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The Basics of a Reverse Exchange and The Key to a Successful Transaction

Written By Diane Schaefer, CES™ and President of Exchange Solutions, Inc., N.Y.

Reverse exchanges are becoming more prevalent in today’s market. Taxpayers are securing their replacement property prior to selling their relinquished property. I felt the necessity to revisit the topic of reverse exchanges and revenue procedure 2000-37. Within the past several months, I have witnessed many spoiled reverse exchanges because the taxpayer took title to the replacement property prior to selling the relinquished property. I have also found that lenders and attorneys are still not certain of this procedure.

Since the revenue procedure was issued back in September of 2000, more Qualified Intermediaries (QIs) are adding this service as a normal function of IRC Section 1031 and reverse exchanges have become more commonplace. The intention of this article is to briefly highlight the key issues of this guidance published by the IRS approving the use of parking arrangements. Transactions would commonly use one of the following methods: exchange occurs first, relinquished property is parked or; exchange occurs last, replacement property is parked. If the taxpayer follows these guidelines with the assistance of a good QI, the service will not challenge the procedural qualifications of either approach for the purpose of the treatment of the exchange. The following requirements must be met:

1. The property must be held in a Qualified Exchange Accommodation Arrangement (QEAA) wherein the taxpayer and the Exchange Accommodation Titleholder (EAT) must enter into a QEAA no later than 5  business days after the transfer of legal title of the property to the EAT.

2. The EAT must have qualified indicia of ownership of the property which may be legal title or other indicia of beneficial ownership. The property that is transferred to the EAT is done so with the taxpayer’s intent to qualify for nonrecognition of gain or loss under 1031 and the written agreement must provide language that the EAT is holding this property for the benefit of the taxpayer in order to facilitate an exchange under  1031. The EAT is not an agent of the taxpayer for federal income tax purposes. The EAT must agree to report the acquisition, holding and disposition of the property and will be treated as the beneficial owner for federal income tax purposes.

3. The taxpayer or a disqualified person may guarantee the obligations of the EAT with respect to secured or unsecured debt incurred to acquire the parked property and may indemnify the EAT against costs and expenses.

4. The taxpayer or a disqualified person may loan or advance funds or guarantee a loan or an advance to the EAT in order to acquire the parked property.

5. The relinquished property must be identified within 45 days from the date the replacement property was transferred to the EAT. Identification will properly be followed in accordance with the same rules that apply to a forward exchange (1.1031(k)-1(c)).

6. The acquisition of the parked property from the EAT to the taxpayer through the use of a QI must be no later than 180 days after the date the transfer of the parked property was conveyed to the EAT from the true seller. Transactions that occur outside the 180-day safe harbor are not touched upon in this article nor are the financial issues involved in these transactions. The reverse exchange is an alternative for taxpayers to structure their like-kind exchange under an approved guidance issued by the service. The appeal of a reverse exchange is that it affords the taxpayer the opportunity to acquire or construct on replacement property where the disposition of the relinquished property is delayed and the taxpayer can still enjoy the tax benefits of the 1031 exchange.

Taxpayers, attorneys and accountants need to seek out a professional QI and/or EAT in order to facilitate a reverse exchange. Not all QIs are familiar with reverse exchanges and equipped to handle out of state transactions. Many neglect to file proper federal income tax returns. These issues can result in major claims and IRS audits. You should expect to pay premium transactional fees for a premium service. Due diligence is key; consumers and professionals should search for a reputable intermediary by contacting the Federation of Exchange Accommodators.

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