<h2>Background on Reverse Tax Deferred Exchanges</h2>

<p>Modern day tax deferred exchanges began in the early 1980s with a court ruling (the Starker case) that an exchange for relinquished property and the purchase of corresponding replacement property did not need to take place simultaneously to be valid.&nbsp; The Tax Reform Act of 1984 contained a legislative response to the holding in the Starker case.&nbsp; While the Starker case involved a five-year period between sale and purchase, Congress reduced this to a maximum of 180 days from sale to purchase.</p>

<p>There was still a lot of uncertainty at the time on how to do a non-simultaneous exchange, and near the end of 1991, the Treasury Department put forth a <a href="/exchange-library/internal-revenue-service-regulations-irc-%C2%A71031">detailed body of regulations</a> providing a roadmap for non-simultaneous exchanges. While this guide to a delayed exchange was very welcome, the Treasury Department chose not to include guidance on property “parking” transactions.&nbsp; Property parking transactions include <a href="/blog/are-1031-reverse-tax-deferred-exchanges-real-estate-approved-irs">reverse exchanges</a> in which a taxpayer needs to buy the replacement property prior to the sale of the relinquished property and <a href="/blog/are-1031-reverse-tax-deferred-exchanges-real-estate-approved-irs">property improvement exchanges</a> in which a replacement property requires improvements to be paid out of relinquished property sale proceeds. To accomplish these transactions, the exchange company had to take legal title to the property and so it was often said that the property was “parked” with the exchange company.</p>

<p>In 2000, the Treasury Department and IRS published a <a href="/sites/default/files/Rev%20Proc%202000-37_0.pdf">revenue procedure</a> providing guidance on parking type exchanges. Similar to the time limit of 180 days for a routine exchange, the time limit of 180 days was also allowed for a parking transaction.&nbsp; As long as a taxpayer followed the rules and wrapped up the parking transaction within 180 days, he was deemed to fall within the safe harbor of properly doing a parking transaction.&nbsp; Unlike a conventional exchange, in which the exchange company acts as a qualified intermediary, in a parking exchange the company is acting as an accommodator.&nbsp; Under the safe harbor for parking exchanges, the following are permitted:</p>

<ul>
<li>The taxpayer can guaranty any loan that is required from a bank to the accommodator for the purchase of the property or for the cost of improvements.</li>
<li>The taxpayer may lend money directly to the accommodator.</li>
<li>The taxpayer can lease the property from the accommodator.</li>
<li>The taxpayer can manage the improvement of the property.</li>
<li>The taxpayer and accommodator can enter into puts, calls and fixed prices.</li>
<li>The ability to readjust monies to account for deviation from the amount the accommodator might use to “buy” the taxpayer’s relinquished property compared to the amount for which that property later sells</li>
<li>For IRS purposes. the accommodator can be made the express agent of the taxpayer (actually this became permitted by PLR 200148042).</li>
</ul>

<p>Unfortunately, the revenue procedure did not address how to accomplish a parking transaction that required a longer time period than 180 days.&nbsp; These are generally referred to as non-safe harbor exchanges. It was widely believed that a transaction outside the safe harbor needed to include the following:</p>

<ul>
<li>The accommodator had to hold the “benefits and burdens” of the property ownership.</li>
<li>The transfer of the property to or from the accommodator had to be at true market value.</li>
<li>The accommodator had to have some “skin in the game,” meaning it had to put some of its own money into the property.</li>
<li>The transaction had to have “risk of loss” if the loan went bad.</li>
<li>Any lease of the property from the accommodator to the taxpayer had to have real economics.</li>
<li>Any of the arrangements between the parties had to be at arm’s length.</li>
<li>Any characterization of agency between the accommodator and taxpayer would be fatal.</li>
</ul>

<p>As a consequence of these stringent requirements non-safe harbor parking exchanges were exceedingly rare.&nbsp; Those persons whose day-to-day work included a heavy mix of 1031 exchanges and parking exchanges eagerly awaited a decision. A particular Tax Court case was pending for ten years involving a non-safe harbor property improvement situation.&nbsp; On August 10, 2016 the United States Tax Court filed its opinion in the Bartell case.</p>

<h2>The Bartell Case and What it Means for Reverse Exchanges</h2>

<p>Somewhat surprising to the 1031 exchange community, the Tax Court holding in the Bartell case was very taxpayer-favorable.&nbsp; Among other things the Court noted that:</p>

