The use of like-kind exchanges to defer gain on business and investment property is common, with about 4 million transactions between 1998 and 2013, according to the IRS. A large percentage of like-kind exchange transactions are real estate swaps, many involving “reverse exchanges”, where the taxpayer acquires replacement property first and later transfers the relinquished property. These transactions use so-called “parking arrangements” where a third-party accommodator or intermediary holds title to the properties during the pendency of the exchange. Recently, the IRS has indicated that it intends to curb these transactions.
Reverse Exchanges and the Bartell Case
Reverse exchanges are subject to strict time limits imposed by the IRS in Revenue Procedure 2000-37, which states that the IRS will not challenge exchanges that are completed within 180 days. In 2016, the Tax Court allowed an exchange that was substantially outside of this time limitation, a construction project that took 17 months to complete. In Estate of Bartell v. Commissioner, a drug store chain in Seattle, Washington acquired land to build a new drug store. After the store was constructed, the taxpayer relinquished its existing drug store located in a strip mall. While the new store was being built, an exchange accommodator held title to the land. The taxpayer leased the land back from the exchange accommodator and managed construction of the new store. The whole process took 17 months to complete, far longer than the 180-day period authorized by the IRS in Rev. Proc. 2000-37.
The Tax Court held that the taxpayer could still apply the like-kind exchange rules to defer gain on the transaction even though it took 17 months to complete and even though the taxpayer had the “benefits and burdens” of ownership of the replacement property during construction.
IRS Rejects Longer Replacement Period
Taxpayers were cautiously optimistic that the Bartell decision would allow them to qualify longer construction projects as like-kind exchanges. Now, a year later, the IRS has signaled in AOD 2017-06 that it will not accept the Bartell decision as settled law and will instead continue to challenge like-kind exchanges that fall outside of the 180-day time limit. (AODs are “Actions on Decisions” that establish the IRS’s litigating position on contrary court rulings.) This does not mean that taxpayers cannot enter into longer construction projects when seeking to complete a like-kind exchange. It only means that the IRS reserves the right to challenge projects that fall outside of its 180-day “safe harbor.”
What’s a taxpayer to do? Reverse like-kind exchanges that take more than 180 days to complete may still qualify for nonrecognition of gain. However, taxpayers need to proceed cautiously and should consult their tax advisors before entering into any reverse exchange agreements because of the uncertainty resulting from the Tax Court opinion and the contrary IRS guidance.
The Like-Kind Exchange Rules
The like-kind exchange rules allow taxpayers to exchange business or investment property for like-kind property without recognizing gain in the transaction. To qualify, the property must be “like-kind.” For real property, the concept of “like-kind” is broad. Any real estate for any other real estate qualifies. Congress and the IRS have imposed strict time limits in exchanges that are not simultaneous.
About the Blogger
Lucia Nasuti Smeal is a guest blogger on tax topics for Frazier & Deeter. Smeal is an attorney, a tax Professor with Georgia State University’s J. Mack Robinson College of Business, and former editor of Tax Notes Today, published by Tax Analysts. Smeal also worked as a legislative analyst for the Congressional Research Service and is a former member of the U.S. House Periodical Press Corps. She is a frequent speaker on current tax developments.