In today’s distressed real estate market – especially in resort areas – there are many good bargains! For someone wanting to also do a 1031 tax-deferred exchange, there is a handy strategy called a Reverse Exchange:
- 1. The purchase and closing of the ‘new’ replacement property occurs BEFORE the closing of the sale of the (yet-to-be) relinquished property (hence the name “Reverse” exchange)
- 2. The client cannot take title to the ‘new’ replacement property – because if they did they could not do an exchange between the replacement and relinquished properties, because the client is on title to both at the same time
- 3. So…the Qualified Intermediary (QI) or Accommodator – IPX 1031® Exchange – must close and take title to the ‘new’ replacement property. Essentially, the QI parks title under Revenue Procedure 2000-37– using an IRS-required special purpose entity called an EAT (Exchange Accommodation Titleholder)
- 4. This purchase of the replacement property by the QI-EAT-IPX must be paid for by the client: either they (1) Have cash to lend to the EAT (secured with a promissory note), or (2) They can use a lender’s funds (which can be secured with the replacement property, and perhaps even cross-collateralized with the relinquished property; and the lender can also request personal guarantees and be secured by mortgage or deed-of-trust as well).
- 5. After the purchase of the replacement property by the EAT, the client then goes on with their life and business, and will eventually sell their ‘old’ relinquished property – this is closing #2…
- 6. After the closing of the sale of the relinquished property, there needs to be a third closing whereby title is transferred from the QI-EAT to the client on the ‘new’ replacement property. This completes the Reverse Exchange.
- 7. If all of this is accomplished within 180 days from the date of the sale of their relinquished property, then this is a Safe Harbor Reverse Exchange…which essentially provides the client with an “Audit Pass” of sorts from the IRS.
- 8. If the reverse exchange takes longer – or is originally anticipated to take longer – than 180 days, then that type of reverse exchange falls outside of the Safe Harbor under Rev Proc 2000-37 and is called a Traditional or non-Safe Harbor Reverse Exchange. It is still allowed by the IRS, but the client as lost their “audit pass”… This type of reverse exchange, if properly structured and documented, is OK with the IRS, but the QI needs to know in advance if this is where the client wants to go.
- 9. The following links from our website (www.ipx1031.com) explain in more detail a Reverse Exchange: (1) http://www.ipx1031.com/pdf/IPXBriefExchangePDFs/ReverseExchange.pdf and (2) http://www.ipx1031.com/pdf/IPXBriefExchangePDFs/HowToInitateReverseExchange.pdf