<ul>
<li>The taxpayer had all of the benefits and burdens of ownership.</li>
<li>The taxpayer had the benefit of any appreciation in the property while parked.</li>
<li>The taxpayer had the risk of loss of any decline in value of the property.</li>
<li>The taxpayer lent funds to the parking entity .</li>
<li>The taxpayer had the other burdens of ownership such as taxes and other liabilities.</li>
<li>The taxpayer financed and directed construction of improvements.</li>
<li>The taxpayer had actual possession of the property via a lease.</li>
</ul>

<p>The Court went on to state that other cases at the Tax Court had concluded that the third party (the accommodator) did not have to have the burdens and benefits of property ownership.&nbsp; The Court went on to say that if its decision was appealed, it would be heard by the Ninth Circuit Court of Appeals and it too had held that burdens and benefits of ownership were not necessary in this context.&nbsp; The Tax Court also placed substantial emphasis on the fact that in all of the prior favorable rulings, as well as the case in hand, a third party exchange facilitator (the accommodator) held ownership of the property during the transaction.&nbsp;</p>

<p>This was distinguished from another opposite holding by the Court in a case known as DeCleene v. Commissioner in which the taxpayer had owned the subject property at a prior time and did not use a third party facilitator to hold title.&nbsp; The court stated, “This feature also distinguishes DeCleene from the myriad of other cases where taxpayers seeking 1031 treatment were careful to interpose a title-holding intermediary between themselves and outright ownership of the replacement property.” Likewise the Court was not bothered by the fact that Bartell had rights of possession of the property pursuant to a lease or that the parking agreement was up to twenty four months.</p>

<h2>Takeaways from the Bartell Decision</h2>

<p>It appears that a third party accommodator can merely be a placeholder (or a “warehousing” entity as referenced in the case) and that it does not need to receive the burdens and benefits of true ownership. There can also be non-arm’s length agreements between the taxpayer and accommodator.&nbsp; Utilizing a third party to hold title is a key factor in the decision, so structures that do not use a third party accommodator are ill-advised.&nbsp;</p>

<p>The amount of time a parking transaction can be in place is open ended.&nbsp; The Bartell case had an actual parking period of 17 months and the agreements between the parties had a 24-month term.&nbsp; With regard to the time issue, the Court stated “We express no opinion with respect to the applicability of section 1031 that extends beyond the period at issue in these cases.”&nbsp; So a term greater than 24 months may be acceptable but cautious practitioners may want to limit transactions to the time limit in Bartell.&nbsp; As mentioned above, Congress enacted the 180-day limit to forward exchanges to limit the five-year term that was allowed in the Starker case and Congress may very well enact legislation to codify a non-safe harbor parking limit.</p>

<p>While this ruling has precedential value, it is possible that another Tax Court in a different circuit could choose not to follow the rationale set forth in the case.&nbsp; Similarly, another court might not reach the same conclusion as the Ninth Circuit did in the “myriad of cases” that the Tax Court relied upon.&nbsp; Lastly, the facts in this case preceded the Safe Harbor regulations that were promulgated in 2000, and a court may require a taxpayer to adhere to those time limits in order to qualify for a valid parking arrangement.</p>

<p>On August 31 and September 1, Accruit CEO and Federation of Exchange Accommodators (FEA) Government Affairs Committee co-chair Brent Abrahm, co-chair and IPX1031 Executive Vice President Suzanne Baker, and Government Affairs Committee member Bill Horan, President of Realty Exchange Corporation, are in Washington, D.C. meeting with legislative staffers to discuss tax proposals that have the potential to significantly impact U.S. businesses.</p>

<p><a href="http://1031.org/FEA/Legislation/FEA/Legislative_News.aspx&quot; target="_blank">Learn more about the FEA's legislative efforts</a>.</p>

<p>Denver, Colorado&nbsp;– July 27, 2016</p>

<p>Accruit LLC, the nation’s leading provider of qualified intermediary and 1031 like-kind exchange program solutions, today announced the appointment of Sandy MacPherson to its Board of Directors. Mr. MacPherson joins Accruit's Board with over 30 years’ experience in health and wellness, consumer products, and healthy food and beverages at both Fortune 500 and smaller, early stage companies.</p>

<p>“We are honored to have Sandy join us. He’s a proven leader with a string of successes at companies both large and small, and we're confident that his guidance will be of great benefit to Accruit," said Accruit CEO, Brent Abrahm.</p>

<p>Mr. MacPherson began his career at Labatt Breweries of Canada where, as a senior marketing executive, he was responsible for branding and growth of several of Labatt's lines. At Bristol-Myers Squibb, he led the multi-billion dollar Mead Johnson nutrition business, introducing many new products, including Boost nutritional drink and Viactiv calcium chews for women. Mr. MacPherson went on to lead several smaller entrepreneurial companies to profitability and successful commercialization, after which he founded his own consulting firm dedicated to assisting companies of all sizes develop sustainable growth strategies.</p>

