Understanding Non-Safe Harbor Reverse Exchanges: Lessons from Bartell v. Commissioner
Reverse 1031 exchanges are a powerful way for real estate investors to acquire replacement property before relinquishing their current asset. While the IRS issued a “safe harbor” procedure in Revenue Procedure 2000-37, not all transactions fit neatly into that framework. When that happens, the result is what’s known as a non-safe harbor reverse exchange—a structure that operates outside of the IRS's clearly defined guidelines.
One of the most influential cases in this area is Bartell v. Commissioner, which helped clarify whether reverse exchanges outside the safe harbor can still qualify for tax deferral. Let’s break down what non-safe harbor reverse exchanges are, the impact of the Bartell case, and what it means for investors.
What Is a Non-Safe Harbor Reverse Exchange?
In a safe harbor reverse exchange, the investor works with a Qualified Intermediary (QI) and an Exchange Accommodation Titleholder (EAT) to acquire and hold title to the replacement property for up to 180 days. As long as certain timelines and documentation requirements are met, the IRS generally won’t challenge the transaction.
However, in a non-safe harbor reverse exchange:
The structure doesn’t meet all the conditions outlined in Rev. Proc. 2000-37.
The 180-day timeline might be exceeded.
The EAT structure might not be used, or the documentation may be insufficient.
The investor may retain beneficial control of the property directly or indirectly.
Despite these deviations, non-safe harbor exchanges aren’t automatically disqualified—they’re simply not given the same IRS assurance. This creates higher audit risk and requires careful legal and tax planning.
The Significance of Bartell v. Commissioner
In the landmark Bartell v. Commissioner (2016) case, the U.S. Tax Court ruled that a reverse exchange could still qualify for like-kind treatment even if it did not comply with the IRS safe harbor.
The Facts:
The taxpayer (Bartell Drug Company) arranged for a replacement property to be constructed.
The company took possession of the property more than 17 months before selling the relinquished property.
The arrangement did not use a traditional EAT structure, and the holding period far exceeded the 180-day limit.
The Outcome:
The court ruled in favor of the taxpayer, allowing Section 1031 treatment. The key factor was that the taxpayer never took legal title to the replacement property before the exchange and held only equitable interests, even if it bore much of the construction cost and control.
This case demonstrated that substance-over-form arguments can prevail, even when formalities of the safe harbor aren’t followed.
Key Takeaways from Bartell v. Commissioner
IRS Safe Harbors Are Not the Only Path
While following IRS guidance offers more certainty, failing to do so doesn’t automatically disqualify the exchange.
Substance Over Form Matters
The court focused on whether the taxpayer truly owned the property before the exchange, not just whether procedural boxes were checked.
Documentation and Legal Structure Are Crucial
Even outside safe harbor rules, thorough agreements and third-party arrangements that support the exchange’s intent can be persuasive.
Risks of Non-Safe Harbor Exchanges
While Bartell set a favorable precedent, non-safe harbor reverse exchanges still carry significant risk:
Audit risk is higher, and favorable outcomes may depend on litigation.
The lack of formal guidance creates uncertainty about what structures are acceptable.
Not all tax courts may interpret facts the same way, so results are fact-dependent.
If the IRS successfully challenges the structure, the investor may owe capital gains and depreciation recapture taxes.
Should You Consider a Non-Safe Harbor Reverse Exchange?
In general, safe harbor exchanges are preferable due to clarity and lower risk. However, investors who must operate outside of those boundaries—due to timing, construction needs, or unique deal structures—may consider non-safe harbor routes with strong legal guidance.
Work closely with your Qualified Intermediary, CPA, and real estate attorney to ensure the exchange is properly structured and defensible, especially if it involves long timelines or atypical arrangements.
Non-safe harbor reverse exchanges are complex but not impossible. The Bartell decision shows that courts may accept creative, well-documented exchange structures even when they fall outside the IRS’s preferred framework. However, the burden is on the taxpayer to prove the transaction meets the intent of Section 1031.
If you're considering a reverse exchange that may not meet the safe harbor criteria, get expert help early. With the right strategy, you can still achieve full tax deferral—just be prepared for a higher standard of scrutiny.
