Reverse 1031 Exchanges – What They Are and How to Use Them

David Moore: Hello, David Moore with Equity Advantage, 1031exchange.com. And today I’ve got Tina Colson from my firm joining me.

Tina Colson: Hello.

David Moore: And she’s going to be testing.. Tina!

Tina Colson: Yes.

David Moore: So what do you got for me today, Tina?

Tina Colson: So today we’re going to talk about reverse exchanges. Properties are flying off the market right now. And so the problem tends to be that somebody may not be ready to sell a property before they find their property that they are looking to purchase, and they want to purchase that property really quick. So with a reverse exchange, people think, “Well, what’s the big deal? I’m just going to buy first and sell later.”

What they don’t realize is that they, one, need to come in with cash for the property before their other property sells and they have the proceeds from that. And then secondly, by law, they cannot take title to both the old property and the new property at the same time. So, therefore, we have to warehouse either the relinquished property or the replacement property during the exchange. So I want to talk today about which property we warehouse and how that decision is made, and the rules between whether we take the relinquished or take the replacement. David?

David Moore: Great. Good question. I mean, it’s really a crazy time. As we discussed yesterday, one of the brokers we work with had posted something stating they got, what was it, 75 or 78 all cash offers in one day, and they were just saying that has to be some type of record. So what that means to our clients is, obviously, the 45-Day ID period is so problematic.

In today’s world, is really tough. I mean, for the brokers out there, if somebody came to you with contingency offer today, I mean, what would happen? You’d say, “Heck no.” So the reverses are very, very popular, and we’ve been doing reverses since 1991, and for the first nine years there, until we got the rev proc 2000-37th for reverse exchanges, as Tina said. One of the safe harbors in that rev procedure is that you cannot have ownership of the new and old property at the same time.

David Moore: Before that was in place, we used to do what we’d call a true reverse exchange. And I’m not going to burn any time on it, but it was really just the opposite of a delight. And the first thing I’ve got to say about any reverses, if you don’t have the financial ability to buy the property, we’re not going to buy it. We’re not going to do the transaction. We don’t loan money. So any reverse is going to require you, the taxpayer, to have the cash to make the deal happen and it’s going to be a question of how much you have available.

And as you were asking, Tina, it’s like a reverse warehouse replacement means that we’re going to create a limited liability company. In the exchange world, it’s called an EAT, an Exchange Accommodation Titleholder. We certainly do live in a world of acronyms these days. But the bottom line is a single member LLC that the exchange company is a member of.

David Moore: So a warehouse replacement means we’re going to warehouse the replacement property. Warehouse relinquish means we’re going to warehouse the relinquished property. Your question was, how do we decide which way we’re going to go on it?

Tina Colson: Absolutely.

David Moore: One of those factors is personal preference. What do you want to own? Two, the question is, if there’s financing that’s involved, what are they going to allow us to own? So we’re always going to be balancing that decision to warehouse, to relinquish a replacement.

It’s going to be driven by whether you’ve got the cash to buy it outright, whether you’re going to finance it, how much money you have available for the purchase versus what you actually have coming out of the relinquished property. And we’re going to do a warehouse replacement. And by the way, warehouse replacement is really the same structure as an improvement exchange. So we’re just going to create the entity. It’s going to take ownership of the asset. An improvement exchange just means we’re going to be going vertical on the thing during the time we “warehouse it” or “park it.”

David Moore: So just for those out there that are confused with the term warehousing or parking, again, the reverse does not allow you to own both at the same time. So we’re going to create an entity that’s going to own one or the other and warehousing or parking are just words that are used to describe which property we’re taking ownership of. So if you’ve got less money available to buy than what you expect to net, typically, that means we’re going to warehouse the replacement property.

So what would happen if you’ve got a half million dollar deal and you have 1000 to put down on it, you have 200 coming out of the old property, you’re going to show up to the purchase with 100 to buy that property. We’re going to have a note drawn between you, the taxpayer, and we, as the accommodator saying basically, “We borrowed 100,000 from you, and we’re going to close on that property.”

David Moore: And that’s going to require, in that scenario we’re going to require a lender that’s going to allow us to take ownership. And that loan is going to look something like this. It’s going to be a loan to the limited liability company we’re the member of, secured by the property, but guaranteed by the taxpayer. The taxpayer is going to go out and secure financing as though he or she were buying it. Ultimately, it’s going to be theirs.

Now, using that structure, what I like to do is name the entity in a name that the taxpayer ultimately wants to own the asset. And if we can do that, and it’s a single member person or entity that’s coming into that transaction to complete the deal, we’re just going to sign a membership interest in the LLC back through their client to complete the exchange instead of having to deed that from our entity over to them, completing the transaction.

Tina Colson: So now they hold that property in their own LLC at the end of the day?

