Learn About the 1031 Exchange Process – Qualifying For Reverse 1031 Exchanges

If you have heard of the concept of a 1031 exchange, but don’t know precisely what it is, you can turn to us for assistance. We specialize in helping our clients with all sorts of different exchanges, including tax deferred exchange transactions and reverse exchange transactions. This page will help you figure out whether or not you are eligible to engage in a reverse exchange. This sort of 1031 exchange is meant to allow buyers to purchase new properties now, while hanging onto real estate they want to sell until later when it might be worth more. If you believe a reverse exchange could be right for you, give us a call.

The Reverse Exchange is the opposite of the Delayed Exchange. Where the Delayed Exchange requires the Exchangor to relinquish property before he acquires property, the Reverse Exchange allows the Exchangor to acquire property first and relinquish property second. In other words, the Reverse Exchange allows an investor to acquire a new property today, when an excellent investment may be available, and sell other property later when a better price might be obtained.

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.

If you would like to find out about the reverse exchange process or the tax deferred exchange process, contact one of our experts today. We want to help your 1031 exchange transaction go as smoothly as possible.

REVERSE EXCHANGE

The Reverse Exchange is structured primarily with Revenue Procedure 2000-37 in mind. Although Reverse Exchanges have been structured for decades prior to the Revenue Procedure, many investors now follow the Revenue Procedure to receive the safe harbor benefits.

The Revenue Procedure provides that the IRS will not challenge the qualification of property as either “replacement” or “relinquished” if there is a qualified exchange accommodation arrangement (QEAA). The requirements of the QEAA are:

  1. The property is transferred to an exchange accommodation titleholder (EAT). Equity Advantage creates the EAT in the form of a LLC. The purpose of the transfer is so that the taxpayer is not the holder of the property.
  2. At the time of transfer to the EAT, it is the taxpayer’s intent that the property held by the EAT represents either the replacement and/or relinquished property.
  3. No later than five business days after the transfer of the property to the EAT, there must be a written Qualified Exchange Accommodation Agreement.
  4. 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 rules.
  5. The combined time period that the relinquished and replacement properties are held in the Qualified Exchange Accommodation Agreement is not to exceed 180 days.

 

Additionally, the Exchangor cannot receive property already owned as replacement for property to be relinquished.

PRACTICAL CONSIDERATIONS FOR THE REVERSE EXCHANGE

Funding

First and foremost the Exchangor needs to have the financial ability to purchase the replacement property. Remember, the Exchangor will not have the benefit of sale/exchange proceeds since the relinquished property has not yet been sold. The Exchangor must draw upon other financial resources for the acquisition. If a loan from a commercial lender is needed, then the lender has to be willing to lend the money to the EAT.Equity Advantage knows of such lenders who can make this accommodation and may provide the information to you.

Parking

Parking refers to the EAT taking and holding title to the property during the exchange. (“Warehouse”, “station”, “place” would also be apt descriptions, but the IRS uses “park” as its metaphor.) This parking technique is used because Revenue Procedure 2000-37 prohibits the Exchangor from having ownership of the relinquished and replacement property simultaneously.

There are two parking approaches for completing a Reverse Exchange: park replacement property and park relinquished property. Deciding which property (either the replacement property or relinquished property) is parked is determined by considering a number of factors: the funding source to pay for the acquisition, liens on the relinquished property, and the equity in the relinquished property.

If the Exchangor wishes to improve the replacement property, then the replacement property must be parked. Any improvements are to be constructed prior to the Exchangor’s receipt of the replacement property.

No matter which property is parked, the property is available to the Exchangor. Equity Advantage creates a lease and property management agreement between the EAT and the Exchangor so that the Exchangor has complete access to the parked property.

Park Replacement Property

In the park replacement approach, Equity Advantage creates a new single member LLC in which Equity Advantage is the sole member of and the replacement property is the sole asset.

The new LLC serves as the EAT. The LLC borrows money from the Exchangor (and/or a lender) to acquire title to the replacement property. The LLC retains ownership of the replacement property until a buyer is found for the relinquished property. The sale proceeds go to Equity Advantage when the relinquished property is sold just as they would in a delayed exchange. The sale proceeds are then used to payoff loans incurred by the LLC. Finally, Equity Advantage’s ownership of the replacement property is transferred to the Exchangor completing the exchange.

Park Relinquished Property

In the park relinquish approach, Equity Advantage creates a new single member, single asset LLC. Equity Advantage is the sole member of the LLC and the relinquished property will become its sole asset.

When the LLC acquires the replacement property, the LLC simultaneously swaps it with the Exchangor’s relinquished property. In effect, the LLC has transferred the replacement property to the Exchangor and the LLC has received title to the relinquished property. The relinquished property is owned by the LLC until a buyer is found. At the time of closing, title of the relinquished property will be transferred from the LLC 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 loans incurred by the LLC, completing the exchange.

EXCHANGOR’S GUIDELINES TO ACCOMPLISHING THE REVERSE EXCHANGE


EQUITY ADVANTAGE’S COURSE OF ACTION TO COMPLETE THE REVERSE EXCHANGE