What is a Reverse Exchange?

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:

• You have found the ideal replacement property but have not yet sold or closed on your relinquished property.
• You must settle on the replacement property or lose substantial down monies and/or favorable financing.
• A Buyer of your relinquished property has not been found or falls through at the last minute and the closing on the replacement property cannot be postponed without jeopardizing the transaction.

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.