THE SAFE HARBOR REVERSE EXCHANGE
If you find a replacement property that you would like to acquire before you sell your current property, you can utilize a Reverse Exchange to maximize your tax deferral. Basically, A “reverse” exchange occurs when the taxpayer acquires the replacement property before transferring the relinquished property. A “pure” reverse exchange, where the taxpayer owns both the relinquished and replacement properties at the same time, is not permitted. The IRS has provided guidance on structuring a reverse exchange, offering a safe harbor under Rev. Proc. 2000-37. An Exchange Accommodation Titleholder (EAT), acquires and holds the target property (the parked property) in a separate special purpose entity, typically a single member LLC (the EAT and LLC are jointly referred to as “EAT”). To complete a reverse exchange, the EAT will take title to either the Relinquished Property or the Replacement Property under a “Qualified Exchange Accommodation Arrangement” (QEAA).
Reverse 1031 Exchange Time Periods
The same 45 day Identification Period and 180 day Exchange Period deadlines of IRC §1031 apply to a safe harbor reverse exchange under Rev. Proc. 2000-37, with a slight tweak. If the EAT has begun the exchange by acquiring the Replacement Property, then the Exchanger must identify within 45 days after the EAT’s acquisition of the parked property, one or more Relinquished Properties to be exchanged for the Replacement Property. The identification rules require that written identification be delivered to another party to the exchange, such as the EAT or the Qualified Intermediary, identification permitted under the three property or 200% rules.. The identified Relinquished Property must be sold, and the parked Replacement Property transferred to the Exchanger to complete the exchange within 180 days of parking the Replacement Property with the EAT.
Replacement Property Parked Reverse Exchange
Replacement Property Parked – Phase I In the most common type of reverse exchange, the EAT acquires and “parks” legal title to the Replacement Property. In the first phase of the reverse exchange, the Exchanger or a third party lender loans the funds necessary for the EAT to purchase and take title to the Replacement Property. The EAT leases the property to the Exchanger under a triple net lease. This permits the Exchanger to receive the economic benefits and burdens of the property during the time that it is held by the EAT.
Replacement Property Parked – Phase II When the Exchanger sells the identified Relinquished Property, title is transferred directly to the buyer through direct deeding. The cash proceeds of the sale go to the Qualified Intermediary, which uses these Exchange Funds to acquire the Replacement Property from the EAT. Upon receipt, the EAT will first repay the loan from the Exchanger and then use remaining Exchange Funds to pay down the third-party loan on the Replacement Property prior to transferring the parked property to the Exchanger. If the Relinquished Property sale yields more Exchange Funds than necessary for the Qualified Intermediary to acquire the parked property, the Exchanger may identify additional Replacement Property within 45 days of the transfer of the Relinquished Property, and complete the additional acquisition within 180 days of the Relinquished Property transfer
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