Qualified Exchange Accommodation Arrangements

A qualified exchange accommodation arrangement is a tax strategy where a third party, known as the accommodation party, temporarily holds a real estate investor's relinquished or replacement property.

A qualified exchange accommodation arrangement enables investors to comply with section 1031 of the Internal Revenue Code, which allows investors to defer taking a capital gain or loss on the sale of real estate as long as the relinquished property is replaced by a like-kind property. Also known as a 1031 exchange, this transaction is a tax-deferred exchange that allows for the disposal of an asset and the acquisition of another similar asset without generating a tax liability from the sale of the first asset. Qualified exchange accommodation arrangements, while still subjecting investors to strict guidelines for the sale and purchase of like-kind properties, increase flexibility in the timing of sales and simplify qualifications for the tax deferral.

This strategy was recognized by the IRS in 2000 but previously was in use for many years. IRS approval of the procedure and establishment of specific qualification guidelines made investor compliance with 1031 exchange rules more straightforward. Because the purpose of such transactions was to hold a property temporarily, they also were known as warehouse transactions. Until passage of tax legislation in December 2017, this could include the exchange of one business for another or one piece of tangible property, such as artwork or heavy equipment, for another. Such an exchange since the 2017 tax reform is allowed only for one real estate investment property with a like-kind property and it must be for real estate held for investment or for productive use in a trade or business located in the United Sates.

Though tax is deferred and no gain or loss is recognized, the 1031 exchange must be reported on Form 8824, Like-Kind Exchanges. Form 8824's instructions explain how to report the details of the 1031 exchange. Section 1031 allows an investor to give or receive cash, liabilities or other property that is not like-kind in addition to the like-kind real estate exchanged. Cash, liabilities or other property that is not like-kind and that is given or received in a 1031 exchange is called boot. Boot triggers taxable gains or losses in the year of the exchange. The taxable amount that is not deferred by Section 1031 is the amount of the boot. The taxable amount that is deferred by Section 1031 is the capital gain or loss on the like-kind real estate exchanged. Gain recognized because boot was received is reported on Form 8949, Schedule D on Form 1040, or Form 4797, as applicable. If depreciation must be recaptured, then this recognized gain may have to be reported as ordinary income.