1031 Reverse Exchange Overview
If you find a property you would like to acquire before you sell your current property, a 1031 Reverse Exchange can save you thousands of dollars in capital gains tax.
1031 Exchange transactions, especially Reverse 1031 Exchanges, are complex tax-deferred tax strategies. You should always seek competent qualified intermediary to discuss your Reverse 1031 Exchange transaction. Adelphi Retirement Management, LLC, is here to assist you and you advisors in planning your Reverse 1031 Exchange.
What is the IRS’s Position on Reverse Real Estate Exchanges?
The IRS issued Revenue Procedure 2000-37 (Rev Proc) in September 2000 that gives taxpayers guidance on Reverse 1031 Exchanges. A “Safe Harbor” Reverse introduces a new entity into the reverse process – an Exchange Accommodation Titleholder (EAT). An EAT is a single member limited liability company (LLC) established by a Qualified Intermediary (QI) for use specifically in a reverse exchange. The EAT takes title to, or parks, a property for the taxpayer and holds it until the taxpayer is able to sell the old property. Rev Proc places a time restraint on the taxpayer-the EAT must convey the title on or before 180 days from the date of the EAT’s purchase. When the EAT parks the new property, Rev Proc requires the taxpayer to identify their old property on or before 45 days from the EAT’s purchase.
Our reverse exchange experts will guide you through this process. Rev Proc also refers to the fact that some reverse exchanges will fall outside of the “Safe Harbor”. A “Non-Safe Harbor” Reverse will follow the guidelines outlined in Rev Proc, with the exception of the 180 day requirement. Typically, construction exchanges fall into this category because they require more time to complete the exchange.
Before the reverse process begins, we will review with the two types of reverse exchanges so you have the information necessary to select the reverse exchange that is best suited to your needs.
Reverse 1031 Exchanges: There are many reasons why you might find yourself in a position where you must acquire or would prefer to acquire your like-kind replacement property first before you sell your current relinquished property in your 1031 Exchange.
You might unexpectedly find an investment opportunity that you must act on before you even have time to consider selling or listing your current relinquished property. The sale or disposition of your relinquished property may unexpectedly collapse and you do not want to lose your acquisition that is closing soon. Or, you may prefer to buy first to eliminate the pressure of having to identify your like-kind replacement property within the 45 calendar day identification deadline in a regular Forward 1031 Exchange.
Whatever your reason for deciding to purchase your replacement property first, the Reverse 1031 Exchange allows you to acquire your like-kind replacement property first and then subsequently list and sell your relinquished property within the prescribed 1031 Exchange deadlines. It can be a great strategic tool when needed or preferred. Revenue Procedure 2000-37 — The Safe Harbor Reverse Exchange
The Internal Revenue Service issued Revenue Procedure 2000-37 on September 15, 2000, which provides a safe-harbor for how to properly structure a Reverse 1031 Exchange transaction by using a parking arrangement in conjunction with a simultaneous 1031 Exchange. Reverse 1031 Exchanges that fall outside of this Revenue Procedure may still qualify and are referred to as non-safe-harbor Reverse 1031 Exchange transactions.
Simultaneous 1031 Exchange: The actual 1031 Exchange portion of your Reverse 1031 Exchange transaction is a simultaneous or concurrent 1031 Exchange either at the beginning or end of your Reverse 1031 Exchange transaction. You will enter into a 1031 Exchange Agreement with Adelphi Retirement Management, LLC, as your Qualified Intermediary for the administration of your 1031 Exchange.
Parking Arrangement: You will enter into another agreement called the Qualified Exchange Accommodation Agreement (“QEAA”) that will structure the parking arrangement for your Reverse 1031 Exchange. The QEAA is signed by you and Adelphi Retirement Management, LLC, as your Exchange Accommodation Titleholder (“EAT”). The Exchange Accommodation Titleholder (“EAT”) is the entity that will acquire and hold or “park” legal title to either your relinquished property or your like-kind replacement property during your Reverse 1031 Exchange transaction.
Reverse 1031 Exchange Structures: The challenge in structuring your Reverse 1031 Exchange is deciding which of your investment properties will be acquired and held or “parked” by Adelphi Retirement Management, LLC, as your Exchange Accommodation Titleholder (“EAT”). The structure selected by you will depend on whether there is financing involved and which investment property your lender will allow Adelphi Retirement Management, LLC to hold or park legal title to.
The two structures are commonly referred to as Exchange Last and Exchange First because the simultaneous 1031 Exchange occurs either at the beginning (Exchange First) or at the end (Exchange Last) of your Reverse 1031 Exchange transaction.
