REVERSE EXCHANGES

In cases where the replacement property must be purchased before the sale of the relinquished property, an Exchange Accommodation Titleholder (EAT) may acquire the replacement property and hold it as titleholder until the relinquished property is sold to a third party buyer. This is known as a reverse exchange. With a reverse exchange, the taxpayer preserves the 1031 exchange tax benefits by receiving the replacement property at the same time the relinquished property is sold. During the “gap” period between the purchase and exchange, the replacement property is net-leased to the taxpayer.

Financing Replacement Property
The major issue faced by taxpayers is how to finance the purchase of the replacement property when the equity from the relinquished property is not yet available. Ordinarily, in a reverse exchange, the taxpayer can arrange for a loan to the EAT on commercially reasonable terms for the purchase of the replacement property. The loan is paid back from the proceeds of the relinquished property sale, with the taxpayer assuming any portion of the loan that the sales proceeds do not cover.

Types of Reverse Exchanges

• Safe harbor—Internal Revenue Service Revenue Procedure 2000-37 (issued September 15, 2000) outlines the necessary requirements and procedures to provide taxpayers with a “safe harbor” for the structure of a reverse exchange in limited circumstances, the most notable of which is the restriction that the Safe Harbor Exchange be completed within 180 days.
• Non-safe harbor—Transactions that fail to comply with the safe harbor requirements are significantly more complex, and therefore necessitate additional planning and structuring on behalf of the taxpayer and his or her advisor(s).

Reverse Exchange Sequence (Exchange Last)

A typical reverse exchange real estate transaction involves the following steps:

1. The taxpayer has contracted to acquire replacement property and wants to create an exchange for relinquished property. However, the relinquished property sale will not close before replacement property is purchased.
2. The taxpayer requests the EAT to prepare a qualified exchange accommodation agreement and coordinate the exchange closing.
3. The taxpayer arranges funding for the replacement property, either from an affiliated third party or, where necessary, a direct loan from the taxpayer.
4. The EAT uses the loan proceeds to acquire the replacement property and holds it until the sale of the relinquished property.
5. The replacement property is net-leased to the taxpayer, and the loan to the EAT is secured by the property.
6. The taxpayer locates a buyer for the relinquished property.
7. At the sale of the relinquished property, the proceeds from the sale are sent to the Qualified Intermediary and placed in an exchange account.
8. The proceeds from the sale of the relinquished property are then sent to the EAT to acquire the replacement property. The taxpayer receives title to the replacement property and the sale proceeds are used to pay off the outstanding loan. If these proceeds are insufficient, the taxpayer assumes the unpaid loan amount.

For more information about 1031 exchanges, contact Wachovia Exchange Services at (888) 693-5566.

Related Links

•Wachovia Exchange Services Overview 

Corporate & Institutional Customer Service

Buyer:

The party that acquires the relinquished property from the exchangor (taxpayer).

Relinquished Property:

The property the taxpayer begins with and wishes to dispose of in an exchange.

Replacement Property:

The property the taxpayer intends to acquire in the exchange, and the property the taxpayer ends the exchange with.

Reverse Exchange:

A Reverse Exchange occurs when the exchangor (taxpayer) closes on the replacement property prior to closing on the relinquished property.