Reverse Exchanges

SAFE HARBOR AND NON-SAFE HARBOR REVERSE EXCHANGES

Current market conditions are such that Cooney & Associates, Inc. has seen an increase in Reverse Exchanges over the past six months. 

Real estate investors are finding investment properties they want to purchase, but the properties they want to sell are not selling as quickly.  When the investor wants to "jump" on an investment property they want to purchase even though the property they want to sell has not sold yet, a Reverse Exchange is a great option.  Through a Reverse Exchange the investor can complete a 1031 exchange and reap the tax deferral benefits in the same way as a regular deferred exchange.  However, the Reverse Exchange is often misunderstood by the investor and their advisors and thought to be too complicated, not possible, or too costly.

In a Reverse Exchange, the replacement property is acquired prior to the sell of the relinquished property; that is the investor/taxpayer wants to purchase an investment property and plans to sell a piece of investment property they own sometime thereafter. To accomodate this type of 1031 exchange, the Qualified Intermediary takes title to the Replacement Property (property purchase) and holds title until the taxpayer can find a buyer for the Relinquished Property (property investor wishes to sell) and close on the sale under an Exchange Agreement with the Intermediary. Subsequent to the closing of the Relinquished Property, the Intermediary conveys title for the Replacement Property to the investor/taxpyer thus completing the exchange.  In essence, the investor/taxpayer has sold their Relinquished Property and acquires the Replacement Property shortly thereafter when the Intermediary transfers the title of the Replacement Property into the taxpayer's name.   

Effective September 15, 2000, the IRS recognized reverse exchanges and issued “safe-harbor" guidelines which follow the same time frames (45 and 180 days) as for other types of exchanges.  These "safe harbors" for reverse exchange are simply described as follows:
  1. An EAT (Exchange Accomodation Titleholder), usually an LLC, acquires the Replacement Property and holds title for up to 180 days.  The EAT cannot be the taxpayer or a disqualified party (agent, emplyee, etc.); therefor the Qualified Intermediary is permitted to act as the EAT.  This EAT arrangement is sometimes referred to as a "parking style exchange." 
  2. The Revenue Procedure requires that the Relinquished Property be identifed not later than 45-days after the purchase of the Replacement Property by the EAT.  As with a forward deferred exchange, this identification should be written and the property/ies should be identified so that a person could find the property from the description (most commonly: street address, city, state, zip).  Up to three possible Relinquished properties can be identified.
  3. The parked property must be transferred to the taxpayer no later than 180 days after the transfer of the property to the EAT.  In other words, to complete the exchange the taxpayer must sell their Relinquished Property and have the EAT transfer the Replacement Property to them by the 180th day.
Prior to Revenue Procedure 2000-37, all Reverse Exchanges were Non-Safe Harbor.  IRS has not indicated that they would disallow a Non-Safe Harbor Reverse Exchange, stating that they recognize that parking arrangements can be accomplished outside of the safe harbors.  There are no “specific guidelines” for structuring a Non-Safe Harbor Reverse Exchange in the tax code itself and this is an evolving area of tax law.  In summation, a taxpayer can enter into a Reverse 1031 Exchange and if the Relinquished Property is not sold by the 180th day, with the appropriate documentation, the taxpayer can extend their Reverse Exchange beyond the 180-day period.  Non-Safe Harbor Reverse Exchanges are most commonly used for a construction project due to length of construction period, to save a failing safe harbor reverse exchange, and/or to acquire desired Replacement Property while want to hold on to Relinquished Property because of market.

In order to ensure that a particular Non-Safe Harbor Reverse Exchange can be accomplished the taxpayer should consult with their Qualified Intermediary, accountant, and/or attorney. We can assist with this consult with our dedicated exchange specialists.