SPE 1031

Taking a Break from the Global Credit Crunch, Reverse Exchanges received good news from the Treasury Department last month with a ruling that described how a Reverse Exchange can be used in connection with a (Forward) Deferred Exchange.

Example 1. An investor may decide to sell multiple properties (A, B, and C) in a Section 1031 Exchange in order to purchase another larger property (D). In preparation for the Exchange, the investor may have located the specific larger property and entered into a contract to acquire the property. For example, Property A, Property B and Property C are due to close on September 15, 2008. The new Property D is equal to or greater in price to the combined sale price of Properties A, B and C. The new property D, is scheduled to close on September 30, 2008.

However, for some reason, Property C did not close on September 15, 2008. This may have been due to loan problems, appraisal issues, zoning issues, title defects, or Buyer default. In any event, Property C will not sell before the replacement property D is purchased. Once the Investor has closed on Property D, the Exchange is over and Property C cannot be part of the Exchange. If Property C is later sold, the taxable gains from the sale cannot be deferred unless the Investor purchases another property, which may not be acceptable to the Investor. However, under the new ruling, the Professional Advisor can assist the Investor in crafting a solution to keep both sales non-taxable.

Example 2. An Investor has decided to sell Property A in a Section 1031 Exchange in order to purchase another property. After the sale of Property A, the Investor finds Property B, C and D. However Property B and Property C are much larger properties. The Investor decides that if he buys either Property B or C, he might want to also sell Property Z, which would provide enough cash to purchase either B or C.

Property A sells on September 15, 2008. The new properties (B, C and D) were timely identified within 45 days of September 15, 2008. The Investor decides to sell Property Z and purchase Property B. However, the Owner of Property B will not wait until Property Z is sold. Property B must be purchased by November 15, 2008. Once the investor has received Property B, the Exchange is over and Property Z cannot be part of the Exchange. When Property Z is later sold, the taxable gains from the sale cannot be deferred unless the Investor purchases another property, which may not be acceptable to the Investor. However under the new ruling, the Professional Advisor can assist the Investor in crafting a solution to keep both sales non-taxable.

Chief Counsel Advice Legal Memorandum (ILM 200836024), released on September 5, 2008, in a non-precedential ruling, permits the combination of a (Forward) Deferred Exchange and a Reverse Exchange citing the broad latitude that the Courts have accorded Section 1031 Exchanges in the past. However, like private letter rulings, this ruling cannot be relied upon by anyone other than the taxpayer to whom it was addressed.