After a few years’ hiatus, reverse exchanges are making a comeback! And are they! This is an encouraging sign that the real estate market is improving. Until recently, we have seen the reverse exchange activity come almost to a stand still. Many investors want to acquire their desired replacement property but their real estate professionals were not optimistic about finding a buyer for their relinquished property within the next 180 days. However, a renewed interest in reverse exchanges point to renewed hope and investors are again electing to structure reverse exchanges to help preserve their ability to defer their gain through a 1031 tax-deferred exchange.
What Is A Reverse Exchange?
A reverse 1031 exchange is a strategy used when you want to defer the capital gain under Section 1031 but must acquire the replacement property prior to conveying title of your relinquished property to a buyer. The most common situations that necessitate a reverse exchange include:
A 1031 exchange is considered to be a continuation of the initial investment and cannot be accomplished if you simply own both properties. It must contain the sale of relinquished property followed by the purchase of replacement property within 180 days.
Overview of Reverse Exchanges
Revenue Procedure 2000-37 provides a “safe harbor” for reverse exchanges. A “safe harbor” generally means the IRS will not attack a transaction if it is structured within the rules specified. The Rec. Proc. uses a structure called a Qualified Exchange Accommodation Arrangement (QEAA). To facilitate the reverse exchange, legal title to either the relinquished or the replacement property must be held by an Exchange Accommodation Titleholder (EAT) until title to the relinquished property can be conveyed to a buyer. The EAT is typically a single member limited liability company in which the single member is the Qualified Intermediary (QI) or an affiliate of the QI. The safe harbor allows the EAT to “park” legal title for a maximum of 180 days with all of the burdens and benefits of ownership including maintenance of accounting records and tax reporting. To protect your property, the entity used to hold title to your property should only ever hold title to this one property and should be dissolved immediately after title is conveyed from the EAT.
How Does A Reverse Exchange Work?
Financing and the anticipated length of time the EAT is expected to "park" title to your property are usually the determining factors when deciding whether the EAT takes title to your replacement or relinquished property.
Exchange Last
Parking the replacement property (an “Exchange Last”) is generally preferred when you have existing debt on the relinquished property that cannot be paid off or if you wish to complete improvements to the replacement property during the 180-day QEAA period.
These are the steps to setting up an Exchange Last reverse:
Exchange First
Parking the relinquished property (an “Exchange First”) may be a better option for you when there is no debt on the relinquished property or the existing debt can be paid off or assigned to the EAT; the existing lender has agreed not to call the loan when title of the relinquished property is transferred to the EAT; the replacement property is located in a state that would require payment of duplicate transfer taxes of a larger amount than the relinquished property or there is complex financing already in place on the replacement property.
To structure an Exchange First reverse exchange, you must enter into an Exchange Agreement with a QI and a QEAA with the EAT as in an Exchange Last reverse.
However in order for the EAT to acquire the relinquished property, you will need to follow these additional steps:
Things to Keep in Mind
While there are additional costs and they require more planning, if you have identified the property you want to acquire but have not yet secured a buyer and need to close soon, consider a reverse exchange. A reverse 1031 exchange is more complex than a regular 1031 exchange but provides the opportunity to make what seems like an impossible situation, possible.
The 1031 CORP. Exchange Team has the expertise to keep your reverse exchange easy. Contact us to discuss your discuss your situation with one of our Certified Exchange Specialists®.