REVERSE EXCHANGE

A reverse exchange is the purchase of the Replacement Property prior to closing on the Relinquished Property. An Investor may need to consider a reverse exchange in a situation where the Replacement Property must be acquired before the Relinquished Property can be sold.  Due to increased transaction and exchange costs associated with a reverse exchange, IES strongly recommends that Investor first exhaust all options to delay closing on the Replacement Property until the closing on the Relinquished Property has occurred.  Some possible ways to delay closing on the Replacement Property include:

1. Putting up more non-refundable earnest money to buy a closing extension.  Again, it may be cheaper to pay for an extension that to pay the Intermediary the additional costs associated with a reserve exchange.
2. Leasing the Replacement Property with an option to purchase that would trigger upon sale of the Relinquished Property.  This approach has the duel advantage of allowing Investor access to the Replacement Property and giving the Seller some rental income while they wait for the Relinquished Property to sell.

Revenue Procedure 2000-37 (finalized on September 15, 2000) provides the framework to safely perform a reverse exchange.   The most common variation of a reserve exchange allowed under Revenue Procedure 2000-37 (often called “replacement property parked” or “exchange last”) involves an entity referred to as an “accommodating title holder” or “AT” first purchasing the Replacement Property. When the Relinquished Property is sold at a later date, the AT completes the exchange by deeding the Replacement Property back to the Investor.  During the AT’s ownership, the Replacement Property is leased to Investor in order to give Investor the beneficial use of the Replacement Property during the exchange period.

The AT will usually be a single purpose limited liability company owned and managed by IES. The following agreements are permissible regardless of whether or not they contain terms which may typically destroy an arms length relationship between the EAT and the Investor.

1. The AT may act as both the qualified intermediary and the AT.
2. The Investor may guarantee all or part of the obligations of the AT including debt and incurred expenses.
3. Investor may loan or advance funds to the AT and not charge interest on these amounts.
4. The AT may lease the property to Investor at below market rates.
5. The AT may enter into a management agreement with the taxpayer at below market rates.  Typically, the lease or management agreement will provide enough income to the AT to satisfy their debt services payments under bank financing as well as covering all operating expenses for the Replacement Property.
6. The Investor may act as contractor and/or supervisor with respect to the Replacement Property if improvements are going to be constructed.
7. AT and Investor may enter into agreements using puts and calls at fixed or formula prices for subsequent dispositions in the event the exchange cannot be completed within the 180 day period.

An “exchange last” transaction can be illustrated as follows:

Click here to download Reverse Exchange Outline PDF

In the event that the Relinquished Property cannot be sold within the 180-day period following the AT’s acquisition of the Replacement Property, the QEAA provides that the Relinquished Property will be transferred back to Investor subject to the acquisition debt.  The subsequent sale of the Relinquished Property after the 180-day period could still be structured as a 1031 exchange provided that Investor acquired “like-kind” property other than the Replacement Property that was parked by the AT as part of the reverse exchange.

In a reverse exchange, it is especially crucial that you select an Intermediary who has the experience and knowledge of the steps and precautions necessary in these complex transactions.
Also, it is critical to engage the Intermediary well in advance to the purchase of the Replacement Property in order to allow sufficient time to work with the lender’s, attorneys, and closing agent involved.  Working with an Investor’s tax advisors and attorneys, IES draws upon substantial experience with reverse exchanges to help lead the investor safely through a minefield of potential hazards.