exchange because
the ruling provides some support for the practice of immediately repaying the loan made by the
exchanger to the EAT to acquire the Reverse RP, without waiting until the end of the deferred exchange.
However, practitioners should be aware, as with other similar types of guidance, a Chief Counsel Advice
Memorandum technically carries no precedential value and cannot be relied upon by anyone except the
specific taxpayer who received the ruling.
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