Reverse Exchange

Typically the taxpayer closes on their investment property before closing the new replacement property and a traditional forward 1031 tax exchange would be completed. Of course, that’s not always the case, especially when the housing market is improving, and in many areas of the country, multiple offers are received within days of listing. In 2000, the IRS enacted Revenue Procedure 2000-37, providing the guidelines for which the taxpayer may complete a 1031 reverse exchange.  A reverse exchange is when the replacement is acquired before selling the relinquished or old property.

The first step in a reverse exchange is talking with and engaging a qualified intermediary (QI) to discuss the steps of a reverse exchange. A QI is necessary because the taxpayer is not allowed to be on title to both the new and old property at the same time. The QI will coordinate the establishing of an exchange accommodation titleholder (EAT), which will be the entity that takes title to the replacement or relinquished property. The dilemma is how to acquire the replacement property without having access to the relinquished property proceeds or net equity. A loan can be secured to purchase the replacement property and once the relinquished sells, the funds can be used to pay down the debt or reimburse the taxpayer. As with all 1031 exchanges, the Seller should be notified by assignment language that the taxpayer intends to complete a reverse exchange.

Reverse First

In a reverse first, the new property is parked with the EAT. The taxpayer may need to get a loan in the name of the EAT from a lender to complete the purchase given the proceeds from the old property aren’t available as they are with a traditional 1031 exchange. Lenders are typically not cooperative to have the EAT on title, but with those that are, the EAT signs a non-recourse note meaning EAT is not responsible for the payment of the loan.

Reverse Last

I find that parking the old property with the EAT and allowing the taxpayer to acquire the replacement property directly is the preferred strategy. In a reverse last, a loan may be needed to acquire the replacement property; the taxpayer is able to do so directly with the lender. Loan payments on the old and new property are the responsibility of the taxpayer. Rental revenues are received just as normal to the taxpayer while expenses including utilities, maintenance, insurance and taxes for the old property parked with the EAT are the responsibility of the taxpayer.

Timing

The timing for a reverse exchange is similar to a traditional 1031 exchange. Within 45 days of the closing date on the replacement property, the taxpayer must identify the property they intend on selling and within 180 days from the same purchase date, the actual sale must be completed. These reverse exchange time guidelines are very strict.

Title Transfer

Once the sale of the relinquished property is completed, the QI will wire the sales proceeds to pay off the loan the taxpayer had to secure in order to purchase the new property. The taxpayer is not in possession of the old property, so the QI transfers title to the parked property either to the Buyer in a reverse last or to the taxpayer in a reverse first, completing the reverse exchange.

Another title transfer option is for the EAT to assign the EAT to the taxpayer to avoid possible state imposed real property transfer taxes.

There are improvement and reverse/forward hybrid exchanges that allow the taxpayer to use the relinquished property proceeds towards making improvements to the new property. There are also 1031 exchanges where following the replacement and first relinquished property closing, if there are additional cash and debt requirements another replacement property can be acquired with a full 180 calendar timeframe.

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1031 Exchange Consultation