In PLR 202520001, the IRS ruled that a taxpayer's (Taxpayer) proposed exchange transaction would satisfy the requirements for the use of a qualified intermediary (QI) and an exchange accommodation titleholder (EAT) in a deferred exchange, such that Taxpayer would not recognize gain on the transaction under IRC Section 1031(a).

Facts

In PLR 202520001, a real estate investment trust (REIT) owns limited partnership interests in, and is the general partner of, Taxpayer, a limited partnership treated as a partnership for federal income tax purposes. Taxpayer owns property held for use in its rental business and land held for development. Taxpayer also owns membership interests in (1) Subsidiary, a taxable REIT subsidiary of the REIT, and (2) Partnership, a limited liability company treated as a partnership for federal income tax purposes. Subsidiary owns the remaining interests in Partnership.

Taxpayer contributed land held for development to Partnership (Land), and Subsidiary agreed to contribute cash to be used for Partnership's operations. Partnership will construct improvements on the Land and lease such improvements to tenants under lease agreements that are not triple net leases and will involve substantial activity and expense for Partnership. Taxpayer represented that, upon contribution of the Land, title passed to Partnership under state law and Partnership assumed all rights and obligations with respect to the Land consistent with tax ownership of the Land. Partnership may also acquire additional land for development from third parties and similarly construct improvements for lease to tenants. Taxpayer further represented that Partnership's acquisition of the Land will separate Partnership's ground-leasing business and other real estate operations in specific geographic territories from Taxpayer's other real estate business operations.

At least 180 days after Taxpayer's contribution of the Land to Partnership, Partnership will ground lease the Land to an EAT or a wholly owned subsidiary of the EAT (EAT Subsidiary) for more than 30 years. The ground lease will permit EAT Subsidiary to construct improvements during the lease term, and Subsidiary will manage the construction. Taxpayer will loan funds to EAT Subsidiary to fund construction costs and rental payments under the ground lease. Taxpayer represented that (1) Partnership expects to engage in significant activity with respect to the ground lease and (2) the EAT will hold the qualified indicia of ownership (as defined in Revenue Procedure 2000-37) of the Land and improvements at all times from the lease date until the Replacement Property (defined below) is transferred to Taxpayer.

Partnership, the EAT and EAT Subsidiary will also enter into a qualified exchange accommodation arrangement (QEAA) agreement, whereby the EAT will agree to transfer the interests in EAT Subsidiary to Taxpayer within 180 days as replacement property in an exchange qualifying for nonrecognition under IRC Section 1031. Because EAT Subsidiary is a disregarded entity for federal income tax purposes, Taxpayer's replacement property will consist of EAT Subsidiary's interest in the ground lease and any improvements EAT Subsidiary has constructed on the Land (Replacement Property).

Within 45 days of entering into the QEAA agreement, Taxpayer will identify properties to be sold as relinquished properties in the IRC Section 1031 exchange by sending an identification form to the EAT and will then enter into contracts to sell certain identified properties (Relinquished Properties) to third-party buyers. Taxpayer will enter into a tax-deferred exchange agreement with a QI pursuant to which Taxpayer will assign to QI the sale contracts for the Relinquished Properties.

Within 45 days of the sale of each Relinquished Property, Taxpayer will provide QI with a form identifying the Replacement Property as replacement property in Taxpayer's IRC Section 1031 exchange. Taxpayer will then assign to QI Taxpayer's rights under the QEAA agreement to acquire the Replacement Property.

Within 180 days of the QEAA agreement, at QI's direction, the EAT will transfer the interests in EAT Subsidiary to Taxpayer. If all of the Relinquished Property proceeds are not fully reinvested in the construction of improvements prior to this transfer, Taxpayer will recognize gain to the extent of the remaining funds (boot).

Taxpayer represented that both the Relinquished Properties and the Replacement Property will be held for productive use in Taxpayer's trade or business or for investment, and not primarily for sale, and that neither Taxpayer nor Partnership will engage in a taxable sale of its interest in the Land or the Replacement Property within two years after the last transfer that was part of Taxpayer's IRC Section 1031 exchange.

Law and analysis

Under IRC Section 1031(a)(1), no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment for like-kind property to be held for productive use in a trade or business or for investment.

Treas. Reg. Section 1.1031(a)-1(b) defines "like-kind" "as referring to the nature or character of the property and not to its grade or quality."

Treas. Reg. Section 1.1031(a)-1(c)(2) specifies that no gain or loss is recognized if a taxpayer who is not a dealer in real estate exchanges a leasehold with a term of 30 years or more for real estate, or exchanges improved real estate for unimproved real estate.

Under IRC Section 1031(f)(1), nonrecognition under IRC Section 1031 does not apply to an exchange if (1) a taxpayer exchanges property with a related person, (2) the taxpayer does not recognize gain or loss under IRC Section 1031, and (3) within two years of the last transfer that was part of the exchange, either the taxpayer or the related person disposes of the property .

