IRS Gives OK to Non-Safe-Harbor Reverse Exchange

In January, the IRS issued a Private Letter Ruling (PLR 200901004) approving a reverse improvement exchange under §1031 that did not comply with Revenue Procedure 2000-37 (the “safe harbor” exchange guidelines issued by the IRS).

There were two unusual features to this exchange –

• It is a “non-safe-harbor” reverse exchange, and
  
  
• The replacement property is an improvement built on property (easements) owned by the taxpayer.

These are issues for which no specific guidance or approval had been previously issued by the IRS. Usually, like-kind replacement real estate has been thought to require ownership of real property as distinguished from an improvement constructed on land already owned by the taxpayer.

As described in the PLR, the taxpayer proposed to exchange “Old Facility” for “New Facility.” Old Facility was to be sold to an unrelated third party. Taxpayer was to hire a contractor (Accommodator) to build New Facility on easements already owned by Taxpayer or acquired by Taxpayer prior to the exchange. The contractor would initially own and finance the construction of the New Facility independently of the Taxpayer. Following completion of New Facility, the contractor would transfer ownership of New Facility to Taxpayer (presumably using the exchange cash to service debts of the contractor).

This is the substance of the proposed exchange described by the PLR. However, there are more complicated relationships in the transaction which can be summarized as follows –

• The contractor was a domestic subsidiary of a foreign corporation which also owned the Taxpayer. However, the contractor is not a related party to Taxpayer because the parent is a foreign corporation which is excluded from the definition of a related party.
  
  
• The contractor had no equity in the project other than funds from its parent foreign corporation.

Unlike the DeCleene Case, the ruling does not examine whether the contractor acting as Accommodator possessed the benefits and burdens of ownership, whether it was acting as Taxpayer’s agent or whether the exchange is a step transaction resulting in the Taxpayer acquiring improvements on its own property. The ruling does imply that an exchange can be structured using an accommodator for property in which the taxpayer has a substantial ownership interest or over which it otherwise exercises control.

As with all PLRs, this opinion was issued as a private letter ruling to the taxpayer requesting a ruling, and therefore it cannot be cited as precedent. The Internal Revenue Service has the right to change its position on this matter without notice. If you have questions about structuring your improvement or reverse exchange, please give us a call at 888-367-1031.