Summary
Section 1031 exchange agreements with intermediaries affected by COVID-19 may wish to insert the following language:
Limited Force Majeure Extension. If, due to a disaster or other unforeseeable circumstances (including COVID-19), the exchanger cannot perform, then the time for the performance of any action required by exchanger for either an identification or completion of a replacement will be extended as allowed by the Treasury (pursuant to guidance issued for affected taxpayers under Rev. Proc. 2018-18). IRS Notice 2020-23 is specifically acknowledged as applicable, and the parties agree to extend any action due after April 1, 2020 and before July 15, 2020, to be due July 15, 2020.
The Service’s Notice 2020-23, issued on April 9, 2020, now allows Section 1031 deadlines (tax-deferred exchanges) extensions of time to take certain actions.
The following outlines the application of this Notice:
The Service has granted relief to Section 1031 exchanges affected by COVID-19. While relief under the Service’s Notice 2020-23 is not directly referenced by a statement on Section 1031 itself, the Notice references Revenue Procedure 2018-58, 2018-50 IRB 990, which does cover relief from time sensitive actions under Section 1031 exchanges. In that context, there are two key statements provided under the Service’s Notice 2020-23:
The Secretary of the Treasury has also determined that any person performing a time-sensitive action listed in either § 301.7508A-1(c)(1)(iv) – (vi) of the Procedure and Administration Regulations or Revenue Procedure 2018-58, 2018-50 IRB 990 (December 10, 2018), which is due to be performed on or after April 1, 2020, and before July 15, 2020 (Specified Time-Sensitive Action), is an Affected Taxpayer. [Underline added].
Section C of the Notice states that:
Affected Taxpayers also have until July 15, 2020, to perform all Specified Time Sensitive Actions, that are due to be performed on or after April 1, 2020, and before July 15, 2020.
What does this all mean?
Well Notice 2020-23, “Additional Relief for Taxpayers Affected by Ongoing Coronavirus Disease 2019 Pandemic,” means that taxpayers who are currently engaged in a 1031 exchange having time-sensitive action (i.e., either a 45-day identification deadline or a 180-day closing date deadline), having a due date on or after April 1, 2020, and before July 15, 2020, will be treated as an Affected Taxpayer and, accordingly, should have a position that they are granted an extension to July 15, 2020, to perform the required action. This position, however, is not without an unanswered question and risk, described under Exchange Intermediary Guidance, below.
Holding off on the issue as to risk below, this is both good news and bad news for Section 1031 exchanges generally.
First, the bad news, which as with destiny, comes in threes:
- Identification Due Date. If the taxpayer’s (exchanger’s) 45-day identification period expired before April 1, 2020, there is no extension for the identification due date. Any prior identification is final and cannot be changed.
Example
On January 15, 2020, taxpayer identified 3 replacement properties, and completed two of the replacements, but needs to complete the third replacement to avoid having taxable boot. The seller of replacement property number 3 refuses to proceed to sell her property in light of COVID-19 (and the courts are closed to try to force a sale) because she is concerned that she cannot find replacement property and argues that she is relieved from any duty to perform due to COVID-19. Taxpayer cannot get a “do-over” to identify another replacement property.
- Replacement Period. If the taxpayer’s replacement period expired before April 1, 2020, there is no extension of the replacement period due to COVID-19.
Example
On March 29, 2020, the 180th day, Taxpayer could not close because the lender was not prepared to proceed on the purchase. The contract contained no force-majeure clause and seller insists that the contract be performed. Taxpayer gets no extension, and is stuck between a rock and a hard place. Whether or not he closes, there will be taxable boot; and if he does not close, there may be a lawsuit by seller for nonperformance.
- Limited Relief. For anyone who has tried to read Rev. Proc. 2018-58 upon which Notice 2020-23 is based, it must be kept in mind that the provisions under this Notice are more limited than what the Service might have granted under that Revenue Procedure. Rev. Proc. 2018-58 identified that that the Service could have granted relief up to 100 days, and as an ongoing emergency, there was discretion for the IRS to liberally grant a longer period of relief. However, both Rev. Proc 2018-58 and Notice 2020-23 recognize the right to grant less relief as specifically identified by the Service. Notice 2020-23 is very specific that it only grants the relief expressly provided in it and nothing greater. (In particular, it does NOT give an extra 100 days, or end of the year, or to return filing, whichever is earlier).
