reverse exchange

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 Rules

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

In Revenue Procedure 2000-37, enacted on September 15, 2000, the IRS provides a clear picture as to the process of completing a reverse 1031 exchange. A reverse 1031 exchange has a similar procedure to that of a traditional 1031 exchange, with a few extra steps because of the complex nature.

1031 Reverse Exchange

While in a traditional 1031 exchange, the taxpayer sells the old property before purchasing the replacement property, a reverse 1031 exchange allows the taxpayer to purchase a new property before selling the old property. Because regulations restrict the taxpayer from being in possession of both properties simultaneously, there are a few things that must be done.

Exchange Accommodator Titleholder

The process starts with the purchase of a new property. As mentioned above, the taxpayer must not be in possession of both properties at once, so the taxpayer will contract a Qualified Intermediary (QI) to assist in the process of the reverse 1031 exchange. The QI will establish an Exchange Accommodator Titleholder (EAT), which will purchase and receive title to either the new or old property to avoid the taxpayer being in possession of both. The EAT is a single member limited liability company with the sole member a related company to the QI.

Reverse First

In a reverse first, the new property is parked with the EAT. The taxpayer may need to get a loan in the name of the EAT from a lender to complete the purchase given the proceeds from the old property aren’t available as they are with a traditional 1031 exchange. Lenders are typically not cooperative to have the EAT on title, but with those that are, the EAT signs a non-recourse note meaning EAT is not responsible for the payment of the loan.

Reverse Last

I find that parking the old property with the EAT and allowing the taxpayer to acquire the replacement property directly is the preferred tactic. In a reverse last a loan may be needed to acquire the replacement property; the taxpayer is able to do so directly with the lender. Loan payments on the old and new property are the responsibility of the taxpayer. Rental revenues are received just as normal to the taxpayer while expenses including utilities, maintenance, insurance and taxes for the old property parked with the EAT are the responsibility of the taxpayer.

The Purchase and Sale Agreement should reflect assignment language or that the property is being purchased with the intent to complete a reverse 1031 exchange. In a reverse first, the EAT will park the purchased property until the taxpayer is able to sell the old property. In a reverse last, the EAT will park the old property.

Identification Requirement

The next step is identifying and finally selling the old property. The taxpayer has 45 days from the purchase date to identify the property that he/she plans to sell to complete the exchange and 180 days from the date of the purchase to actually complete the transaction. Upon the sale of the old property, the net equity goes to pay off the taxpayer’s loan on the replacement property. It is at this point that the QI will transfer the ownership (transfer of the deed or transfer ownership rights of the EAT to the taxpayer) of the new property to the taxpayer to complete the reverse 1031 exchange.

Transfer Taxes

Taxpayer should research whether the initial transfer to the EAT triggers a state or county tax. Florida recognizes the role of the EAT in a 1031 exchange and does not impose a transfer or documentary stamp tax other than the standard recording fees which for a two page deed is currently less than $25.00.

Improvement Exchanges

When improvements are to be made to the replacement property, the EAT will park in either a reverse first or deferred improvement exchange to pay the approved contractor invoices with a targeted completion date of 180 calendar days post-closing on the first property. Those exchange funds that are not paid out for work completed are returned to the taxpayer and are taxable.

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