Reverse Exchange: Purchase The Replacement Property First
1031 Reverse Exchange Benefits
In Revenue Procedure 2000-37 (“Rev. Proc. 2000-37”), guidelines are provided for taxpayers to acquire replacement property before the sale of their relinquished property is complete. If the taxpayer cannot delay closing the replacement property, the reverse exchange may be the ideal solution. Investors can achieve several objectives through reverse exchanges:
- Take advantage of this once-in-a-lifetime opportunity! Before selling the relinquished property, acquire a desirable replacement property.
- Avoid the pressure-filled problems associated with 45-day identification periods.
- Capital improvements can be made to the replacement property to increase its value.
- Investors can take advantage of the current real estate market while deferring capital gains by following Rev. Proc 2000-37 safe harbor guidelines.
Exchange Structures For 1031 Reverse
It has been clarified by Rev. Proc 2000-37 that the Exchanger cannot own both properties simultaneously. The exchange accommodation titleholder (“EAT”) is entrusted with either ownership of the relinquished property or the right of the replacement property.
The Exchanger will own one property, and the EAT will hold the other after a recorded deed to transfer the ownership.
Reverse Exchanges: Additional Issues
The Exchanger causes funds to be loaned to the Exchanger so that the EAT can acquire title to the replacement property. Exchangers sell relinquished property via a “delayed exchange” format within 180 days and EATs transfer replacement properties to Exchangers.
The Exchanger acquires replacement property after the relinquished property is conveyed to the EAT property under a “simultaneous exchange” format. In the 180 days following the relinquishment, the EAT retains title to the property until it is sold.
In a reverse exchange or improvement exchange, the EAT acquires the replacement property and improves it. The improved property is exchanged for the relinquished property within 180 days to complete the exchange.
All investors should thoroughly review a reverse exchange transaction with legal and tax advisors.
Reversal Exchange Variations: "comparison Of Two Different Parking Arrangements"
In reverse 1031 exchanges, buyers must purchase replacement properties before the relinquished property closes. Reverse exchanges are expected in a “seller’s market” where recently listed properties are quickly under contract.
Within 180 calendar days of the Exchange Accommodation Titleholder’s (EAT) purchase of the replacement property, Revenue Procedure 2000-37 provides guidelines for the Exchanger to perform a “parking arrangement” exchange.
"Replacement Property Parked"
The Exchanger causes the Exchanger to lend the EAT funds to purchase the replacement property. Exchangers sell their relinquished property within 180 days, and the EAT transfers them to their replacement property.
Positives of the "Replacement Property Parked"
- It is not necessary to have total exchange equity.
- It is possible to use this format for a deferred exchange.
- Multi-property relinquishment is possible.
- “Replacement Property Parked” has several negative aspects.
- The lender may have problems lending to the EAT.
In some cases, double transfer taxes and title insurance fees may result in high expenses.
"Parked Relinquished Property"
Exchangers transfer relinquished properties to EATs and then acquire replacement properties simultaneously. Relinquished properties remain on EAT title for 180 days until they transfer to buyers.
A Positive aspect of the "Relinquished Property Parked" program
- A direct loan is made to the Exchanger, making the loan and purchase of replacement property easier.
- For relinquished properties, transfer tax may be less expensive.
Negatives of the "Relinquished Property Parked"
- Equity and debt should match to avoid “boot.”
- Property tax basis may be increased by transferring to EAT.
- Problems with lenders on relinquished properties (due on sale clauses, prepayment penalties).
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