A reverse tax deferred exchange typically occurs when the replacement property is acquired before the closing of the Relinquished Property.
However, the Internal Revenue Service has issued Reverse Tax Deferred Revenue Procedures outlining in detail how reverse exchanges may be accomplished and also providing a “safe harbor” advising all taxpayers that their transaction will qualify, provided they and their Accommodating Title Holder strictly follow those Regulations.
A Typical Reverse Exchange Scenario
Let’s assume an exchangor has an opportunity to acquire an investment property that is “the deal of a lifetime.” Let’s also assume that his/her goal is to defer the capital gains tax from the sale of his/her investment property that has not yet been sold or, if the property has been “under contract”, the transaction has not closed. The exchangor has a limited amount of time to close on that acquisition property. The exchangor prefers to acquire it with the benefit of a tax deferred exchange, but the Relinquished Property has not closed.
In a typical reverse exchange, the Accommodating Title Holder acquires the Replacement Property and holds title to that property until the Relinquished Property sells and closes. In order to fund the transaction, the Accommodating Title Holder borrows money from the exchangor to acquire the property or asks the exchangor to guarantee third-party financing independently arranged by the Accommodating Title Holder. Under these Regulations, it is extremely important that the Accommodating Title Holder report to the Internal Revenue Service independently all income and expenses of the property held by it during the term of the reverse exchange.
Even under the Regulations, however, not all taxpayers will be able to take advantage of a reverse exchange. The taxpayer must have the funds or his/her collateral available to fund his/his/her purchase by the Accommodating Title Holder. A reverse exchange (notwithstanding the safe harbor rules) is not practicable in many situations.
Accommodating Title Holders must assume the “benefits and burdens” of the property in which they hold title. To merely have the Accommodating Title Holder hold title to certain real estate is not enough. Under the Regulations, the Internal Revenue Service has expanded greatly the involvement or control the exchangor may have over the property owned by the Accommodating Title Holder, including:
- Allowing the exchangor to provide funds directly to the Accommodating Title Holder to acquire the property.
- Allowing the exchanger to guarantee any borrowing by the Accommodating Title Holder to acquire the property.
- Allowing the exchanger to enter into an Agreement with the Accommodating Title Holder to manage the property.
- Allowing the exchanger to actually directly lease the property from the Accommodating Title.
- Allowing the exchanger to supervise improvements being made to the property during the time the Accommodating Title Holder holds title to the property.
- Allowing the exchanger to act as a contractor themselves in making repairs or improvements to the property.
Time Limitations For A Reverse Exchange
It is critical to the success of a Reverse Exchange that a Qualified Exchange Accommodation Agreement (QEAA) be executed prior to the closing or within five (5) days after the title passes to the Accommodating Title Holder.
The exchanger must determine within forty-five (45) days after the Accommodating Title Holder has acquired title to the “parked property” which specific property the exchanger intends to sell as part of the ultimate Forward Exchange. The Internal Revenue Service utilizes the Multiple Declaration Rules promulgated under Regulations l.1031(k) – l(c)(4) to allow exchangers to identify multiple or alternative properties.
The total time period allowed for “parking” the property held by the Accommodating Title Holder under the statutory “safe harbor” framework specified in this memo, has now been set in stone under the Regulations. The exchangor (or a third party in the case of the sale leg reverse exchange) must acquire title to the property from the Accommodating Title Holder not later than 180 days after the Accommodating Title Holder has taken title to the replacement property (or less common, taken title to the sale leg property).
Reverse Exchanges Are Not For Everyone
Many clients call us about reverse exchanges. Not a week goes by that we don’t receive at least 10-12 calls. Most clients can’t complete a reverse exchange because they don’t have the financial capability to acquire a property without first selling their relinquished property.
These Regulations point us in the right direction, but they are in no way the most efficient or cost-effective method of completing a normal forward tax-deferred exchange. The procedures may be a real benefit in certain transactions, but will never replace our “tried and true” regular Qualified Intermediary administered forward delayed tax deferred exchange.
If You Need More Than 6 Months To Sell Your Relinquished Property … Please Call Our Office
This paper outlines only the specific provisions and requirements for completion of a Statutory “safe harbor” Reverse Exchange. Under the Tax Code, there are other methods to complete a Reverse Exchange that can greatly expand the holding periods by the Accommodating Title Holder. Please contact our office to learn more about these “Classical Reverse Exchanges.