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The IRS issued guidance on reverse exchanges: Rev. Proc. 2000-37 (effective September 15, 2000). This Rev. Proc. provides a safe harbor under which the IRS will not challenge the qualification of relinquished property or replacement property in certain "reverse exchanges."

Significant planning opportunities are available as a result of the new Rev. Proc., including the ability to treat the Exchange Accommodation Titleholder ("EAT") as the owner of property for federal income tax purposes, and the Taxpayer as the owner of the property for financial reporting purposes.

The Rev. Proc. defines a safe harbor for structuring a reverse exchange under Section 1031 and, in brief, provides the following:

1. The IRS will not challenge the qualification of property as either "replacement property" or "relinquished property" as defined in the Treasury Regulations. In addition, the IRS will not challenge the treatment of an EAT as the beneficial owner of such property for federal income tax purposes, if the property is held in a "qualified exchange accommodation arrangement" pursuant to a "Qualified Exchange Accommodation Agreement" ("QEAA").

2. Property is deemed to be held in a QEAA if the following requirements are met:

i. Qualified indicia of ownership is held by someone other than the Taxpayer or a disqualified person (i.e. the EAT) who is subject to federal income tax.

Qualified indicia of ownership can be demonstrated by:

A. Legal title held by the EAT,

B. Other indicia of ownership such that the EAT is treated as the beneficial owner of the property, as in a contract for deed, or

C. A single member LLC that holds legal title to the property (or some other entity that is disregarded for federal income tax purposes), the membership interest of which is owned by the EAT.

ii. At the time the property is transferred to the EAT, the Taxpayer must have bona fide intent that the property represents either replacement property or relinquished property that is intended to qualify for nonrecognition of gain under Section 1031.

iii. No later than five business days after the EAT acquires the property, the Taxpayer and the EAT must enter into a QEAA. The QEAA must specify that the EAT is holding the property for the benefit of the Taxpayer to facilitate an exchange under Section 1031. The QEAA must also specify that the EAT is the beneficial owner of the property, and all parties must report ownership of the Property as such for federal income tax purposes.

iv. No later than 45 days after the transfer of the replacement property to the EAT, the Taxpayer must identify the relinquished property in a manner consistent with the Treasury Regulations (i.e. the "3-property rule" or the "200 percent rule").

v. No later than 180 days after the property is transferred to the EAT, the property is transferred to the Taxpayer as replacement property, or to a person who is not the Taxpayer or a disqualified person, as relinquished property.

vi. The combined period that the relinquished property or the replacement property is held in the qualified exchange accommodation arrangement does not exceed 180 days.

3. In addition, the Rev. Proc. provides the following:

i. The EAT may also act as Qualified Intermediary in the exchange (provided the EAT is not a disqualified person). Intermediary in the exchange (provided the EAT is not a disqualified person).

ii. The Taxpayer (or a disqualified person) can guarantee all of the obligations of the EAT, including a guarantee of the debt incurred by the EAT to acquire the replacement property, and can indemnify the EAT against costs and expenses.

iii. The Taxpayer (or a disqualified person) can loan funds to the EAT to acquire the replacement property.

iv. The property can be leased by the EAT to the Taxpayer.

v. The Taxpayer (or a disqualified person) can manage the property, oversee improvements to the property, act as contractor, and provide services to the EAT.

vi. The Taxpayer and the EAT can enter into agreements arranging for the purchase or sale of the property, including puts and calls, effective for a period not to exceed 185 days from the date the EAT acquires the property.

vii. The Taxpayer and the EAT can enter into an agreement to deal with fluctuations in the price of the relinquished or replacement property during the period of time that the property is owned by the EAT.

In addition, the planning opportunities presented by the Rev. Proc. afford significant flexibility in managing the timing of acquisitions and dispositions as like-kind exchanges.

However, there are other considerations that influence a Taxpayer's decision to take advantage, or not, of the tax savings opportunities.

First, the potential duplicate assessment of real estate transfer taxes at the state and local level could serve as a deterrent to Taxpayers considering structuring a parking arrangement.

Second, the potential that the EAT files for bankruptcy while owning the parked property is a very legitimate concern.

Both of these issues were addressed in two private letter rulings issued to CDEC.

PLR 200148042 concludes that CDEC's QEAA may contain an express declaration of agency for all purposes except federal income tax purposes. We are not aware of any jurisdiction where a transfer from an agent to a principal is a taxable event.

PLR 200201024 takes the concept that a single member limited liability company is not treated as an entity separate from its owner one step further by creating a "hybrid" single member LLC. In this scenario, a Taxpayer may be reluctant to utilize the EAT structure because of risks arising from the potential bankruptcy of the EAT member of the LLC. The ruling concludes that the Taxpayer (or Taxpayer's lender) could hold a non-economic membership interest in the LLC without causing the LLC to be treated as something other than a disregarded entity.