<p>“Accruit's leadership in the industry, their pioneering use of technology, and recent acquisition of Bankers Escrow all make this an exciting time to join their Board of Directors," said MacPherson. “I’m delighted to be part of the company’s evolution and look forward to contributing to their continued success.”</p>

<p>In addition to being a consultant, Mr. MacPherson is an Entrepreneur in Residence at Invest Ottawa as well as the Industry Partner for Wellness at Maxim Partners LLC, a private equity firm based in Chicago.</p>

<p>In <a href="/blog/1031-like-kind-exchange-pitfalls-avoid">1031 Like-Kind Exchange Pitfalls to Avoid</a>, we examined 1031 exchange practices that could inadvertently cause an exchange to go awry.&nbsp; Most of those examples pertained to the taxpayer coming into constructive receipt of funds.&nbsp; Here, we’ll look at a variety of other practices where problems sometimes occur.</p>

<h2>1031 Exchange Pitfall No. 7 – Execution of the Exchange Agreement and Identification Forms</h2>

<p>Often relinquished property in a<span style="color:#ff0000;"> </span>tax deferred exchange can be held by co-owners, including spouses.&nbsp; This is documented differently than an LLC where the spouses are sole members.&nbsp; In the event of co-ownership, either spouse can make decisions on behalf of the couple and even sign the other spouse’s name.&nbsp;&nbsp; In other co-ownership arrangements, one co-owner may sign for the group of co-owners.&nbsp; However in an exchange transaction, it is important to stick to the formalities of each person with an ownership signing all applicable documentation.&nbsp; Failure to do so will invalidate the exchange.</p>

<h2>1031 Exchange Pitfall No. 8 – Identification of a Group of Replacement Properties</h2>

<p>Most replacement properties are identified according to the <a>three property rule</a>, meaning that a taxpayer may identify up to three replacement properties, regardless of their value. It doesn’t matter how many of the three properties are purchased, however problems arise when one party doing an exchange wishes to acquire a group of properties that are owned by one seller and sold under one contract.&nbsp; While there is a temptation to consider the group as one property, there does not appear to be any foundation for identifying them as one property.&nbsp;</p>

<p>A similar issue arises when a taxpayer wishes to identify a small percentage in a group of properties in which that interest is being sold as a Delaware Statutory Trust (DST).&nbsp; These are popular with taxpayers who want a good-yielding, secure investment that involves no management headaches.&nbsp; However, the number of different properties underlying the individual investment are considered separate properties for exchange purposes.&nbsp; The 200% rule may be helpful in these instances.</p>

<h2>1031 Exchange Pitfall No. 9 – Diminution of Exchange Proceeds Due to Prorations</h2>

<p>In the case of a non-exchange sale of property, it is customary to give the buyer a credit for partial month’s rent held by the taxpayer as well as the security deposits.&nbsp; Most practitioners prepare an exchange-related closing statement the same way. &nbsp;While it makes no difference if the transaction is not part of an exchange, it does make a difference when an exchange is taking place.&nbsp; More specifically, the taxpayer is retaining the value of the rent and security deposits and thereby reducing the cash received for the exchange account.&nbsp; In other words, a taxpayer cannot retain these items of income and offset the amount of money going into the replacement property.&nbsp; The best solution is to pay to the buyer directly for the rent and security deposits and not give a credit on the closing statement.</p>

<h2>1031 Exchange Pitfall No. 10 – Notice to All Parties to the Agreements</h2>

<p>In a 1031 exchange, the taxpayer assigns his rights for both the sale of the old property and purchase of the new property to the qualified intermediary. Under safe harbor exchange procedures, the taxpayer must give notice in writing to all parties to each contract of the assignment of rights to the qualified intermediary.&nbsp; In most cases when a taxpayer is dealing with one buyer and one seller, this notification is easily done.&nbsp; However sometimes there are many buying or selling entities as well as third parties.&nbsp; I recently reviewed a contract in which the title insurance company was included as a party under the contract.&nbsp; Care must be taken to ensure that all parties receive such notice, not just the counterparty.&nbsp; Note, however, that although it is customary to request the counterparty’s signature on this notice of assignment in order to prove compliance should the transaction be audited, the counter-signature is not a requirement.</p>

<p>&nbsp;</p>

<p>A 1031 like-kind exchange (LKE) program allows a business to postpone the tax hit on sales of used equipment in anticipation of buying replacement equipment, and each year more business owners seize upon the cash-flow benefits available via a 1031 like-kind exchange strategy, recognizing that reinvesting money into their business beats sending it to the government in the form of unnecessary taxes.</p>

