1031 reverse exchange

Reverse 1031 Exchange: What a Lender Should Know

Posted on | by Tom Gustafson | Leave a Comment on Reverse 1031 Exchange: What a Lender Should Know

The majority of 1031 tax deferred exchanges are forward meaning that the old property is closed on before the new property is purchased. However, sometimes it makes sense to initiate a reverse exchange when the new property is acquired first and the old or relinquished property is sold later. Successful completion of a reverse exchange requires the participation of an Exchange Accommodator Titleholder (EAT) that takes title to either the new or the old property because the Internal Revenue Service does not allow the taxpayer to own both properties at the same time. What happens if a mortgage is required for the new property? What should a lender know before a loan approval process? The answer to that question depends on the type of a 1031 reverse exchange that was initiated.

Reverse First

An EAT is created in the entity form of a single member limited liability company to take title to either the new or the old property. The taxpayer has a secured position in the EAT through a Pledge of Membership Interest from the EAT member to the taxpayer.

In a reverse first, the old property is parked with the EAT. Prior to the closing on the new property, a deed is created conveying title from the taxpayer to the EAT. If a mortgage exists on the old property, the taxpayer continues to make payments. The taxpayer is responsible for taxes, insurance and expenses on the old property throughout the time owned by the EAT. The old property is marketed and sold to the buyer as normal. At the closing, the property is conveyed from the EAT to the buyer. Net proceeds from the sale are wired to the taxpayer.

Reverse Last

In a reverse last, the new property is acquired by the EAT on behalf of the taxpayer. If a mortgage is required for the new property, the EAT will sign a non recourse note with the lender. It is important to know before the loan application gets to the loan committee that the transaction is part of a reverse 1031 exchange. Once the loan is approved, it can be a challenge to re-do the loan approval process given the EAT will temporarily be on title.

Once the old property is sold, the title for the new property is conveyed to the taxpayer. This can be done through a warranty deed. If the state assesses a transfer tax, the EAT can also be conveyed to the taxpayer, consequently the title does not change, just the member of the EAT.

What the Lender Should Know

Which property will be parked or titled to the EAT? If the new property is parked, then be sure to involve the EAT in the loan approval process. If the old property is parked with the EAT, the existing lender will not be aware of the temporary title change given there is no interruption of mortgage payments.

Do you have a question? Contact our office of complete a few questions for a response be clicking on the free consultation request.

Five Emerging 1031 Exchange Trends

Posted on | by Tom Gustafson | Leave a Comment on Five Emerging 1031 Exchange Trends

The last several years in the 1031 exchange industry have been to say the least challenging. Don’t get me wrong, I love doing what I get to do everyday. What is that? As a qualified intermediary, I help individuals and companies defer capital gains taxes through what is known as a 1031 exchange.

1031 Exchange Trends

Since late 2006, real estate prices for investment properties began to stall, slowly falling into free fall from 2007 through 2010. States effected the most were those that also saw the rapid appreciation of 25 to 30% for the period 2003 – 2005 such as Florida, Nevada and California. I saw first hand how condominiums and rentals properties along the Gulf Coast from Texas to Florida experienced the highs and lows of perceived value compounded by natural disasters of hurricanes and an oil spill. Today, I see the following trends in the 1031 exchange market:

  • all cash buyers both individuals and corporations;
  • a desire to diversify replacement property into oil and gas royalties as an alternative to real estate;
  • unallocated gold and silver bullion exchanged for the physical metal;
  • bonus depreciation for corporations has reduced the need for 1031 exchanges in like-kind exchange (LKE) programs;
  • more reverse 1031 exchanges than the traditional forward acquiring under valued properties in preparation for the current upward trending business cycle.

The Joint Committee on Taxation estimates a 21.88% increase in the value of tax deferrals from $2.5 billion in 2011 to $3.2 billion in 2012. This is up from $2.1 billion in 2010. The majority of those exchanges or 62.5% are estimated to be by corporations in 2012.

The individual exchange will be a slower to rebound given Revenue Procedure 2008-16 effective March 10, 2008 requiring vacation rental properties to be held for two years followed by the replacement rental property to also be held for two years to qualify for a 1031 exchange.

Conclusion

Unless the 1031 exchange is eliminated as a deficit reduction measure, the number and value of the tax expenditure is estimated to continue a slow rebound from the 2003 – 2005 era when the estimated value of tax deferrals reached $73.6 billion in 2004.

When considering whether a 1031 exchange makes sense, consider other reasons than just the tax deferral. If you are not sure, call us for a free consultation.

What You Get

  • Rapid response within 12 hours of request;
  • Thoroughness and expertise of a Certified Exchange Specialist®;
  • The value of your potential exchange;
  • The estimated recognized tax if an exchange is not initiated;
  • Email summarizing plan of action and details of consultation.

What You Don’t Get

  • A sales call;
  • Mumbo jumbo technical jargon;
  • Responses that are not compliant with the 1031 code.

