Most taxpayers know about the tax-deferred benefits of 1031 exchange but many are not as familiar with reverse exchanges. A reverse 1031 exchange is a strategy used when you want to acquire the replacement property prior to conveying title of the relinquished property to a buyer. The most common situations leading to a reverse exchange are as follows:
Our reverse exchanges are structured under Revenue Procedure 2000-37 which provides a 180-day “safe harbor” period to “park” title until the exchange can be completed. Under this structure, we create an entity to act as the Exchange Accommodation Titleholder (EAT), bound by a qualified exchange accommodation arrangement (QEAA) which is essentially a “parking” arrangement. As an exchange is considered the continuation of the original investment, you cannot own both the relinquished and the replacement properties at the same time. To facilitate the reverse exchange, title to either the relinquished or the replacement property is held by an EAT until the relinquished property can be conveyed to a buyer. The Revenue Procedure allows the EAT to “park” title for a maximum of 180 days.
In today’s market, investors often locate the replacement property before putting the relinquished property on the market. A reverse exchange is often preferred because investors want the time to locate the desired replacement property without the pressure of the 45-Day Identification Period timeclock ticking. The reverse exchange provides the opportunity to sell the property at market value without forcing a fire sale. A reverse exchange can also afford the opportunity to complete improvements on the replacement property prior to giving up the relinquished property which is often essential when relocating a business.
To acquire the property, the EAT borrows the funds from the investor or more often from the investor and a third-party lender. During ownership by the EAT, the EAT leases the property to the investor through a triple net lease which gives the investor the opportunity to report the income and expenses on investor’s tax return.
Reverse exchanges do take more planning and cost slightly more than a typical forward exchange but are certainly well worth the time and expense to preserve the tax-deferral treatment under Section 1031.
Reverse exchanges make the impossible, possible.
The 1031 Exchange Team brings over three decades of combined exchange industry experience and has facilitated thousands of exchanges. Based in Collegeville, Pennsylvania and Bend, Oregon, our exchange experts are ready to answer your questions, guide the process, and facilitate your exchange.
An Exchange Accommodation Titleholder (EAT) is used to complete a reverse exchange or improvement exchange.
Construction/improvement exchanges occur when you want to make improvements to the replacement property utilizing the sale proceeds of the relinquished property.
Whether a reverse or forward improvement exchange, the acquisition of the parked property should be structured with the following considerations.
There are instances where the taxpayer may need to take ownership of the new property prior to the sale of the old property. For example, the taxpayer may run the risk of losing that perfect replacement property or the sale of the relinquished property cannot be accomplished in advance of the purchase.