THE POWER OF A REVERSE EXCHANGE
| Read comments | Add comment / Rate this Article | Article by: Christine Latulip |
Section 1031 Exchanges can be done in a forward format, where the old property is sold and then the new property is acquired or they can be done in reverse. A Reverse Exchange is exactly what it sounds like; an opportunity to acquire a new property before the old property is sold. The trick is not to own both the new property and the old property at the same point in time. A parking entity is used to facilitate the acquisition until the old property is sold.
A Qualified Intermediary (QI) is engaged to handle the transaction as a Reverse Exchange. The QI creates an Exchange Agreement and a parking entity referred to as an Exchange Accommodation Titleholder (EAT), usually a corporation or limited liability company. This new entity is then positioned with funds directly from the taxpayer or its lender to immediately acquire the new or Replacement Property. The EAT will be the temporary titleholder/owner of the new property. If a lender is involved, the lender will require the EAT to be the borrower. This can be a stumbling block for some lenders, however, the credibility of the taxpayer/exchangor will be required to endorse or guarantee the loan.
Reverse Exchanges must adhere to the same time constraints as forward exchanges. The Relinquished Property, the property to be sold, must be identified within 45 days of the commencement of the exchange. This provision allows the taxpayer the opportunity to list more than one potential sale property increasing the flexibility of the transaction. The taxpayer can then elect the property that sells first as the Relinquished Property. The identification rules provide for up to three properties to be listed or more as long as the value in the second case does not exceed twice the value of the existing property. The exchange can be derived from the sale of more than one property if the values between the old and new properties must be further equalized. The goal is to go even or up in value from the old property to the new property.
The Relinquished Property must sell within 180 days so that the new property can be conveyed to the taxpayer before the deadline. Assuming the Relinquished Property sells in time, the funds will be directed to the QI at closing and used to pay down the debt incurred to acquire the Replacement Property and then the parked property can be conveyed to the taxpayer to complete the exchange. The exchange is the last event to occur and is therefore referred to as a Reverse Exchange-Last transaction. A powerful tool for real estate investors who know what they want!
This information is not intended to replace qualified legal and/or tax advisors. Every taxpayer should review their specific transaction with their own legal and/or tax counsel.