Deferred exchanges and QI safe harbors

Treas. Reg. Section 1.1031(k)-1(a) defines a deferred exchange as one in which, pursuant to an agreement, the taxpayer transfers property held for productive use in a trade or business or for investment and subsequently receives property to be held for productive use in a trade or business or for investment. If the identification and receipt of replacement property requirements under IRC Section 1031(a)(3) are not met, the replacement property received by the taxpayer will not be treated as like-kind to the relinquished property.

Under Treas. Reg. Section 1.1031(k)-1(e)(1), the transfer of relinquished property in a deferred exchange will not fail to qualify for nonrecognition of gain or loss merely because the replacement property does not exist or is being produced at the time the property is identified as replacement property.

Treas. Reg. Section 1.1031(k)-1(f)(1) generally provides that a transfer of relinquished property in a deferred exchange will not qualify for nonrecognition under IRC Section 1031(a) if, as part of the consideration, the taxpayer receives money or other property (i.e., boot), and the taxpayer's gain or loss on the exchange will instead be determined in accordance with IRC Section 1031(b) or (c). Gain or loss may be recognized if the taxpayer actually or constructively receives boot before the taxpayer actually receives like-kind replacement property.

Under Treas. Reg. Section 1.1031(k)-1(f)(2), except as provided in the safe harbor rules under Treas. Reg. Section 1.1031(k)-1(g), whether and to what extent the taxpayer is in actual or constructive receipt of boot before the taxpayer actually receives like-kind replacement property is made under the general tax rules concerning actual and constructive receipt. Actual or constructive receipt of boot by the taxpayer's agent is treated as actual or constructive receipt by the taxpayer.

Under Treas. Reg. Section 1.1031(k)-1(g)(4)(i), if a taxpayer transfers relinquished property through a QI, the QI is not considered the agent of the taxpayer for purposes of IRC Section 1031(a). Accordingly, the taxpayer's transfer of relinquished property and later receipt of like-kind replacement property is treated as an exchange, and the determination of whether the taxpayer is in actual or constructive receipt of boot before the taxpayer's actual receipt of like-kind replacement property is made as if the QI is not the taxpayer's agent. The regulations also require that the QI enter into an agreement with the owner of the replacement property for the transfer of that property, and that the replacement property is transferred to the taxpayer pursuant to the agreement.

EAT safe harbor

Revenue Procedure 2000-37 provides a safe harbor for the acquisition of replacement property under a QEAA. If the QEAA requirements are satisfied, the IRS will not challenge (1) the qualification of the "parked" property as either replacement or relinquished property or (2) the treatment of the EAT as the beneficial owner of the property.

To satisfy the QEAA requirements, the Revenue Procedure requires that qualified indicia of ownership of the property be held by the EAT at all times from the date of the property's acquisition until its transfer by the EAT. In addition, (1) the taxpayer and the EAT must enter into a QEAA agreement no later than five days after qualified indica of ownership of the property is transferred to the EAT; (2) the relinquished property must be properly identified no later than 45 days after the qualified indica of ownership is transferred, and (3) the property must be transferred either (a) directly or indirectly through a QI to the taxpayer as replacement property or (b) to a person who is not the taxpayer or a disqualified person no later than 180 days after the qualified indica of ownership is transferred. The relinquished property and replacement property cannot be held in the QEAA more than 180 days.

Revenue Procedure 2000-37 also specifies that the property will continue to be treated as held in a QEAA even if one or more of the following legal or contractual arrangements exist (regardless of whether the arrangements have arm's-length terms): (1) an EAT satisfies the QI safe harbor under Treas. Reg. Section 1.1031(k)-1(g)(4) so is allowed to serve as a QI (pursuant to an exchange agreement with the taxpayer) in an IRC Section 1031 simultaneous or deferred exchange of the property; (2) the taxpayer or a disqualified person guarantees obligations of the EAT or indemnifies the EAT against costs and expenses; (3) the taxpayer or a disqualified person loans or advances funds to the EAT and/or (4) the taxpayer or a disqualified person provides services to the EAT with respect to the property (e.g., manages, supervises improvements or acts as a contractor).

Revenue Procedure 2004-51 modified Revenue Procedure 2000-37, providing that the safe harbor of Revenue Procedure 2000-37 will not apply if the taxpayer owns the property intended to qualify as replacement property within the 180-day period ending on the date qualified indicia of ownership of the property was transferred to the EAT.

Ruling

The IRS ruled that the transaction will satisfy the requirements for using a QI and EAT in a deferred exchange and will therefore qualify for nonrecognition treatment under IRC Section 1031. In so ruling, the IRS noted that Taxpayer will exchange a fee interest in improved real estate for a long-term leasehold interest and improvements, making the property to be transferred and the property to be received by Taxpayer "like-kind" under Treas. Reg. Section 1.1031(a)-1(b). The IRS added that Revenue Procedure 2004-51 does not apply because Taxpayer did not own the Replacement Property within the 180-day period preceding the date the qualified indicia of ownership of the Land and any improvements were transferred to EAT Subsidiary.

Further, the IRS observed that the QI and the EAT will not be treated as Taxpayer's agents, and therefore Taxpayer will not be treated as being in actual or constructive receipt of boot before receiving the Replacement Property.