What is a Reverse Exchange and What Causes it to Fail?A conventional IRC §1031 tax deferred exchange involves, among other things, a taxpayer’s sale of old property (the “relinquished property”) followed by the purchase of new property (the “replacement property”) within a 180 day period (see http://www.accruit.com/1031-news/%C2%ADare-tax-deferred-exchanges-real-estate-approved-irs ). A so-called reverse exchange takes place when the taxpayer is forced to acquire the replacement property, or face losing it, prior to the sale of the relinquished property. The sequence of the disposition and acquisition is “reverse” from the conventional transaction.
- Consolidate many properties into fewer properties
- Diversify fewer properties into more
- Trade appreciated low cash flow property for high cash flow property
- Maximize ability to borrow against properties using bank funds rather than owner’s
- Trade for higher basis property to take advantage of depreciation deduction
- Acquire property closer to owner in the event of relocation
Tax deferral afforded through Section 1031 like-kind exchanges has been under threat of repeal or being reduction for many years. A committee made up members from the Senate Finance Committee and the House Way and Means Committee known as The Joint Committee on Taxation have made such recommendations many time over the past few decades. Cutbacks to Section 1031 had been recommended as far back as President Clinton’s administration. In 1997, that administration suggested requiring exchanges to be limited to “same-kind” properties rather than like-kind (any kind of real estate is like-kind to any other type of real estate). It came as no surprise that the recent House and Senate proposals for tax reform chose to whittle down Section 1031 in order to raise tax revenues to offset some of the tax reductions contained in the reform plans.
Over the years IRC Section 1031 tax-deferred exchanges have been known by many names. In addition, there are many different types of exchanges that one way or another relate to Internal Revenue Code Section 1031. Let’s take a look at some of these names and transaction types.
With so many weather-related natural disasters occurring with seemingly increasing frequency, let’s take a look at how such disasters affect persons seeking to complete exchange transactions. While the safe harbor timelines for conventional forward exchanges and for reverse exchanges are strictly enforced, there is some relief afforded in the event of a federally declared disaster in the form of time granted. The applicability of a particular federally declared disaster can be found on the IRS website, which provides news releases covering disaster events.
Often, when learning of the tax deferral benefits of like-kind exchanges for the first time, sellers are surprised. It seems too good to be true, but it is. Capital gains taxes, recapture of depreciation, state taxes and a health care tax can all be deferred in full. But given the current climate of impending tax reform, is it still advisable?
Escrow is an arrangement in which transacting parties retain a third party, an escrow agent or escrowee, whose job is to safeguard funds and assets according to conditions that have been agreed upon in advance. Such an arrangement protects the transacting parties in the deal, providing that neither has an unfair advantage and that both are earnest about the deal.