Non-Safe Harbor Reverse Improvement Exchanges: The Bartell Decision
Revenue Procedure 2000-37 provides a "safe harbor" for reverse exchanges – situations where you acquire replacement property before selling your relinquished property. But what if your transaction doesn't fit the safe harbor? The Tax Court's Bartell decision offers significant flexibility.
Understanding the Safe Harbor Framework
Under Rev. Proc. 2000-37, a reverse exchange works through a Qualified Exchange Accommodation Arrangement (QEAA):
1. An Exchange Accommodation Titleholder (EAT) – typically an affiliate of the qualified intermediary – acquires and holds the replacement property 2. The EAT "parks" the property while you arrange to sell your relinquished property 3. Within 180 days, you complete the exchange: selling your relinquished property and acquiring the replacement property from the EAT 4. The EAT is treated as the owner for tax purposes during the parking period
Improvement Exchanges add another layer: while the EAT holds the property, improvements are made, increasing its value so you can exchange into property worth more than the raw acquisition cost.
When Safe Harbor Doesn't Work
Several scenarios fall outside Rev. Proc. 2000-37:
- Construction exceeds 180 days: Major improvements simply can't be completed in time
- Parking arrangement fails technical requirements: The QEAA has specific documentation and structural requirements
- Complex multi-party transactions: Some deals don't fit the EAT model
- Taxpayer already acquired property: If you bought the replacement property before establishing the QEAA, you can't retrofit the safe harbor
Bartell v. Commissioner: Rejecting the IRS's Restrictive Approach
In Bartell v. Commissioner (T.C. Memo 2010-176), the Tax Court provided crucial guidance for transactions outside the safe harbor – and it was far more taxpayer-friendly than the IRS wanted.
The Facts: - The Bartells owned commercial property they wanted to exchange - They identified replacement property and began improvements - The parking period extended to 17 months – well beyond the 180-day safe harbor - During the parking period, the Bartells had temporary possession of the replacement property pursuant to a lease - The structure didn't comply with Rev. Proc. 2000-37's requirements - The IRS disallowed the exchange
The IRS's Position:
The IRS argued that the benefits and burdens of ownership test should apply. Under this test, the IRS contended that the Bartells were the true "owners" of the replacement property during the parking period because they bore the economic risks and enjoyed the benefits. If the Bartells were already the owners, they couldn't "exchange" with themselves, and the transaction would fail.
The Tax Court's Holding:
The Tax Court specifically rejected the benefits and burdens test. Instead, the court held:
1. "Great Latitude" in Structuring Exchanges: Taxpayers have substantial flexibility in how they structure parking arrangements and exchanges. The safe harbor is not the exclusive path.
2. Agency Is the Relevant Test: Rather than benefits and burdens, the court focused on whether the accommodator was acting as an agent of the taxpayer. An independent accommodator holding title in its own right – not merely as agent – satisfies the exchange requirements.
3. DeCleene Distinguished: The court distinguished DeCleene v. Commissioner, where the exchange failed, on narrow grounds: in DeCleene, the taxpayer made an outright purchase of the replacement property before transferring it to a purported accommodator (a cooperative buyer). That's fundamentally different from a properly structured parking arrangement where the accommodator takes title first.
4. Two Key Requirements: For a valid non-safe harbor exchange: - The taxpayer must intend to effectuate an exchange at the outset - An unrelated facilitator must take title to the replacement property before the exchange
5. Temporary Possession Not Fatal: The court was not troubled by the taxpayer's temporary possession of the replacement property pursuant to a lease during the parking period.
6. Extended Parking Periods Acceptable: The 17-month parking period in Bartell was significantly longer than in prior cases the court had approved – Alderson v. Commissioner (3 months) and Biggs v. Commissioner (4.5 months) – yet the exchange still qualified.
