When the term “warehousing” occurs in the 1031 Exchange world, it’s typically in reference to a Reverse or Improvement exchange… In the latest 1031 Exchange Seminar, David Moore covers your 1031 exchange questions surrounding “warehousing” exchanges!
“Warehousing” 1031 Exchanges
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Warehousing transactions… warehousing means that we’re working toward warehousing a property. And when I got to the safe harbors and reverse exchanges in Rev. Proc. 2000-37, what they did is they took away our ability to do what we call a true reverse exchange. And that turned all of our transactions in the reverse world into warehousing. What that means is that the taxpayer cannot own the new and old property at the same time; they can only own one or the other. So, if we do a reverse exchange and we do a warehouse replacement transaction, that means we’re going to create an LLC, that EAT, Exchange Accommodation Titleholder, that’s going to warehouse the replacement property until the relinquish property sells.
If we warehouse a relinquished transaction, warehouse relinquished means we’re going to take title to the relinquished property. A warehouse replacement transaction is nice in that it’s the same structure as we use for improvement exchanges. And I want to stress … If you look at this page, it just talks about warehouse relinquished, warehouse replacement, but what about Bartell? Bartell, what is Bartell? When we’re looking at that, that was a court case that came down last year and some of the exchange accommodation intermediary world said, “Yay, great, wonderful! Now we’ve got rules that say we can work outside the safe harbors of Rev. Proc. 2000-37, meaning that we don’t have only 180 days to get the deal done.” Our position was: nothing has changed. I run the programs for a lot of the commercial community and they were talking about this revolutionary Bartell ruling and it was going to change everything, and I said, “Nothing’s changed.” You have to understand what that ruling actually says, what it means. And all that happened in that transaction was exactly what we said was going to happen; the IRS came back in and said, “Hey, that was a horrible ruling, bad ruling. We’re not going to follow this law and you can’t do that.” So, the companies that were all the sudden pushing to make things work outside those safe harbors, nothing’s changed.
We do transactions that work outside the 180-day time line, but if we’re going to do that transaction, we know we have to cover some other issues like benefits and burdens of ownership. If we’re looking at a reverse and we work within the safe harbors, the government has sort of agreed to look the other way. And what I mean by that is; say we do a reverse exchange and we warehouse the replacement property, the replacement maybe has some great cash flow. And let’s say that we get into this transaction, we do the warehouse replacement … do you think my client, or if you’re my client, do you think you want the income off that property during the time we’re warehousing it? Yes, of course you do! Can we give it to you? Yes, we can, per 2000-37. Because we can offer you the benefits and burdens of ownership of that property during the time that we have title if we work within the safe harbors.
So, the up-side of the property, is you probably want it. Do you think I want the down-side of the property? What happens if the thing goes dark and there’s payments that need to be made? Do you think I want to do that? I’m getting paid $4500-5000 to do an exchange; do you think I’m going to pay a $5000 debt service payment for you? Probably not. So, you look at this transaction and say, “Okay, Rev. Proc. 2000-37 allows the accommodator to act in basically an agency relationship as long as you’re working within the safe harbors, that 180-day time period being one of them.” If you said, “Dana, I’ve got a transaction that is going to take me a year to get done; we’re doing an improvement exchange, and it’s going to take us two years to build it. Can we do that transaction?” Yes, only now we’re choosing to work outside Rev. Proc. 2000-37, which puts us at a higher standard. Now we have to worry about benefits and burdens of ownership. Now I have to put money in and have money at risk, otherwise I’m merely acting as an agent which was okay inside the safe harbors but now we’re outside the safe harbors and the government’s going to say, “No, no, no, you can’t do that.”
Once again, when the government puts rules in place it both ratifies and limits. It gives you a course, it gives you a path, but you have to play within the rules they give you. So could you do a reverse exchange or improvement exchange taking more than 180 days? Yes, and Bartell sort of says that, but you need to understand that you’re at risk. We have to do it correctly. If we’re doing a non- safe harbors reverse exchange, or non-safe harbors improvement exchange… safe harbor reverses we charge $4500 plus 1/10 of 1% of the value of the asset we take title to, so 100 per 100,000. So for a million dollar deal, you’re looking at a $5500 transaction. If it’s an improvement exchange, a base set-up of $5500 plus the 1/10. If you come to me and say, “Hey, this is going to take us a year, two years.” Now we’re outside of those safe harbors, so I’m going to base-set a fee of $15,000 because I’m going to have to put money in there too. And I’m going to have to decide if I want money tied up for next year too, whether I’m even going to do that transaction.
But is it possible, yes, it’s possible it just costs more, takes more planning and we have to make sure we’re covering those benefits and burdens of ownership issues because we are now vulnerable from an agency perspective if we’re choosing to work outside the safe harbors.
An improvement exchange is the same, it’s a warehouse transaction. An improvement exchange is a warehouse replacement exchange. So, in addition to our costs, the other thing you have to be aware of is the cost of ownership. If there’s a loan involved, will the bank allow us to take ownership of that property? If you walk into one of the big banks they probably don’t have the box on the form to check. If it’s a regional bank you can go in and talk to somebody, and they’ll probably do the deal. So, when we’re looking at warehousing a relinquished property or warehousing a replacement property, the choice between those two is based upon:
- Your desire, which one you want to own.
- How much money you have to put down versus how much you expect to net out of the relinquished property.
If you have as much money or more to put down on the replacement property as what you expect to net, that means we can give you ownership of the new property. If you want improvements done, we want to warehouse the replacement property. So, if you have less money to put down than what you expect to net from a future sale, that tells me we’re going to do a warehouse replacement transaction, which, once again, requires a bank that’s going to cooperate with us in that scenario.
Other things that can happen: transfer taxes. We’ve got a lot of deals in California right now. Alameda County, and every time there’s a transfer of property they want to ding you. How do we get those transfers done? Maybe we do assignments and membership interest. In Washington state, you guys have transfer taxes. Depending on the side of the transaction, they will make accommodations for 1031 purposes. On one side versus the other we can get credits for things so you’re not having to pay that transfer tax twice, just once.
So anytime we’re doing warehouse transactions we have to look at these and you need to understand that potentially in addition to the cost of the transaction, there’s other things. Banking wise that may come into it or other counties, and states that may have some other issues that jack the prices up too. My position on reverse exchanges is; they’re there, they’re great if you need them, but use it as a fall back don’t use it as a primary course of action. Ask for the time you feel you need. If we get to that point and we can’t get the transaction closed, there’s a delay, see if you can buy additional time. If you can’t buy additional time, then the reverse is there.