Reverse 1031 exchanges aren't as complicated as you think

1031 exchanges are typically of the "forward" variety - they start when you sell an asset and then buy a replacement asset of like-kind. But more and more our clients are finding themselves in the position of needing to purchase a new asset before they sell their old one. This happens for a variety of reasons; companies may need new equipment in service before they can remove the old equipment, for instance; they simply can't afford the down time between selling the old and buying the new. Experienced exchangers know that the 45-day ID period for identifying new property is tight, and many investors want the opportunity to get their replacement property in place before they sell. Other clients may have both their sale and their purchase all lined up but at the last minute they lose their buyer and there goes the sale. Now they're ready to buy but can't sell. How can they still do an exchange?

The solution is a reverse exchange. In a reverse you can purchase your new property before you sell your old property and still get all the benefits of a 1031 like-kind exchange. The reverse 1031 exchange transaction is permitted under Revenue Procedure 2000-37. Although reverse exchanges were taking place way before the year 2000, this RevProc gives us clear safe-harbor guidelines for this type of an exchange.

This is how it works. The IRS will not let you hold title or ownership to both your new and your old property at the same time, but they will allow your Qualified Intermediary (QI) to take title to your new property for you until you can sell your old one. This is called "parking a property. " Your QI can do this by way of a single member LLC that's opened up specifically for your exchange. This LLC is called an Exchange Accommodation Titleholder, more commonly referred to as an EAT, and it does just what is says: it holds the title - that's it. The property is leased from the EAT to the taxpayer/exchanger. This allows the taxpayer/exchanger to have full access to the new property and to make money from that new property right away.

How does the EAT pay for the new property? Simple, they rely on the taxpayer. The taxpayer can buy with cash or get a lender. If a lender is used, it must be willing to have the EAT sign the security instrument for the loan, as they are going to be the owners of the new property. With a safe harbor reverse exchange an EAT does not necessarily have to be on the loan as a borrower, but if the bank insists, the EAT will be a non-recourse borrower with all recourse going to the taxpayer. Also the taxpayer needs to be prepared to add the EAT to the insurance of the parked property.

So how do you know that the EAT will not sell your property to someone else while your waiting to sell? Easy, a purchase option is always part of the Qualified Exchange Accommodation Agreement. That is the legal document that allows the exchanger and the EAT to move into a parking arrangement. This purchase option gives the exchanger the exclusive right to buy the replacement property from the EAT, and that is exactly what the exchanger will do right after they sell. The exchanger must take title to the new property from the EAT within 180 days after it is parked and they must identify what they are selling within 45 days of parking.

It's really that easy. After the taxpayer sells the EAT will use the exchange proceeds to pay back the taxpayer what they owe them and give title of the asset to the taxpayer/exchanger. If this does still sound a little tricky to you, not to worry. Accruit has several reverse exchange experts who can address all your questions about a typical reverse as well as more complicated reverses( such as exchange first reverses, straddles, and improvement exchanges).