by J. Patrick Dowdall, Atlantic Exchange Company, LLC
A situation that we are seeing with more frequency in the aircraft market is what we will refer to as the "busted" safe harbor reverse exchange-i.e., a reverse exchange that is not able to close within the six month period specified in Rev. Proc. 2000-37. The issue may be frequently posed as "What can I do if I cannot sell my aircraft in 180 days?" Briefly, pursuant to that Revenue Procedure, the IRS will not challenge a reverse exchange arrangement if it meets certain criteria, including closing out within 180 days. In other words, the exchange accommodation titleholder ("AT") must hold the parked property (either the relinquished property or the replacement property) no longer than such 180-day period.
In the case of a busted safe harbor transaction, the 180-day requirement cannot be met because the relinquished property has not been sold. In such situations, the following alternatives and their consequences should be considered.
A. Terminate the Parking Arrangement. The exchanger may conclude that he is unlikely to sell the relinquished property in the near future (or he may have changed his mind about selling it). In this instance, he may simply have the AT transfer the parked property to him. The tax consequences of this action are less clear than may at first seem evident.
The primary issue is who should be treated as the owner of the property during the parked period, which will have implications as to who can claim depreciation deductions. Rev. Proc. 2000-37 stipulates as one of its conditions that the AT be treated as the owner of the parked property and that the tax returns reflect that. However, if there is to be no exchange, the exchanger probably will want to be treated as the owner and claim depreciation, particularly if the parked property is the replacement property. In general, these issues are not addressed in Rev. Proc. 2000-37, and there are no clear answers.
If the 180 day period has taken place during the same taxable year, the parties might consider a rescission of the parking arrangement and the related agreements since the case law recognizes the effect of a rescission for tax purposes if it does occur in the same taxable year as the original transaction. See Penn v. Robertson, 115 F. 2d 167 (4th Cir. 1940); Rev. Rul. 80-58, 1980-1 C.B. 181. On the other hand, if the period extends over two taxable years, this remedy may not be available.
Even if it were the second year and the formal rescission doctrine were not available, there would be the argument that the parked aircraft was owned by the exchanger during that period on the theory that the AT was merely the agent of the exchanger. If the qualified exchange agreement recited the agency relationship, then the argument would be more compelling (it should be noted, however, that it may not necessarily be advisable to include such language in the agreement since such could foreclose options 2 and 3 discussed below).
The issues could be even more complex if the AT has already filed a tax return and treated itself as the owner of the property. Presumably, the AT could file an amended return in which ownership of the property would not be claimed.
B. Do Nothing and Close Outside the Safe Harbor of Rev. Proc. 2000-37. The second alternative is to do nothing to the arrangement, sell the aircraft when there is a buyer and take the position that the arrangement will be treated as a valid parking arrangement even though the safe harbor requirements are not met. The difficulty is that the AT will have none of the burdens and benefits of ownership, which Rev. Proc. 2000-37 referred to as a criteria of tax ownership that would be required to qualify outside the safe harbor.¹
In this instance, the exchanger
might point to some authorities to support the position that an intermediary in
a Section 1031 transaction does not need to have an economic interest in the
property. See, e.g., Biggs v. Commissioner, 69 T. C. 905 (1978).
Alternatively, he might adopt the approach of the IRS in PLR 200111025², which seemed to require only
a minimal amount of burdens and benefits of ownership and relied on the theory
that the AT was not an agent of the exchanger. Note that this theory could be
advanced only if the exchange documents did not refer to the AT as an agent.
Another argument that might be advanced is that a "true" reverse exchange occurred and that the deemed simultaneous ownership of the two properties by the exchanger was not relevant. See, e.g., Rutherford v. Commissioner, T.C. Memo 1978-505. However, it is unclear as to the application of this doctrine, particularly where more than two parties are involved.
In general, despite these various arguments, the "do nothing" strategy would appear to be risky if the intent is to have a valid exchange.
C. Inject Some Additional Economics into the Transaction. Another alternative is to amend the arrangement to provide some economic benefits to the AT. For example, the lease of the parked property by the AT to the taxpayer might be amended to provide for rental payments representing a reasonable return to the AT. Thus, the argument would be that the relationship between the AT and the taxpayer in its entirety results in sufficient benefits to the AT under applicable case law.
Some have taken the position that a non-safe harbor reverse transaction cannot be "added on" to a safe harbor transaction. While that is probably true under the provisions of Rev. Proc. 2000-37, the real issue is the effect of such an amendment as to the treatment of the overall arrangement under the case law. As noted above, the underlying issue is whether the AT is to be treated as the agent of the taxpayer or as a principal. If there were sufficient burdens and benefits of ownership, the AT should be treated as the principal and not the agent under the applicable authorities.
Assuming that other factors are favorable in this respect (e.g., the AT meets the various requirements set forth by the IRS in LTR 200111025, the exchange agreements do not refer to the AT as the agent), the additional economic benefits to the AT could be helpful in establishing the case that the reverse exchange should be respected.
D. "White Knight" Transaction. The final alternative is to have a "white knight" enter the picture and acquire the relinquished property from the AT. The white knight would serve as interim owner of the property until a final buyer were found, but its acquisition and ownership would be structured in a manner to have sufficient incidents of ownership of the property for tax purposes so that it would be treated as the principal under applicable tax law. The best way to do this is for the white knight to have both upside and downside potential with respect to the property. In most respects, the analysis of a bona fide white knight transaction will be similar to that of a non-safe harbor reverse transaction. See Dowdall, "Non-Safe Harbor…" at n. 1.
Through the use of the white knight, the exchange transaction is essentially completed since the relinquished property has been sold by the exchanger (or the AT if the relinquished property was parked).
If the intent is to consummate the exchange, the "white knight" alternative seemingly presents the strongest case for meeting that objective since the intent is to sell the relinquished on a basis qualifying as a sale for tax purposes.
The question then becomes as to who should be the white knight. Presumably it should be someone independent of the exchanger. If the white knight were deemed to be an agent of the exchanger under general tax principles, the objectives probably would not be met. There do exist some companies who specialize in this type of business.
For example, Atlantic Exchange Company through its affiliate, AEC Acquisition Corp, has instituted a white knight program for potential busted safe harbor reverse exchanges. Pursuant to that program, relinquished property has been held for periods ranging from a few weeks to several months.