<p>In addition to the fact that more cash in your business is never a bad thing, there are noteworthy ancillary benefits that accompany the adoption of a 1031 like-kind exchange program. Even currently, with the availability of bonus depreciation, LKE program clients retain their LKE program and continue to enjoy benefits beyond the cash-flow.</p>

<h2>Streamlined Business Practices</h2>

<p>The adoption of a 1031 like-kind exchange program does little to disrupt existing practices for the purchase and sales of business equipment, however questions arise in this process, the answers to which &nbsp;frequently leading to positive outcomes for the business. During implementation, clients question their current business process practices: <em>Why DO we buy our assets that way? Why doesn’t Purchasing receive information about what is currently being sold?</em></p>

<p>The answers to these questions and others are simple. Companies are BUSY, and if things aren’t broken, they are rarely highlighted for improvement. &nbsp;Personally, I had not checked auto insurance rates for years, choosing instead to trust my insurance advisor. When I finally did check, I ended up saving over 50% on my premium! The same thing happens in businesses as they begin to closely examine potential improvements in the following areas.</p>

<h2>Increase Sales Proceeds in the Disposition of Used Equipment</h2>

<p>In the trucking industry, the resale value of used trucks has skyrocketed relative to their trade-in value. Savvy trucking company owners have seen a 10% increase in sales proceeds when selling used equipment direct or through a third party such as an auction company.&nbsp; Asking “what if” or “why” presents opportunities to increase the bottom line and update long-standing, outdated practices. The same is true in the heavy equipment, leasing, and car rental industries.</p>

<h2>Financing Benefits Intrinsic to 1031 Like-Kind Exchanges</h2>

<p>A 1031 like-kind exchange program allows owners of rental car, trucking, and equipment fleets to channel cash proceeds into fleet equity instead of income taxes. In so doing, many of these companies see a substantial financing benefit as lenders prefer to extend more favorable terms to a fleet financed with an 80%-20% LTV (loan-to-value) versus the commonly extended (and higher priced) 100% financing options.</p>

<h2>Equipment and Depreciation Tracking Benefits of 1031 Like-Kind Exchanges</h2>

<p>It’s surprising how many equipment-intensive companies still have asset-tracking and depreciation calculation challenges, especially those located in multiple states with varying tax rules and regulations. A like-kind exchange program often encompasses a solution that fully automates <em>all</em> of these challenges and shortcomings.</p>

<h2>Ongoing Business Consulting Expertise and Support</h2>

<p>There are few companies these days that are not engaged in some or all of the following activities:</p>

<ul>
<li>Acquiring new lines or business or selling existing lines of business</li>
<li>Evaluating complex compliance, legal, and tax issues and challenges</li>
<li>Strategizing best practices to maximize performance and profits</li>
<li>Tax certainty around existing programs and strategies.</li>
</ul>

<p>The creation of a like-kind exchange program includes consulting with tax and business experts, and ongoing access to these resources and their respective support and input is a highly-valued benefit of a properly-implemented LKE program.</p>

<h2>Summary</h2>

<p>While cash-flow and the opportunity to invest funds that would otherwise be lost to taxes back into the business are the primary reasons for adopting a 1031 like-kind exchange program, the ancillary benefits discussed above are among the reasons companies keep their LKE programs active.</p>

<p>In June, two members of the House Agriculture Committee, Representative Bob Gibbs (R-OH) and Representative David Rouzer (R-NC), and 17 other congressmen and congresswomen wrote a letter to House Ways and Means Committee Chairman Kevin Brady (R-TX) urging the committee to help preserve 1031 like-kind exchanges. The letter, attached below, called Section 1031 "integral to [its] operations and ongoing vitality."</p>

<blockquote>
<p>"The provision serves as an important tool for providing flexibility and increased economic efficiencies for the agricultural community. Section 1031 permits a taxpayer to exchange business-use or investment assets for other like-kind business-use or investment assets, without recognizing taxable gain on the sale of the old assets. These taxes, that would otherwise be due if the transaction was structured as a sale, are deferred. The repeal of this fundamental provision would have a monumental negative impact on the industry as a whole."</p>
</blockquote>

<p>In the photo above, Federation of Exchange Accommodators Government Affairs co-chair and Accruit CEO Brent Abrahm discusses the letter with Representative Brady at a legislative event with the Associated Equipment Distributors trade association. Read more about these recent efforts on behalf of Section 1031 in yesterday's article on the Americans for Tax Reform website, <a href="http://www.atr.org/kind-exchanges-are-model-all-capital-gains&quot; target="_blank">"Like-Kind Exchanges are a Model for All Capital Gains."</a></p>