The Journal of The DuPage County Bar Association

Back Issues > Vol. 17 (2004-05)

Combining a Reverse Exchange and a Forward Exchange Utilizing Revenue Procedure 2000-37
Introduction by Richard W. Kuhn
Article by Mary Cunningham-Watson


Do you encounter clients who wish to sell investment real property? When this occurs, the proverbial light bulb should come on instantly flashing the inquiry to your client, "would you consider trading the property to defer capital gain taxes?" Too often clients and attorneys are not conversant with the now widely used technique known as the IRC 1031 tax deferred exchange. Under IRC 1031, the taxpayer can sell Parcel A and at a later time acquire Parcel B, and defer recognition of the capital gain on Parcel A.

However, until recently, the taxpayer was not allowed to perform a reverse exchange (i.e. Buying before Selling), but now this is also possible. The techniques previously used in the common situation where the Seller had selected the replacement parcel, but had not yet sold the relinquished parcel, included "parking" the replacement parcel, or purchasing an option to acquire the replacement parcel. Traditional "parking" techniques utilized an "acquaintance" to buy the replacement parcel, and the taxpayer would then buy the replacement parcel from the acquaintance after selling the relinquished parcel. One can imagine the problems of financing and trusting the acquaintance, not to mention the tax risks. The other method was to enter into an option to purchase the replacement parcel until the relinquished parcel was sold. However, more often than not, the Seller of the replacement parcel was not willing to enter into an option agreement.

The following article is written by Mary Cunningham Watson, who is an expert in the field of deferred exchanges. Mary is employed by Chicago Deferred Exchange Corporation and has assisted attorneys with thousands of exchanges. She is a frequent lecturer and author on the topic of 1031 deferred exchanges. If you practice in the transaction area of real estate law, the following article is a must for your library of articles.

Revenue Procedure 2000-37

The Internal Revenue Service issued Revenue Procedure 2000-37 on September 15, 2000. Revenue Procedure 2000-37 provides a safe harbor for structuring what would otherwise be characterized as a "Reverse" Like Kind Exchange, so long as certain technical requirements are satisfied.

The Deferred Exchange Regulations established useful safe harbors for structuring forward exchanges (i.e.: where the Taxpayer first transferred relinquished property and subsequently acquired replacement property) by creating a somewhat unique tax entity called a Qualified Intermediary. The Regulations provided that rights conferred upon a Taxpayer under state agency law to dismiss a Qualified Intermediary, and thus obtain the benefits of money or other property held by the Intermediary, will be disregarded in determining whether the transaction satisfied the exchange requirement of section 1031. However, those regulations explicitly do not apply to "Reverse Exchanges". Therefore, any attempt to structure a reverse exchange necessarily required a delicate balancing of the client’s tax objectives and its business objectives: how much risk was the Taxpayer willing to transfer to a "friendly third party" (and how much risk was the "friendly third party" willing to undertake) in order to establish that the third party was not acting as the Taxpayer’s agent, thereby disqualifying the exchange?

Revenue Procedure 2000-37 provides an opportunity to accommodate a Taxpayer’s business objectives while at the same time minimizing the tax risk that a reverse exchange will be disqualified as a result of agency. The analysis that follows is perhaps best understood if the reader considers two concepts separately. First, there will be a transaction where property is "parked" with an "Exchange Accommodation Titleholder". Second, there will be a simultaneous exchange with a Qualified Intermediary.

Revenue Procedure 2000-37 provides generally that the Service will not challenge the qualification of property as either "relinquished property" or "replacement property" if the property is held by an "Exchange Accommodation Titleholder" ("EAT") subject to a "Qualified Exchange Accommodation Agreement" ("QEAA"). The EAT may own property for up to 180 days and the list of permissible agreements between the Taxpayer and the EAT is extensive, including Taxpayer guarantees of indebtedness, puts and calls, and various make-whole agreements. 