David Moore: Yeah. And the beauty of it is if there’s transfer tax, we can get away from additional deeds. We don’t have to have the deeds drawn. We don’t have transfers occurring. If loans are in place, the loans don’t have to be changed. Everything stays the same. Title policies, this is something that you’ve got to understand too, if we’re doing warehouse replacement, the title policy is written for the entity we’re closing it in.

Tina Colson: Mm-hmm (affirmative).

David Moore: Unless you’re going to pay for a second title policy, you need to make sure you’re additionally insured on that policy. So that’s something that you really need to be aware of too in a warehouse replacement. But the beauty of the warehouse replacement is using the scenario, you’ve got 100 to put down, 200 coming out. We’re going to sign the note. We owe you 100. When your property sells, we’re going to take 100 repay the debt to you that we have. The other 100 is going to be used to pay down the debt on the replacement property, and then we will, after paying it down, convey ownership of that property back to you, completing the transaction.

If you want to buy additional property, we can do that via an effective delayed exchange at that point from the date your property sells. So the reverse exchange, just like a delayed exchange, gives you that 180 day timeline to sell things in a reverse instead of buying things in a delayed.

David Moore: But if you wanted to take the additional money, go buy additional assets, you’d just be starting the clock on a delayed exchange at the date that thing goes away. But the beauty of that warehouse replacement is it allows us to put money into it, paying down the debt, getting it taken care of. The downside is that the money’s probably, if you have to get a loan, the money is probably going to be more expensive. You’re going to need a portfolio lender because the ultimate owners, not the owner at the time the loan is being put in place.

So warehouse replacement means we’re warehousing the replacement property. That’s sometimes described as an exchanged last transaction to. A warehouse relinquish means that when we buy that replacement property, that 100 that you come in with is going to buy the property and we’re going to immediately give you that property when your property sells, and we will have been deeded the property that’s to go away.

David Moore: When that property goes away, using the numbers we’ve been using, let’s say 200 in equity, 500 sale, the 200 comes into us, we’re going to take the 100 and pay back what you have loaned us, and then the additional money we can’t put into that property at that point. You already own it. So at that situation, we’re going to have to go buy something else in addition to that or you’re going to have tax exposure on that difference.

Tina Colson: Great. Thank you.

David Moore: Sure. That’s just one of those things that comes up all the time and with respect to which way it’s going, I just think there’s a lot of misunderstanding out there with respect to what happens. And sometimes people think that we loan money, and, obviously, we’re not going to do that. And I want to stress once again, you’ve got with a reverse exchange, you’re going to have 45 days from the date of acquisition to identify what’s to be relinquished and 180 days to actually have those go away. Now, the other question you didn’t ask that comes up is, “Well, what happens if I never sell the property?”

Tina Colson: Oh, yes.

David Moore: Now, I’ve got a “failed” reverse exchange. Well, there’s no tax consequence on that transaction. You didn’t give up anything. So all that’s happening is you’re now the proud owner of another asset, and you no longer have the ability to exchange into it. So if we are warehousing the replacement property, and we now have a failed transaction, we’re just going to transfer that asset back to you, making you whole. If, on the other hand, we are warehousing the relinquished property and it never goes away, we’re just going to transfer it back to you and you don’t have gain because you didn’t realize gains because nothing went away.

Tina Colson: Right.

David Moore: And one last comment, we’re talking about reverses and this comes up, so you can dig through our video library on seller finance in a transaction. A lot of times people will say, “Well, you can’t sell and do an exchange using a note and trust to your land sale contract.”

That’s untrue. There’s five ways we can do it. But if we’re looking at a seller, carry back in a reverse exchange, it’s beautiful. Because think about this, when we buy that property, once again, using the 100 number, so you show up at that purchase with 100K, and we have a debt to you for that $100,00 that’s paid back with the disposition of the relinquished property when it happens in the future, well, if you just carried a note, we’re just going to use the note to repay the debt to you. So a seller carry back with a reverse exchange is very, very easily taken care of. Works great.

David Moore: If you’ve got additional questions, concerns on reverse exchanges, the only dumb question is the one you don’t ask. So ask the questions. And that leads me to this fact, and we’ve got a pretty thorough library of videos, but if you’ve got a topic that you want to know more on, please don’t hesitate to reach out. Send us an email and we’re going to be happy to address any questions or concerns you may have.

Tina Colson: Absolutely. Thank you, David. And so, again, any questions, reach out to us. Equity Advantage, 503-635-1031, or 1031exchange.com on our website. And, again, David Moore and Tina Colson. Thank you for joining us today.

David Moore: I always hate that when we go, “Punch that like button,” but please punch that like button. And if you like what we’re presenting, please subscribe to the channel. We’d love to have you join us for all of these, and look forward to doing business with you. Thank you very much.

Tina Colson: Thank you.