The Reverse Exchange
A Reverse Exchange allows an investor to acquire a new property today and to sell the old property later. The Reverse Exchange greatly expands the ability of the investor to take advantage of changes in the marketplace and to improve his or her investment position. Although the Reverse Exchange has been used for decades, the Internal Revenue Service did not issue any guidelines until 2000 when they published Revenue Procedure 2000-37.
For a Reverse Exchange to be considered, it is necessary for the Exchangor to have the financial ability to purchase the target property while not yet having the proceeds from the future sale. The required down payment will be lent to the Exchange Accommodation Titleholder (EAT). This loan is typically repaid upon the sale of the Exchangor’s relinquished property.
Reverse Exchange Basics
There are two primary strategies for completing a Reverse Exchange:
- Warehouse Replacement PropertyIn the Warehouse Replacement approach, Equity Advantage will create a new single member, single asset LLC that Equity Advantage is the sole member of. The new LLC is commonly called an EAT (Exchange Accommodation Titleholder) and the EAT borrows the down payment from the Exchangor and acquires title to the replacement property. The EAT retains ownership of the replacement property until a buyer is found for the relinquished property. When the relinquished property is sold the proceeds from the sale go to Equity Advantage just as they would in a delayed exchange. The sale proceeds are then used to payoff the initial loan between the Exchangor and the EAT. Finally, Equity Advantage’s ownership of the replacement property is transferred to the Exchangor completing the exchange.
- Warehouse Relinquished PropertyEquity Advantage creates the EAT to hold title of the relinquished property. When the replacement property is acquired it is simultaneously swapped with the Exchangor’s relinquished property. The Exchangor now holds title to the replacement property and the EAT holds title to the relinquished property. The relinquished property is owned by the EAT until a buyer is found. At the time of closing, title of the relinquished property will be transferred from the EAT to the buyer and the sale proceeds will go to Equity Advantage as they would in a delayed exchange. The sale proceeds are then used to payoff the initial loan between the Exchangor and the EAT, completing the exchange.
Again, properties that fall under dealer status do not qualify for a 1031 exchange.
Section 1031 does not contain a minimum hold period other than when exchanging between related parties (then the property must be held for 2 years). Ultimately time is much less important than intent. As these nine points show, a pattern will form. It is possible for an investor to have one or two of the above “strikes” against them and still qualify. Most “dealers” will have a problem with a majority of the points. Ultimately whether a property quali es is up to the Exchangor and the Exchangor’s tax counsel.
Reverse Exchange Requirements
- At the time the property is transferred to the exchange accommodation titleholder (EAT), it is the taxpayer’s intent that the property held by the EAT represents either the replacement and/or relinquished property.
- No later than five business days after the transfer of the property to the EAT, there must be a written Qualified Exchange Accommodation Agreement.
- No later than 45 days after the transfer of the replacement exchange property to the EAT, identification of the relinquished property or properties is required. The identification must be consistent with the existing delayed Exchange rules.
- The combined time period that the relinquished and replacement properties are held in the Qualified Exchange Accommodation Agreement is not to exceed 180 days.
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