Requirement that EAT be treated as owner for federal income tax purposes

"Qualified Indicia of Ownership" must be held by the EAT at all times from the date of its acquisition of either the Replacement Property or the Relinquished Property, until either the Replacement Property is transferred to the Taxpayer, or the Relinquished Property is transferred to the Purchaser. For purposes of the Revenue Procedure, "Qualified Indicia of Ownership" means legal title to the property, other indicia of ownership of the property that are treated as beneficial ownership of the property under applicable principles of commercial law (i.e.: a contract for deed), or interests in an entity that is disregarded as an entity separate from its owner for federal income tax purposes (i.e.: a single member limited liability company, or an Illinois type land trust), and that holds either legal title to the property or such other indicia of ownership.

The Taxpayer must have a bona fide intent that the property held by the EAT is either the Replacement Property or the Relinquished Property in an exchange that is intended to qualify for non-recognition of gain or loss under section 1031.

The Taxpayer and the EAT must enter into a Qualified Exchange Accommodation Agreement providing that the EAT is (i) holding the property for the benefit of the Taxpayer in order to facilitate an exchange under section 1031 and the Revenue Procedure, and (ii) the Taxpayer and the EAT agree that the EAT is the beneficial owner of the property for all federal income tax reporting purposes.

The Taxpayer must identify either Relinquished Property or Replacement Property within 45 days of the acquisition of property by the EAT. The same rules with respect to an identification under the Deferred Exchange Regulations apply to multiple and alternative identifications under the Revenue Procedure.

The EAT must transfer the property it owns either to the Taxpayer, in the case of Replacement Property, or to the Purchaser, in the case of Relinquished Property, not later than 180 days following the acquisition by the EAT.

Permissible Agreements between EAT and Taxpayer

This is the key to avoiding the balancing act described earlier. The Qualified Exchange Accommodation Agreement may contain any one or more of the following legal or contractual arrangements, regardless of whether such arrangements contain non arms-length terms:

1. The EAT can also act as the Qualified Intermediary.

2. The Taxpayer may guarantee some or all the obligations of the EAT, including the debt incurred to acquire the property. The Taxpayer may also indemnify the EAT against all costs and expenses.

3. The Taxpayer or a related party can loan or advance funds directly to the EAT or guarantee a loan or advance to the EAT.

4. The EAT can lease the property to the Taxpayer or a related party, presumably, rent free.

5. The Taxpayer or a related party can manage the property, supervise the construction of improvements to the property, act as a contractor, or provide other services to the EAT.

6. The Taxpayer and the EAT can have puts and calls at fixed or formula prices.

7. The Taxpayer and the EAT can agree that any variation in the value of the relinquished property can be taken into account when the Relinquished property is transferred to the Purchaser through the Taxpayer’s advance of funds to, or receipt of funds from, the EAT. 

Perhaps most importantly, property will not fail to be treated as being held subject to a QEAA even though the accounting, regulatory, or state or local tax treatment of the agreement between the Taxpayer and the EAT is different from the treatment required by the revenue procedure. For example, even though the EAT must be treated as the owner of the property for federal income tax purposes, the Taxpayer may presumably be treated as the owner for GAAP purposes.

Planning Opportunities

The most significant planning opportunity presented by the Revenue Procedure is in combining a partial reverse exchange with a partial forward exchange. This technique offers Taxpayers a total of up to 360 days to acquire sufficient Replacement Property in order to fully defer recognized gain.

A sample "timeline" may be helpful in visualizing this structure.


A. Relinquished Property FMV $100

B. Replacement property No. 1 ("parked property") FMV $60 

Note: Underlined dates critical, italicized dates non-critical.

Qualified Indicia of Ownership will be accomplished by establishing a special purpose entity (LLC) to acquire and hold legal title to Replacement Property No. 1, as the Exchange Accommodation Titleholder ("EAT"). The preliminary steps include:

Taxpayer executes contract for purchase of replacement property No. 1. Prior to closing, Taxpayer executes a Qualified Exchange Accommodation Agreement with the EAT. The EAT forms a special purpose entity (a single member LLC) to acquire title to replacement property No. 1. Taxpayer instructs Seller of replacement property No. 1 to convey title at closing to the LLC.

