General Regulations Part 14
New York State Banking Department
|To:||Examiner Nosikovsky, FWBD|
|From:||Christine R. Cardi, Assistant Counsel|
|Date:||February 5, 2008|
|Subject:||Application of [---] to Establish an Operating Subsidiary to Engage in Reverse Exchanges of Like-Kind Property|
Whether [---]'s proposed investment in an operating subsidiary ("Subsidiary”) established to engage in reverse exchanges of like-kind property is authorized under Banking Law Section 97-4a?
Whether the related application is in compliance with the requirements of Part 14 of the General Regulations of the Banking Board ("Regulations")?
[---]'s proposed investment in a Subsidiary established to engage in reverse exchanges of like-kind property is authorized under Banking Law Section 97-4a. The application submitted in connection with the proposed investment is in compliance with the requirements of Part 14 of the Regulations.
[---] should be informed that it is not required to provide notice of, or obtain Banking Department approval for, each transaction for the reverse exchange of like-kind property that results in the formation by the Subsidiary of an LLC (“LLC”) as described in the application.Background
[---], a wholly owned Subsidiary of [---] has provided notice in accordance with Part 14 of the Regulations of its intention to establish a Subsidiary to engage in the business de novo of facilitating reverse exchanges of like-kind property under Section 1031 of the Internal Revenue Code, 26 U.S.C. Section 1031 ("Section 1031"). [---] indicates that the Subsidiary will conduct the business of facilitating reverse exchanges as authorized under Section 97-4a of the New York Banking Law ("Banking Law"). [---] will contribute a maximum of $[---] to the Subsidiary as operating capital.The Subsidiary will arrange reverse exchange transactions in accordance with the safe harbor of Rev. Proc. 2000-37 ("Revenue Procedure") issued by the U.S. Treasury Department. The property involved in such exchanges will generally be real estate. [---] believes that providing reverse like-kind property exchange services will generate additional revenue for [---], and improve the level of service to clients and the competitive strength of [---] and its affiliates.
As is more fully explained in the [---] notice, Section 1031 provides that a taxpayer may defer taxable gain that would be realized on the relinquishment of property held for productive use in trade or business or for investment by exchanging it for property of like kind. Exchanges of this sort must meet certain conditions under Section 1031 and the implementing regulations issued by the U.S. Treasury to ensure that tax on any gain will be deferred.
[---] has indicated that the Subsidiary will provide such services as (i) reviewing the client's asset portfolio in light of the client's objectives and tax exposure and discussing the possible disposition of existing properties, the suitability of a Section 1031 exchange, and the structure of possible transactions; (ii) reviewing proposed transactions to facilitate compliance with the requirements of Section 1031 and revenue Procedure; and (iii) preparing required documentation, which would be tailored to each transaction. The Subsidiary may also refer any sale transactions of property to be relinquished to an unaffiliated real estate broker, where appropriate, and identify thirdparty providers of such services as real estate management, maintenance, construction or other similar services.
In a reverse exchange, the replacement property is acquired before any property is sold ("Relinquishment Property") by the client ("Taxpayer"). Where Relinquishment Property has been identified for a reverse exchange transaction, the Revenue Procedure provides that a safe harbor exchange must be effectuated through the use of an Exchange Accommodation Titleholder1 ("EAT"). When a Taxpayer decides to make a reverse exchange regarding Relinquishment Property that has been identified, in order to purchase the property to be exchanged ("Replacement Property") for the Relinquished Property, the Subsidiary will, at the Taxpayer's request, form a single member LLC where the Subsidiary is the sole member for the purpose of facilitating the transaction. The LLC is the EAT. The LLC will acquire legal title to the Replacement Property for the Taxpayer to obtain qualified indicia of ownership for tax purposes. However, the LLC will hold no real equity interest in that property and will not share in any gain or loss from holding the property.2
For the reverse exchange to fall within the safe harbor of the Revenue Procedure, which will allow the Taxpayer to defer taxes on any gain received from the sale of the Relinquished Property, the Taxpayer and the EAT must enter into a qualified exchange accommodation agreement ("QEAA") not later than five days after the Replacement Property is transferred to the EAT for the benefit of the Taxpayer. The Relinquished Property must be identified within 45 days of entering into the QEAA. Finally, the Replacement Property held by the EAT must be transferred to the Taxpayer within 180 days of entering into the QEAA and the Relinquished Property must be sold by the Taxpayer within that same time period.It is common for the Taxpayer and the LLC to enter into a lease agreement with respect to the Replacement Property that is the subject of the QEAA. The LLC will lease the property to the Taxpayer so that all economic benefits, such as income from operations, will inure to the Taxpayer. Also, the lease agreement will allow the Taxpayer the right to occupy, use and improve the property, and at the same time, obligate the Taxpayer to pay all tax, improvement and maintenance costs related thereto.
By way of background for the application at issue, in September 2006, the Banking Department approved an earlier application made by [---] in accordance with Part 14 of the Regulations to establish an operating subsidiary to engage in the business of facilitating reverse exchanges of like-kind property under Section 1031. While that application pertained to the same activity now being proposed, the subsidiary discussed therein intended to enter into the business of facilitating reverse exchanges of like-kind property by acquiring a portion of the assets and business of (“CEA”) never effectuated the acquisition of CEA which was sold to another bidder.
The September 2006 approval was based on a legal determination that the proposed business activity of [---]'s subsidiary was authorized under Banking Law Section 974a(f) since [---] itself could legally conduct the same activity. It was-also concluded that [---] would not be required to furnish notice of, or obtain Banking Department approval for, each transaction for the reverse exchange of like-kind property that results in formation by the subsidiary of an LLC, as described in the application. (See attachments).
As was requested in the earlier application regarding the establishment of a subsidiary to engage in the business of facilitating exchanges of like-kind property, [---]'s current application asks the Banking Department to confirm that the, proposed activities to be conducted by the Subsidiary are authorized under Section 97-4a of the Banking Law and Part 14 of the General Regulations of the Banking Board. [---] also seeks confirmation that notice to, and approval of the Banking Department, are not necessary for each transaction for the reverse exchange of like-kind property that results in the formation by the Subsidiary of an LLC.[---]'s application has been reviewed and found to comply with the requirements of Part 14.3 of the Regulations. The Legal Division is of the opinion that the proposed activities to be conducted by the Subsidiary are authorized under Section 97-4a(f) of the Banking Law.
1 I understand that after questions were raised in the course of the examination about the status of the Certificates under Part 322, the Bank substituted other assets as "specified assets" for purposes of meeting the asset deposit requirement.
2 As is explained in the application, the assets of the LLC will be held separately from the assets of the Subsidiary and [---] and therefore, will not be reflected on the balance sheets of these entities.