Example
Taxpayer’s exchange was adversely affected by a stay-at-home order on or before St. Patrick’s Day, March 17, 2020. The actions required failed because of an earlier lapse of an event. While the Service has issued provisions for earlier relief than April 1, 2020 in other matters, there is no relief for the Taxpayer. Furthermore, there is no relief given to any taxpayer beyond July 15, 2020, regardless of how long the Pandemic affects the real estate market.
On the other hand, there is the good news, taken literally as described above as to who may qualify for relief:
Namely, any Affected Taxpayer with a 45-Day Exchange Period or 180-Day Exchange Period deadline between April 1 and July 15, 2020 will be in a position to obtain an automatic extension to July 15, 2020 for the particular action that fell within that period. By another example, if the 45th day to identify is April 1st, then the identification period is extended to July 15, 2020, including the right to update or change identification of replacement property. By yet another example, if the 180-day due date was May 1, 2020, then closing can be July 15, 2020.
Identification: Be careful that any revised identification follows the Regulations if you are changing a previous identification.
- Good – For example, it is safer to say: “I revoke my previous property identification, and the following 3 properties shall supersede as my replacement property identification.”
- Bad – It is not safe to say: “I further identify the following 3 properties” because it is not 100% clear what was intended of a previous identification.
While normally a later identification will supersede, the word “further” may get you in trouble. If you identify more than 3 properties (the two identifications are combined), then you must either: (i) identify not more than 200% of the relinquished property value collectively; or (ii) acquire 95% of all identified properties.
HOWEVER, the good news does not come simply by way of this Notice, as most exchanges involve an exchange intermediary or accommodator, and there are issues as to how these provisions will work with respect to most who do use an intermediary or accommodator.
Exchange Intermediary Guidance. The Service’s Notice 2020-23 says nothing about use of exchange intermediaries. The Notice gives no guidance on how they can adopt these provisions.
This is a problem because a tax deferred exchange with an exchange intermediary involves a contract which includes set days for identification (45-days) and replacement (180-days) intended to try to match Section 1031 of the Code and Regulations. However, contracts may be subject to a challenge by the Service where they are not followed, including taxpayer constructive receipt issues. Because the Service has not addressed constructive receipt or its avoidance in the context of a deferred exchange (including a reverse exchange) in connection with Notice 2020-23, there is no specific guide as to what to do.
If the 180 days has not lapsed, and a taxpayer intends to proceed on an exchange, to obtain an extension of time under Notice 2020-23, we suggest that the exchange agreement should be amended “immediately” i.e. before 180 days have lapsed. This may reduce the risk of constructive receipt. We are not saying that going past 180 days will be challenged if the agreement is amended later, but the risk is that a taxpayer may be deemed to have access to (i.e. constructive receipt) of the exchange funds. (Furthermore, the issue of force majeure – Acts of God, and Rev. Proc. 2018-58, is not covered by most exchangers who have provided exchange accommodation agreements, and therefore the contract has no automatic extension).
Here is suggested language to propose to an exchange intermediary:
Limited Force Majeure Extension. If, due to a disaster or other unforeseeable circumstances (including COVID-19), the exchanger cannot perform, then the time for the performance of any action required by exchanger for either an identification or completion of a replacement will be extended as allowed by the Treasury (pursuant to guidance issued for affected taxpayers under Rev. Proc. 2018-18). Notice 2020-23 is specifically acknowledged as applicable, and the parties agree to extend any action due after April 1, 2020 and before July 15, 2020, to be due July 15, 2020.[1]
Franchise Tax Board. Lastly, no guidance yet exists as to California conformity to the ability to extend Section 1031 deadlines as discussed in this article. Informal discussions with the Franchise Tax Board indicate that they are reviewing this issue. It is unclear if or when they will issue guidance. What is clear is that California will probably not provide any greater relief than granted by the Service if they conform to the IRS’ guidance.
Recommendations
With respect to affected exchanges, we strongly recommend that those undergoing exchanges confer with legal counsel experienced in both real estate and Section 1031 tax deferred exchanges.
In Northern California, Wagner Kirkman Blaine Klomparens & Youmans LLP has counseled clients as attorneys for 40 years on Section 1031 tax deferred exchanges and their real estate transactions, including reviewing the tax consequences of exchanges, negotiations, amendments, exchange terms, legal issues in connection with Acts of God (i.e. force majeure), as well as federal and state tax representation.
[1] The inclusion of this statement is not a guarantee that it will be effective to avoid constructive receipt, but may diminish this risk.