Day 0: Closing on Replacement Property No. 1

(a) Taxpayer arranges for funds to be advanced or loaned to the LLC to consummate the purchase of the replacement property – either though a direct loan from Taxpayer to LLC, or through conventional financing. The loan is non-recourse to the LLC and its originating member, but can be guaranteed by Taxpayer. (b) LLC pays the purchase price to the seller of Replacement Property No. 1. (c) Seller conveys title to Replacement Property No. 1 to LLC. (d) LLC gives note to Taxpayer or Lender that is secured by a mortgage on Replacement Property No. 1. (e) LLC leases Replacement Property No. 1 to the Taxpayer. The lease may presumably carry any rental the parties agree to. If conventional financing is used to acquire Replacement Property No. 1, the lease rate is commonly set at an amount equal to the monthly debt service.

Day 45: Taxpayer Identifies Relinquished Property to EAT

Relinquished property has a FMV of $100. Multiple relinquished properties may be identified in accordance with the identification provisions of the Deferred Exchange Regulations.

Day 100 Taxpayer executes contract to sell Relinquished Property to Purchaser.

Day 175 Taxpayer executes Exchange Agreement with Qualified Intermediary

Taxpayer executes Qualified Exchange Trust Agreement with Trustee, and assigns its rights under the relinquished property contract to the Qualified Intermediary, giving written notice of the assignment to the Purchaser.

Day 180 Closing on Relinquished Property

(a) Qualified Intermediary instructs Taxpayer to convey Relinquished Property directly to Purchaser. (b) Purchaser pays $100 purchase price for Relinquished Property to Qualified Intermediary. (c) Taxpayer and LLC enter into Purchase and Sale Agreement for Replacement Property No. 1 ($60) (d) Taxpayer assigns rights under Purchase Agreement for Replacement Property No. 1 to Qualified Intermediary. (e) Qualified Intermediary pays $60 to Taxpayer/lender in satisfaction of Note given by EAT/LLC to Taxpayer/lender. (f) Qualified Intermediary instructs EAT/LLC to either (i) convey title to Replacement Property No. 1 to Taxpayer, or (ii) transfer 100% membership interest in EAT/LLC to Taxpayer.

Day 225/45 Taxpayer identifies additional Replacement Property to Qualified Intermediary.

Day 300/120 Taxpayer executes contract for purchase of Replacement Property No. 2 (FMV $40)

Day 355/175 Taxpayer assigns contract for purchase of Replacement Property No. 2 to Qualified Intermediary.

Day 360/180 Closing of Acquisition of Replacement Property No. 2.

(a) Qualified Intermediary pays $40 purchase price to seller of Replacement Property No. 2. (b) Qualified Intermediary instructs seller of Replacement Property No. 2 to convey Replacement Property No. 2 to Taxpayer, thereby completing the exchange.

Why not structure all acquisitions utilizing the arrangement sanctioned by Revenue Procedure 2000-37?

There are many situations where additional expenses will encourage practitioners to consider alternative structures to parking arrangements (i.e.: entering into a lease with option for the replacement property). Potential duplicate transfer taxes, duplicate title insurance premiums and other transaction expenses may make an alternative structure more attractive. Increased financing costs associated with loans required for the acquisition of replacement property must be factored in as a cost. Loss of depreciation benefits during the period the property is held by EAT/LLC must also be considered a cost.

However, the opportunities afforded by the Revenue Procedure will, in many transactions, provide the practitioner with a manner of structuring what would have otherwise been a reverse exchange into a parking arrangement with best of both worlds: minimal tax risk and minimal business risk.

Richard W. Kuhn is a partner at Kuhn, Heap & Monson located at 552 S. Washington Street, Suite 100, Naperville, Illinois, and currently serves as the Chair of the DuPage County Bar Association Real Estate Law Committee. Mr. Kuhn can be contacted at (630) 420-8228.

Mary Cunningham-Watson is employed by the Chicago Deferred Exchange Corporation, and has assisted attorneys with thousands of exchanges. Ms. Cunningham-Watson is a frequent lecturer and author on the topic of Section 1031 deferred exchanges. Ms. Cunningham-Watson can be contacted at the Chicago Deferred Exchange Corporation, 135 S. LaSalle Street, Suite 1940, Chicago, Illinois 60603. Telephone: 866-677-1031, Fax: 312-992-4570 and email address:

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