Transactions structured outside of the safe-harbor guidelines, generally referred to as non-safe-harbor Reverse Exchanges, must be structured very differently.
Exchange Last Structure: The Exchange Last Reverse 1031 Exchange structure is the preferred strategy because it will provide you with the most flexibility in terms of structuring and financing your Reverse 1031 Exchange transaction. It also provides you with more advanced structuring capabilities.
Your like-kind replacement property is acquired and held or “parked” by the Exchange Accommodation Titleholder (“EAT”) and a simultaneous or concurrent 1031 Exchange is completed later at the close of your relinquished property sale transaction (i.e. the simultaneous 1031 Exchange occurs at the back-end of your Reverse 1031 Exchange).
The primary obstacle with this structure will be your lender. Lenders are concerned about the Exchange Accommodation Titleholder holding or parking title to the like-kind replacement property that will be used as collateral for the loan. We recommend scheduling a conference call between you, your lender and Adelphi Retirement Management, LLC, as early as possible to determine whether this Reverse 1031 Exchange structure is viable. You may need to shop around for lenders who are willing to work with you. We can certainly assist you with this.
Exchange First Structure: The Exchange First Reverse 1031 Exchange structure will keep your lender happy, but will eliminate your flexibility in terms of structuring and financing the acquisition of your like-kind replacement property and any advanced 1031 Exchange planning capabilities.
Your like-kind replacement property will be acquired directly by you, your lender will lend directly to you on the acquisition of your like-kind replacement property, and simultaneously you will transfer title of your relinquished property directly to Adelphi Retirement Management, LLC as your Exchange Accommodation Titleholder (i.e. the simultaneous 1031 Exchange occurs at the front-end of your Reverse 1031 Exchange).
The difficultly with this structure is that you must temporarily advance (i.e. reinvest) the total amount of your equity that is currently trapped in your relinquished property into your like-kind replacement property up front before your relinquished property sale actually closes. This kind of cash liquidity is usually not available.
Separate Special Purpose Entity: Adelphi Retirement Management, LLC, will set-up a SEPARATE special purpose entity in the form of a separate single member limited liability company that will be used exclusively for your Reverse 1031 Exchange transaction. The sole purpose of this entity is to acquire and hold or “park” legal title to your Reverse 1031 Exchange property.
Adelphi Retirement Management, LLC, will arrange for the formation of this separate special purpose limited liability company, take care of the payment of related filing fees, costs, first year’s state taxes or franchise fees, serve as the registered agent for service of process, and complete the dissolution or transfer of the limited liability company at the close of your Reverse Exchange.
Reverse 1031 Exchange Deadlines: Deadlines for your Reverse 1031 Exchange are essentially the same as in a forward 1031 Exchange transaction. You have 45 calendar days to identify what you are going sell as your relinquished property, and you have an additional 135 calendar days — for a total of 180 calendar days — to complete the sale of your identify relinquished property and close out your Reverse 1031 Exchange.
Reverse 1031 Exchange Fees and Costs: Reverse 1031 Exchanges are more complicated and costly, so you need to review the amount of depreciation recapture and capital gain income tax liabilities being deferred to ensure that the cost of the Reverse 1031 Exchange transaction is justified. We would be happy to provide you with a written Reverse 1031 Exchange fee quote so that you know exactly what you are looking at in terms of fees and costs prior to getting started.
Identify the Relinquished Property: You have exactly 45 days (including Sundays and holidays) from the closing of the new property to identify the property you are going to sell. You have 180 days from the date of closing to close on your sale in order to be within the “Safe Harbor” provided by Rev Proc.
We will send you a notice with the closing date of the new property, the expiration date of the 45-day identification period, the expiration date of the 180-day closing date, and a form to notify us of the location of the relinquished (old) property to be sold.
You must mail or fax the Property Identification Form before midnight of the 45th day from the closing of the new property.
Sale Contract Process
- Negotiate the contract to sell the old property.
- Include language in the contract to establish your intent to do a tax-deferred exchange.
- Identify a title company or closing agent to handle the closing of the transaction.
Sale Closing Process: Inform us when you have a signed sales contract. Information needed includes:
- A copy of the contract
- The phone number, name and reference number for the closing agent or title company
- Sale price of the property being sold
Transfer the Replacement Property
Finally, we will coordinate with the Title company or closing attorney to prepare the closing and transfer of documents.
Wai-Yew Lam, President
TREC Certified Instructor