By Lee David Medinets, Esq., CES®, Chief Counsel, Madison Exchange, LLC
A “Construction Exchange” is a special type of tax-deferred IRC § 1031 like-kind exchange that allows a taxpayer to defer recognizing income by sheltering proceeds from the sale of relinquished property into improvements made to replacement property, not just in the cost of buying the replacement property (as in an ordinary “forward exchange”). In order for a construction exchange to work, the taxpayer cannot own the property at the time the im-provements are made. In a typical safe-harbor construction exchange [Rev. Proc. 2000-37], the replacement property is purchased from a third-party seller on behalf of the tax-payer by an exchange accommodation titleholder (“EAT”). The EAT is essentially acting as the taxpayer’s agent under a contract that allows the taxpayer to use and improve the re-placement property during the taxpayer’s 180-day exchange period. By the end of the ex-change period, the EAT transfers legal ownership of the replacement property to the tax-payer, which completes the exchange.
One common problem is that a safe-harbor construction exchange will not work if the tax-payer owned the replacement property within 180 days of the start of the exchange. [Rev. Proc. 2004-51.] What if the replacement property is owned by a related party, such as a multi-member LLC that the taxpayer controls? There has been some concern that such an exchange might fail to qualify as a safe-harbor construction exchange because ownership of the replacement property by the related party would be viewed by the IRS as the equivalent of ownership by the taxpayer himself/herself. IRS Private Letter Ruling 201408019, issued February 21, 2014, addressed this precise issue. Continue reading