Walking through the steps of a successful real estate parking transaction and tax deferred exchange illustrates the flexibility allowed taxpayers by Rev. Proc. 2000-37. A typical real estate parking transaction involving an income producing asset would be achieved as follows under the new reverse exchange rules:
Step No. 1 The taxpayer enters into a contract to acquire a potential Replacement Property and arranges acquisition financing, in the form of seller
financing, third party financing or the taxpayer advances the acquisition funds.
Step No. 2 The taxpayer enters into a written qualified exchange accommodation agreement ("QEAA") with an exchange accommodation titleholder
("EAT") before the EAT acquires any qualified indicia of ownership. The QEAA may permit the taxpayer or the taxpayer's designee to acquire the parked property for a fixed price at the end of the safe harbor parking period and the EAT and the taxpayer may agree to a transfer at the end of the safe harbor parking period to the taxpayer the entire ownership interest in any special purpose entity used by EAT to hold the parked property.
Step No. 3 The EAT acquires title to the Replacement Property, with financing arranged by the taxpayer and sometimes guaranteed by the taxpayer. A sophisticated EAT may use a single member, special purpose, single asset limited liability company to hold title to the parked property (a "Single Purpose Entity" or "SPE"). The use of an SPE is designed to minimize any exposure to EAT's other assets and protects the taxpayer's expectation that the parked property will not be commingled with other assets or liabilities of the EAT.
Step No. 4 Either in the QEAA or in a separate identification notice, the taxpayer identifies one or more relinquished properties to complete the exchange and delivers the identification notice to the EAT within 45 days after the EAT first acquires title to the parked property.
Step No. 5 The EAT may triple net lease the parked property to the taxpayer for a period that does not exceed the safe harbor parking period with lease rates set at a level intended to meet any debt service requirements and operating expense requirements borne directly by the EAT.
Step No. 6 While the parked property is held by the EAT, the taxpayer locates a buyer for the Relinquished Property and enters into a sale agreement.
Step No. 7 Taxpayer enters into an exchange agreement with a QI and assigns to the QI the taxpayer's right to dispose of the Relinquished Property to the buyer. Taxpayer also assigns to QI the right to acquire the parked property held by EAT under the QEAA.
Step No. 8 The QI causes the taxpayer to convey the Relinquished Property by "direct deed" to the buyer, who transfer the exchange proceeds to the QI. In turn, the QI uses the exchange proceeds to buy the parked property from the
EAT, who uses the same sales proceeds to satisfy any closing costs and any acquisition debt that is not intended to be assumed by the taxpayer upon completion of the exchange.
Step No. 9 Under the exchange agreement, the QI directs the conveyance of the parked property from the EAT to the taxpayer by "direct deeding" the parked property to complete the exchange.
PROS AND CONS OF EXCHANGE LAST vs. EXCHANGE FIRST:
Exchange Last (most common, park Replacement Property):
a. Where acquisition of a specific parked Replacement Property will not fully defer gain realized on disposition of the Relinquished Property, Section 1031(a)(3) periods will start later.
b. If the taxpayer is not certain about which of several Relinquished Properties will be utilized in the exchange, the decision can be made when a contract to sell one of them is made, rather than at the time the Replacement Property is acquired.
[Note, however, that for transactions intended to qualify for the safe harbor under Rev. Proc. 2000-37, the taxpayer's flexibility will be limited by the 45-day
identification requirement.]
c. For non-safe harbor transactions, there is less risk that the EAT will be disregarded and the taxpayer treated as having never transferred the parked property since the parked property will not have previously been owned or controlled by taxpayer.
d. Since the exchange takes place concurrently with the sale of the Relinquished Property, reconciliation of equity values can occur with knowledge of the market value of the Relinquished Property, rather than based on a value assumed at the time of the Replacement Property's purchase.
e. For build-to-suit arrangements, Exchange Last is the only option.
Exchange First (park Relinquished Property, decision often driven by lender):
a. When a lender providing outside purchase financing for acquisition of the Replacement Property requires the Taxpayer to secure the loan with a mortgage, exchange-first allows the taxpayer to execute a mortgage since the taxpayer is obtaining title to Replacement Property immediately.
b. If Replacement Property has particular management problems, immediate acquisition of title by the taxpayer may be necessary.
c. It may just be too late to change deeds already drawn and executed conveying title of Replacement Property to taxpayer.
d. For safe harbor QEAA transactions, there is no identification requirement in the exchange-first structure. The only time constraint is the 180-day period during which the EAT must dispose of the parked Relinquished Property to a third-party buyer.