Reverse 1031 Exchange

Sustaining the view that reverse exchanges are simultaneous should require a court to find that the accommodator is an independent principal in the exchange and not the agent of the taxpayer.

Because the accommodator in reverse exchanges takes title to the replacement property, it can be argued that he acts more as a principal than does his counterpart in Starker exchanges. In most situations, an accommodator in a Starker exchange will not take title to either the relinquished or the replacement properties.

This is accomplished through "direct deeding," a common practice in multi-party exchanges. Using direct deeding, title to the relinquished property is passed directly from the taxpayer to the buyer and title to the replacement property moves from the seller to the taxpayer. Title does not pass through the accommodator. Instead, the accommodator receives and transfers contract rights to the respective properties. In a reverse exchange, direct deeding is used to convey the relinquished property but, unlike Starker exchanges, title to the replacement property is held by the accommodator.

If the accommodator holds title to the replacement property, he may assume risk for personal injury or environmental claims. The accommodator may also be at risk for possible loss if the property declines in value and may have the right to appreciation if the value increases. As in Biggs, there may be some risk for mortgage liabilities. Although assumption of risk is not conclusive, it gives the accommodator a strong argument that its actions are those of a principal.

Most accommodators, however, are unwilling to be exposed to "unnecessary" risk. Usually, there are clauses in the exchange agreement that provide that the taxpayer will reimburse the accommodator in the event of claims against the property or if there is a market decline.

As in Biggs, there may also be a provision allowing the accommodator to terminate the agreement at any time. Often the taxpayer is required to pay for insurance that virtually eliminates risk to the accommodator.

Assumption of risk is not the only factor bearing on whether the accommodator is an independent party. Another important factor is the extent to which the taxpayer has control over the property management decisions of the intermediary.

The more control the taxpayer has over decisions made while the accommodator is in possession of the property, the less the accommodator appears to be acting as a principal. In addition, other factors (such as the prior relationship of the parties) may be considered by a court in determining whether the accommodator is an independent party or an agent of the taxpayer.

The resolution of whether the accommodator is an independent party should be a function of all the facts. Two important factors should be the level of risk assumed by the accommodator and the extent of the taxpayer's control.

In today's financial environment, prudent accommodators are usually reluctant to assume any unnecessary risk and most taxpayers are probably unwilling to leave major decisions regarding the property in the hands of the intermediary. Given this environment, a court adjudicating the agency issue may find the "independence" of the accommodator and the view that reverse exchanges are simultaneous difficult to sustain.

It is also difficult to align the logic supporting simultaneous reverse exchanges with the rationale of Starker and the regulations. If reverse exchanges are simultaneous, why are Starker transactions not also simultaneous?

If the accommodator in Biggs is truly an independent party, is it not reasonable to also conclude that most, if not all accommodators are, by law independent parties and never agents of the taxpayers? Clearly, through the deferred exchange regulations, the Service rejects both of these notions.

1031 Tax |