Practical Applications of Bartell
Scenario 1: Extended Construction Timeline
You're exchanging into a build-to-suit property. Construction will take 12-18 months – far beyond the 180-day safe harbor. Under Bartell, a properly structured non-safe harbor exchange works if:
- You intend to complete an exchange from the outset
- An unrelated EAT takes title to the replacement property before the exchange
- The EAT is not merely your agent
- You document your exchange intent contemporaneously
Scenario 2: Possession During Parking
Your accommodator holds title to the replacement property, but you need to access it during construction or for property management. Under Bartell, a lease arrangement allowing you temporary possession does not invalidate the exchange.
Scenario 3: Lengthy Improvement Projects
Major renovations, environmental remediation, or phased construction that extend well beyond 180 days can still work. Bartell's 17-month parking period – approved without hesitation – demonstrates significant flexibility.
The Tax Court Advantage: Jurisdiction and Stare Decisis
Understanding Bartell's procedural posture provides strategic insight for taxpayers:
Choosing Your Forum
When the IRS audits a 1031 exchange and issues a deficiency notice, the taxpayer can challenge that determination in: - U.S. Tax Court (without paying the tax first) - U.S. District Court (after paying and filing for refund) - U.S. Court of Federal Claims (after paying and filing for refund)
The Tax Court is often the preferred forum because taxpayers need not pay the disputed tax before litigating.
The IRS's Nonacquiescence
The IRS issued a nonacquiescence to Bartell in IRB 2017-33 (August 14, 2017). This means the IRS disagrees with the decision and will continue to challenge similar transactions on audit.
However, a nonacquiescence is merely the IRS's litigation position – it doesn't change the law.
Stare Decisis Across the Country
Here's the key advantage: The Tax Court follows its own precedent under the doctrine of stare decisis. Bartell is Tax Court precedent, and the Tax Court will follow Bartell in future cases involving similar facts – regardless of where in the United States the taxpayer is located.
This means a taxpayer in any circuit can litigate in Tax Court and rely on Bartell. The IRS may continue to audit these transactions, but taxpayers who end up in Tax Court have favorable precedent.
The 9th Circuit Overlay
For taxpayers in the Ninth Circuit (Washington, Oregon, California, Arizona, Nevada, Idaho, Montana, Alaska, and Hawaii), there's an additional layer of protection. If a Tax Court decision is appealed, it goes to the circuit court where the taxpayer resides. The Ninth Circuit has historically been favorable to taxpayers on 1031 issues (see also Magneson), providing additional confidence for Pacific Northwest investors.
Structuring a Non-Safe Harbor Exchange After Bartell
Based on the Bartell framework, a compliant non-safe harbor exchange should include:
1. Contemporaneous Exchange Intent: Document your intent to complete a 1031 exchange before the accommodator acquires the replacement property. Board resolutions, correspondence, and engagement letters all help.
2. Independent Accommodator: Use an unrelated, professional Exchange Accommodation Titleholder. The EAT should not be your agent – it should hold title in its own right with genuine (if limited) economic interest.
3. EAT Takes Title First: The accommodator must acquire title to the replacement property before the exchange occurs. This is the critical distinction from DeCleene.
4. Proper Documentation: Even outside the safe harbor, document the arrangement thoroughly: parking agreement, lease (if applicable), improvement contracts, and exchange agreement.
5. Professional Guidance: Work with a qualified intermediary experienced in non-safe harbor structures and obtain a tax opinion if the transaction involves significant dollars or aggressive timing.
The Bottom Line
Bartell confirms that Rev. Proc. 2000-37's safe harbor is just that – a safe harbor, not the exclusive path to a valid reverse or improvement exchange. The Tax Court rejected the IRS's benefits-and-burdens approach, instead focusing on exchange intent and whether an independent accommodator took title before the exchange.
For taxpayers willing to structure carefully and document thoroughly, Bartell provides significant flexibility – including extended parking periods and temporary possession arrangements that the safe harbor doesn't accommodate. And because the Tax Court follows its own precedent nationwide, Bartell's protection extends beyond the Ninth Circuit to any taxpayer who chooses the Tax Court as their forum.
At Olympic Exchange Accommodators, we've facilitated non-safe harbor exchanges and have the experience to structure these complex transactions. Contact us to discuss your specific situation.
Jeff Helsdon, CES® Certified Exchange Specialist since 2003
