Tax Deferred Exchanges

Contractual interdependence requires that the successful completion of contracts governing the transfer of the relinquished property and the transfer of the replacement property be directly interdependent.

If one contract fails the other would also fail. If the two contracts are not interdependent, they will be viewed as two sales contracts and not an exchange.

In Biggs, the Fifth Circuit substituted another standard for contractual interdependence--that of an "integrated exchange plan." In developing this standard, the court adopted the "step transaction" doctrine articulated by prior courts. This doctrine views the various steps of an exchange in light of the exchange objective. When these steps are, in effect, "a series of transactions designed and executed as parts of a unitary plan to achieve an intended result, the plan will be viewed as a whole . . . . The series of closely related steps will be viewed as merely the means by which to carry out the plan and will not be separate."

The current standard is probably best articulated by the Tax Court in Garcia.

Contractual interdependence, in a technical sense, is not prerequisite to a finding of an exchange. Although the presence of direct dependence is convincing, an exchange may still be demonstrated in its absence.

The infusion of the "step-transaction" doctrine into the realm of section 1031 was clear in Biggs . . ., which set forth the standard of the "integrated plan" in determining whether a qualified exchange had occurred.

In a deferred exchange and especially in a reverse exchange, this liberalized standard is vital. Most sellers in a reverse exchange will probably be unwilling to have the sale of the replacement property dependent on the taxpayer's subsequent sale of the relinquished property.

Sellers will be reluctant to enter into an exchange contract that might subsequently be rescinded. The integrated exchange plan requirement can be met through a properly executed exchange agreement with the accommodator if the contracts with the seller and buyer reflect and reference the exchange and that agreement.

The three factors discussed above provide a judicially supported approach for determining when the "exchange" requirement has been met. Provided the other basic requirements of a like-kind exchange are also met, a reverse exchange should be found to be a viable like-kind exchange.

If a taxpayer engages in a Starker exchange that falls outside of the safe harbors, the presence of these three factors should also be sufficient to validate that exchange as like kind.

1031 Tax |