Set forth herein is the process of the construction exchange. The exchange is being undertaken in accordance with Revenue Procedure 2000-37. This "safe harbor" regulation allows considerable latitude to the taxpayer in its involvement with the replacement property during the delay necessary to complete the construction improvements.
The steps in the process are as follows:
- The taxpayer enters into the contract to acquire the replacement property and arranges acquisition financing, if necessary.
- The taxpayer executes a "Qualified Exchange Accommodation Agreement" ("QEAA") with the exchange accommodation titleholder ("EAT") (the LLC holding company), a disregarded single purpose entity controlled by Title Exchange Company ("QI").
- The EAT acquires title to the replacement property with financing, if necessary, guaranteed by the exchanger and secured by a mortgage from the EAT. We use the single member, special purpose, single asset limited liability company to hold title.
- The EAT holds title to the replacement property until the improvements have been constructed and the value of the replacement property is sufficient to satisfy the Sec. 1031 requirements.
- The QI directs the conveyance of the parked property to the taxpayer by "direct deeding" the parked property to complete the exchange. This must occur within 180 days of the sale of the relinquished property.
Generally, these are the steps in the construction exchange process.
By couching the transaction under this "safe harbor" regulation, we avoid issues that had been previously thought to be required, to-wit:
- The EAT is not required to have any equity investment in the parked property during the safe harbor parking period
- The EAT can be indemnified by the taxpayer or disqualified person against costs and expenses associated with the parking transaction.
- The EAT is not required to guarantee any indebtedness incurred to acquire the parked property; and any taxpayer guarantee of the acquisition financing is permitted.
- The EAT is not required to control the management or operation of the parked property, which can effectively be delegated to the taxpayer under a management or lease agreement.
- The EAT is not required to control or supervise any construction of improvements on the parked property; the taxpayer may approve the construction contract and change orders.
- The EAT is not required to profit on the transfer of the parked property to the taxpayer; and the EAT is not required to bear any significant risk of loss for the parked property.