1031 Exchange Timeline Extensions

Posted on | by Tom Gustafson | Leave a Comment on 1031 Exchange Timeline Extensions

1031 exchange 45 day identification and 180 day exchange periods can be extended by Presidentially declared disasters, terroristic or Exchangors serving in combat zones.  Extensions apply to both forward and reverse 1031 exchanges.

IRS Written Confirmation

The IRS publishes a notice or IRS News Release defining:

  • Location of disaster;
  • Length of exchange period postponements;
  • Exchangors affected;
  • Acts that have been postponed.

Do not rely on the verbal response of an IRS Agent.  Only IRS extensions in writing can be used to support Exchangor’s actions.

The Robert T. Stafford Disaster Relief and Emergency Assistance Act defines disaster as “any natural catastrophe (including any hurricane, tornado, storm, high water, wind-driven water, tidal wave, tsunami, earthquake, volcanic eruption, landslide, mudslide, snowstorm or drought),or, regardless of cause, any fire, flood, or explosion, in any part of the United States, which in the determination of the President causes damage of sufficient severity and magnitude to warrant major disaster assistance to supplement the efforts and available resources of states, local governments, and disaster relief organizations in alleviating the damage, loss, hardship, or suffering caused thereby.”

Regulation § 301.7508A-1(d)(1) defines the seven types of affected Exchangors while terroristic or military action is defined in Internal Revenue Code § 692(c)(2).

Typically, the exchange periods are extended 120 calendar days but in no event may the postponement extend beyond the Exchangor’s tax return due date including extensions or one year.  Not all Exchangors qualify for an extension.  In all cases, seek the advice of your financial or legal advisor. To view tax relief for disaster situations, go to Item Two of Tax Updates.

 

 

Beyond 180 Days in a Reverse 1031 Exchange

Posted on | by Tom Gustafson | Leave a Comment on Beyond 180 Days in a Reverse 1031 Exchange

Recently, I was asked to consider accommodating a Non Safe Harbor reverse 1031 exchange. This type of 1031 exchange is used when the improvements or construction requires greater than 180 calendar days.

Reverse 1031 Exchange

Internal Revenue Service (IRS) Revenue Procedure 2000-37 recognizes reverse 1031 exchanges within the Safe Harbor of 180 calendar days and outside the Safe Harbor of 180 calendar days. The Safe Harbor means the Service will not challenge the treatment of the Exchange Accommodator Titleholder (EAT) as the beneficial owner of the replacement property. The EAT is an IRS requirement used to temporarily take title to or park the property under construction in a construction or leasehold improvement 1031 exchange. An EAT is typically a single member limited liability company (smllc) with the sole member, a parent company independent from the Qualified Intermediary.

Safe Harbor 1031 exchanges represent the majority of reverse exchanges. So why are Non Safe Harbor reverse 1031 exchanges not more popular?

IRS Non Safe Harbor Requirements

The challenge and expense is to demonstrate the EAT has adequate benefits and burdens to support the Service’s requirement for the EAT to be treated as the owner for Federal tax purposes. Eight critieria establish whether the EAT has sufficient benefits and burdens:

  1. whether legal title passes to the purchaser
  2. whether the parties treat the transaction as a sale
  3. whether the purchaser acquires an equity interest in the property
  4. whether the sales contract creates an obligation on the part of the seller to execute and deliver a deed, and an obligation of the purchaser on the purchaser to make payments
  5. whether the purchaser is vested with the right of possession
  6. whether the purhaser pays income and property taxes
  7. whether the purchaser bears the risk of economic loss or physical damage, and
  8. whether the purchaser receives a profit from the operation, retention and sale of the property.

See Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, at 1237-38 (1981).

Conclusion

Non Safe Harbor reverse 1031 exchanges are accomplished given the EAT bears the economic risk of loss and an opportunity for profit. This type of reverse exchange is expensive and not for the risk averse. Adequate planning is required inclusive of a long term lease with lessee purchase option and fair market rent.

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Note: The picture above is of the Arthur Revenel Jr. Bridge in Charleston, South Carolina. Home to the annual 10K Cooper River Bridge Run held in early April. I ran it in 2008 with thirty thousand others in just over an hour.

Reverse 1031 Exchange

Posted on | by Andy Gustafson | Leave a Comment on Reverse 1031 Exchange

Reverse 1031 ExchangeIn the normal course of events, when you sell real property and realize a gain on the investment, you are subject to capital gains taxes. For example, if you purchased a property for $100,000 and later sell it for $150,000, you may be required to pay capital gains taxes on the $50,000 gained as a result of the sale. The Internal Revenue Code, Section 1031, however, allows certain transactions to qualify for a deferral of the payment of capital gains taxes. In order for a transaction to qualify for a 1031 exchange, you must purchase “like-kind” property to replace the property you sold. Under certain circumstances, you may be able to purchase the replacement property first by using a reverse 1031 exchange.

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