Exchange accommodation titleholder


An exchange accommodation titleholder is an independent third party that holds legal title to real property for a limited period of time in connection with a reverse or improvement like-kind exchange under of the Internal Revenue Code. In a typical arrangement the EAT temporarily "parks" either the replacement property that a taxpayer intends to acquire or, less commonly, the property to be relinquished, so that the taxpayer is not treated as owning both properties at the same time for federal income tax purposes.
The concept and a widely used safe harbor structure for exchange accommodation titleholders were formalized by the United States Internal Revenue Service in Revenue Procedure 2000-37, which sets out conditions under which the IRS will treat the EAT as the owner of the parked property for tax purposes. The use of an EAT is optional; reverse and improvement exchanges may also be structured outside the safe harbor under general section 1031 principles, but such structures carry greater tax uncertainty.

Background

Under section 1031, taxpayers may defer recognition of gain or loss on the exchange of certain real property held for productive use in a trade or business or for investment, provided specific statutory and regulatory requirements are satisfied. A traditional or deferred like-kind exchange involves the disposition of a relinquished property followed by the acquisition of a replacement property, typically through the use of a qualified intermediary who holds the sale proceeds during the exchange period.
A reverse exchange is a variation in which the taxpayer acquires the replacement property before selling the relinquished property. In such cases the taxpayer cannot hold legal title to both properties simultaneously and still satisfy IRS guidance for tax-deferred treatment. Before the issuance of Revenue Procedure 2000-37, the tax treatment of reverse exchanges using so-called "parking" arrangements was uncertain, particularly with respect to who was treated as the owner of the parked property.

Legal framework

Revenue Procedure 2000-37

Revenue Procedure 2000-37 created a safe harbor for certain reverse and improvement exchanges in which an exchange accommodation titleholder is used to park property. Under the safe harbor, the IRS will treat the EAT as the owner of the parked property for federal income tax purposes if a qualified exchange accommodation arrangement is properly established and a number of conditions are met, including:
  • the EAT holds qualified indicia of ownership of the property from the date of acquisition until it is transferred to the taxpayer or another party;
  • the taxpayer has a bona fide intent that the property held by the EAT will be either replacement property or relinquished property in a qualifying section 1031 exchange;
  • the taxpayer and the EAT enter into a written QEAA no later than five business days after the property is acquired by the EAT ;
  • within 45 days after the EAT acquires the parked property, the taxpayer identifies the property to be relinquished or, in certain structures, the eventual replacement property ;
  • the transfer of the parked property to the taxpayer, or of the relinquished property to a third party, occurs no later than 180 days after the EAT acquires the parked property.
Revenue Procedure 2000-37 was later modified by Revenue Procedure 2004-51 to address certain parking transactions in which taxpayers attempted to combine the safe harbor with long-term ownership structures or refinancing arrangements. The modification generally limits the safe harbor where the taxpayer transfers property to an accommodation party and subsequently receives the same property back after an extended period or in connection with certain put and call options.

Qualified exchange accommodation arrangement

A QEAA is a written agreement between the taxpayer and the exchange accommodation titleholder that sets out the terms under which the EAT will hold the property and the parties will attempt to complete a section 1031 exchange. Among other requirements, the arrangement must:
  • state that the EAT is holding the property for the benefit of the taxpayer to facilitate a like-kind exchange;
  • set out the intent that the property held by the EAT will be treated as either replacement property or relinquished property;
  • require that all property-related federal income tax reporting be undertaken by the party treated as the owner under the safe harbor;
  • provide that any benefit and burden of ownership not reserved to the EAT is borne by the taxpayer.
A QEAA does not itself guarantee that the exchange will qualify under section 1031; the underlying statutory requirements, such as like-kind status and proper use of the property, must still be met.

Role and characteristics

An exchange accommodation titleholder is typically a special-purpose entity, often a single-member limited liability company, established by or affiliated with a qualified intermediary or other exchange facilitator. The EAT must be independent of the taxpayer and other disqualified persons, meaning that the taxpayer, certain relatives and related parties, and certain professional advisers may not serve as the titleholder.
Although the EAT holds legal title to the parked property, the taxpayer typically bears most of the economic benefits and burdens of ownership during the parking period. The taxpayer may, for example, lease the property from the EAT, guarantee financing, pay operating expenses and receive rental income, subject to the terms of the QEAA and other related agreements. Revenue Procedure 2000-37 allows these arrangements provided that the formal requirements of the safe harbor are satisfied.

Types of transactions

Reverse exchanges

In a reverse exchange, the taxpayer wishes to acquire a replacement property before disposing of the relinquished property. Under the safe harbor, the EAT acquires and holds legal title to either:
  • the replacement property ; or
  • the relinquished property.
Typically, the taxpayer identifies the property to be sold within 45 days after the EAT acquires the parked property and causes the sale to close within 180 days. At or about the time the relinquished property is transferred to a buyer, the parked property is conveyed from the EAT to the taxpayer, often through an assignment of the EAT's rights under a purchase contract and a direct deed from the seller to the taxpayer. If the transaction satisfies the conditions of section 1031 and the safe harbor, the taxpayer recognizes no gain or loss at the time of the exchange.

Improvement or build-to-suit exchanges

Exchange accommodation titleholders are also used in improvement exchanges, in which improvements are constructed on the replacement property while the property is parked with the EAT. During the parking period the EAT holds title to the property, contracts for construction and disburses funds. For purposes of the safe harbor, only improvements completed and considered part of the real property under applicable law before the end of the 180-day exchange period may be taken into account in determining whether the taxpayer has received property of equal or greater value.

Relationship to qualified intermediaries

The exchange accommodation titleholder is distinct from, but often affiliated with, the qualified intermediary used in deferred exchanges. In many commercial transactions a qualified intermediary will form a single-member limited liability company to serve as the EAT, while separately acting as intermediary for the overall exchange.
The same party may act as both qualified intermediary and EAT, provided it is not a disqualified person with respect to the taxpayer and the regulatory and safe harbor requirements are satisfied. In practice, exchange service providers often maintain separate entities and documentation for their intermediary and accommodation titleholder roles in order to segregate liabilities and clarify reporting responsibilities.

Risks and limitations

Although the safe harbor in Revenue Procedure 2000-37 provides greater certainty for reverse and improvement exchanges, use of an exchange accommodation titleholder does not guarantee favorable tax treatment. Transactions must still satisfy all requirements of section 1031, including the like-kind standard, the use of the property in a trade or business or for investment, and the strict statutory and regulatory time periods.
In addition, taxpayers may face practical and commercial issues, such as:
  • financing constraints, because lenders may require specific covenants or guarantees when title is held by an EAT;
  • increased transactional costs, including EAT fees, additional title work and legal documentation;
  • potential state and local tax or recording implications of multiple transfers of legal title.
Taxpayers and advisers have also considered structures outside the safe harbor, particularly where the desired parking period exceeds 180 days. Such arrangements may still qualify under general section 1031 principles, but they are evaluated on a case-by-case basis and may involve greater litigation and opinion risk. Non-safe-harbor reverse exchange structures have been the subject of litigation and commentary, including the Tax Court decision in Estate of Bartell and later IRS nonacquiescence and professional analysis.