A reverse exchange is the purchase of the replacement property prior to closing on the relinquished property. An investor may need to consider a reverse exchange in a seller’s market, where properties are selling quickly and inventory is scarce. The most common variation (often called “parking the replacement property”) involves the Qualified Intermediary first purchasing the replacement property. When the relinquished property is sold at a later date, the Qualified Intermediary completes the exchange by deeding the replacement property back to the Exchanger. It is especially crucial that the Qualified Intermediary has in-depth knowledge of the steps and precautions necessary in these complex transactions. Working with an investor’s tax advisors and attorneys, API draws upon substantial experience with reverse exchanges to help lead the investor safely through a minefield of potential hazards.
PARKING ARRANGEMENT EXCHANGES: SAFE HARBOR FINALIZED ON SEPTEMBER 15, 2000
Revenue Procedure 2000-37 (finalized on September 15, 2000) provides the framework to safely perform a reverse exchange (purchasing a replacement property before selling the relinquished property) or an improvement exchange (making improvements or building a new replacement property).
BASIC POINTS OF CONCERN:
- Issued on September 15, 2000 and also referred to as a Rev. Proc.
- Effective September 15, 2000
- Provides a “safe harbor” if transaction is within it’s parameters
- IRS may amend the Rev. Proc. If necessary
- Reverse” exchanges may still be structured outside the Rev. Proc.
- Transactions already completed or in progress are not affected
REVENUE PROCEDURE 2000-37 KEY TERMS:
- Qualified Exchange Accommodation Arrangements = QEAA
- Exchange Accommodation Titleholder = EAT
- Qualified indicia of ownership. The EAT must not be the taxpayer or a disqualified person and must be subject to federal income tax. Indicia of ownership must be maintained at all times until the property is transferred as described in section 4.02(5) of the Rev. Proc. Qualified indicia of ownership means legal title or other applicable principals of ownership under commercial law such as contract for deed.
- The taxpayer must have bonafide intent that the property held by the EAT must represent either the replacement or the relinquished property in an exchange that is intended to qualify for nonrecognition of gain (whole or in part) under section 1031.
- The taxpayer and the EAT must enter into an agreement (the qualified exchange accommodation agreement) no later than 5 days after the transfer of qualified indicia of ownership to the EAT. The agreement must state that the EAT is holding title for the benefit of the taxpayer in order to complete an IRC section 1031 and this Rev. Proc. And that the taxpayer and EAT agree to report the acquisition, holding and disposition of the property. In addition, the agreement must state that both parties will be treated as the beneficial owner for tax purposes and report it as such on it’s tax returns.
- In the event that the EAT holds the replacement property, the taxpayer must identify within 45 days, the relinquished property. This must be done in accordance with the multiple property identification rules in section 1.1031(k)-1(c)(4).
- The EAT must transfer the property held within 180 days from the date of acquisition to either the taxpayer (in the event EAT held the replacement property) or the buyer (in the event the EAT held the relinquished property).
- The combined time period that the relinquished property and the replacement property cannot exceed 180 days.
The following agreements are permissible regardless of whether or not they contain terms, which may typically destroy an arms length relationship between the EAT and the taxpayer.
- The EAT may act as both the qualified intermediary and the EAT provided that they satisfy the qualified intermediary safe harbor provisions in section 1.1031(k)-1(g)(4).
- The taxpayer may guarantee all or part of the obligations of the EAT including debt and incurred expenses.
- Taxpayer may loan or advance funds to the EAT.
- The EAT may lease the property to the taxpayer.
- The EAT may enter into a management agreement with the taxpayer.
- The taxpayer may act as contractor and/or supervisor with respect to the property.
- EAT and taxpayer may enter into agreements using puts and calls at fixed or formula prices for subsequent dispositions.
REPLACEMENT PROPERTY PARKED
STEP 1 – EAT PURCHASE OF REPLACEMENT PROPERTY
- Exchanger advances/loans funds to the EAT.
- EAT purchases the replacement property.
- Seller deeds the replacement property to the EAT.
- EAT leases the replacement property to the Exchanger.
STEP 2 – SALE OF RELINQUISHED PROPERTY AND EXCHANGE OF THE REPLACEMENT PROPERTY TO THE EXCHANGER
- Relinquished property is deeded to the EAT in exchange for the replacement property to the Exchanger.
- Payoff of the original advance/loan from the Exchanger from sale proceeds.
RELINQUISHED PROPERTY PARKED
STEP 1 – EXCHANGE OF RELINQUISHED PROPERTY FOR THE REPLACEMENT PROPERTY
- Exchanger deeds the relinquished property to the EAT according to the QEAA.
- Simultaneously, the Exchanger and the EAT enter into an Exchange Agreement.
- Exchanger advances/loans funds to the EAT for the acquisition of the replacement property.
- The replacement property is deeded directly to the Exchanger in compliance with the Exchange Agreement. / EAT leases the relinquished property to the Exchanger.
STEP 2 – SALE OF RELINQUISHED PROPERTY
- Exchanger locates purchaser for relinquished property and enters into a contract.
- Exchanger assigns contract to EAT and EAT sells relinquished property to Buyer.
- EAT receives proceeds from sale and pays off advance/loan from Exchanger.