A reverse 1031 exchange enables the taxpayer to acquire the replacement property before selling the old or relinquished property. Prior to Revenue Procedure 2000-37, a reverse 1031 exchange was not recognized under Internal Revenue Section 1031(a)(3). Private Letter Ruling 9814019 permitted a two party reverse exchange where the replacement property was acquired prior to selling the relinquished property. Before reverse 1031 exchanges were authorized, taxpayers would structure simultaneous exchanges where at one long closing, the replacement property was acquired and the relinquished property sold.
Revenue Procedure 2000-37
The intent of Revenue Procedure 2000-37 is to allow the taxpayer time to sell the relinquished property and remain within the scope of the 1031 code. The Revenue Procedure established a safe harbor for “parking” either the new or old property with an exchange accommodator titleholder (EAT). The Internal Revenue Service recognizes the EAT as the beneficial owner of the parked property, given a Qualified Exchange Accommodation Agreement that adheres to the 1031 requirements is in place between the taxpayer and the EAT at the time the new property is acquired.
The EAT is typically a single member limited liability company created for the sole purpose of taking title to or “parking” the old or new property. The owner of the EAT is an affiliated company of the Qualified Intermediary. EATs should not be reused nor should they park properties from non-taxpayer exchanges. The EAT is the property owner for federal income tax purposes and bears the benefits and burdens of ownership. A simple test to determine the indicia of ownership is to ask, “If the property is destroyed in a fire, hurricane or flood, who bears the burden?”
Reverse 1031 Exchange Rules
In either reverse 1031 exchange strategy, the EAT must take title to either the new or old property. Determining which property to park depends on a number of factors, including whether a lender and state or county transfer taxes are present. The exchange must be completed by the 180th calendar day post-closing on the new property.
The EAT cannot be a disqualified person, such as the taxpayer’s agent or a related party to the taxpayer. Related parties include spouse, grandparent, parent, sibling, child, grandchild, corporations of the same control group, individual and a corporation, grantor and fiduciary of the same trust, or partnership and taxpayer. An agent includes a person who has acted as an agent for the taxpayer, including employee, CPA, realtor or broker, or attorney, within the two-year period prior to the 1031 exchange. The same rule applies to attorney’s corporation and accounting firms.
If the replacement property is parked with the EAT, the taxpayer must identify what relinquished properties are to be exchanged no later than the 45th calendar day post-closing on the replacement property. If the taxpayer has multiple relinquished properties, he/she can identify up to three properties regardless of value, or more than three as long as the total value of the identified properties does not exceed 200 percent of the replacement property value parked with the EAT.
In addition, the value of the new property must be equal to or greater than the old property to defer 100 percent of the gain or tax is triggered on the difference. The taxpayer who sells the old property must be the same taxpayer who acquires the new property.
Reverse 1031 exchanges are also structured as deferred improvement exchanges, where the old property is sold and exchanged for replacement property that is improved with exchange proceeds.
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