Non-Safe Harbor 1031 Exchanges

non-safe harbor 1031 exchange

Many people are interested in reverse 1031 exchanges but they are not interested in the 180 holding period cap. The big complaint about rev proc 2037 is that you are only allowed to park a property for up to 180 days, and you can't do much in 180 days. This is especially true if you're doing a construction reverse exchange where you want to construct an enormous amount of improvements. Here are some important things to remember about non-safe harbor 1031 exchanges.

Rev Proc 2037

It's important to note that the IRS does not necessarily say that non-safe harbor exchanges are bad, or make any judgments about them, they just say “if you want to be inside of the safe harbor, stay within the four corners of this revenue procedures.”

Why would you ever want to go outside of the safe harbor? The primary reason is if you need to park a property for longer than 180 days.

Downsides of Non-Safe Harbor Exchanges

So what's the downside of doing a reverse exchange outside of the safe harbor? The critical component is if you're outside of the safe harbor, the LLC that’s holding title to the replacement property cannot be deemed to be an agent of the taxpayer. So there is a critical analysis and a fact-specific determination to make sure the party holding the parked property is not an agent of the taxpayer.

This generally means that the taxpayer’s exchange accommodation title holder needs to act as a principle in the transaction by investing significant amounts of its own cash into the Replacement Property and taking out fully recourse financing with an independent lender for the purchase and construction.  The LLC must have a real economic “upside” and substantial risk of a potential “downside” to be viewed as acting as a principle in the transaction.

Further bolstering this situation, the Treasury Regulations state that the qualified intermediary is not considered the agent of the taxpayer for purposes of Section 1031(a), so perhaps the most ideal party to “park” the Replacement Property and take on these risks is the qualified intermediary.  Given this unique and potentially adverse situation, the taxpayer must have their own separate legal and tax advisor working with them throughout the entire process, particularly because the qualified intermediary is acting for its own accord and for its own economic benefit (the opposite of an agent of the taxpayer).

  • 1031 Hotline: If you have questions about Non-Safe Harbor Exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

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