In a Forward Exchange, the taxpayer first closes on the sale of the Relinquished Property, then acquires the Replacement Property within 180-days to complete his or her Exchange.  In a Reverse Exchange, the closings occur in the opposite, or reverse, order – the taxpayer closes on the acquisition of the Replacement property prior to transferring the Relinquished property.  Reverse exchanges are less common for the simple reason that most taxpayers prefer not to carry two properties for a period of time. 

Taxpayers sometimes prefer Reverse Exchanges if they need continuity of use of the asset.  For example, an airline with scheduled passenger traffic often cannot sell its current aircraft until after the new asset is acquired and prepared for scheduled service.  Similarly, a business often cannot sell its office building until the new headquarters is acquired and configured for use.  There are often good business reasons to consider a reverse exchange, particularly with aircraft and commercial real estate exchanges. 

On September 15, 2000, the IRS issued Revenue Procedure 2000-37, which set forth the Safe Harbor guidelines for Reverse Exchanges, or visit our Section 1031 Library.  


The Regulations

Reverse Exchanges are more complex than Forward Exchanges due to one basic, underlying rule: The taxpayer cannot own the Replacement property and the Relinquished property at the same time.  The usual manner for structuring reverse exchanges is for an ‘Accommodation Titleholder’ (‘AT’) to hold title to either the Relinquished or the Replacement property in a ‘parking’ arrangement until the taxpayer has found a buyer for the Relinquished property. 

Until the issuance of Revenue Procedure 2000-37, there was little IRS guidance on reverse exchange parking transactions.  Most Reverse Exchanges today will be completed within the safe harbor guidelines provided by the Revenue Procedure. 

Under the safe harbor, the IRS will not challenge a ‘Qualified Exchange Accommodation Arrangements’ (i.e., will treat the AT as the owner of the parked property for tax purposes and will respect its exchange of that property with the taxpayer) if the following criteria are met: 
 

1.  The AT takes title to or otherwise has beneficial ownership of the parked property;

 

2. The taxpayer has, at the time the property is parked, a bona fide intent to complete a Section 1031 exchange;

 

3.  A ‘qualified exchange accommodation agreement’ (‘QEAA’) is entered into within five business days of the AT taking title to the parked property;

 

4.  The relinquished property that is to be part of the exchange is identified within 45 days of the time that either the relinquished or the replacement property is parked with the AT; and

 

5.  The transaction is completed within 180 days of the parked property having been acquired by the AT.
 

Rev. Proc. 2000-37 also indicates that a number of arrangements that typically are used in parking transactions may be employed without voiding the exchange.  These include:
 

1.  Financing provided or guaranteed by the taxpayer to enable the AT to acquire the parked property;

 

2.  A lease of the parked property to the taxpayer during the AT’s holding period;

 

3.  The provision of an option to the taxpayer to purchase the parked property should the exchange not be completed – that option cannot extend for more than 185 days from the time that the parked property was acquired by the AT; and

 

4.  The provision of services by the taxpayer with respect to the parked property via management and related agreements.

 
Closing a Reverse Exchange

We cannot emphasize enough the importance of engaging a Qualified Intermediary / Accommodation Titleholder early in the process if a Reverse Exchange may occur. 

Reverse Exchanges can be structured as an ‘Exchange First’ or an ‘Exchange Last’ transaction.  The exact structure will depend on factors such as the role of a lender, the type of entities that own the Relinquished property or ultimately will own the Replacement property, or the tax laws of the states or jurisdictions where the properties are located.  The professionals of Beacon Exchange Company will review your transaction with your advisors and you to ensure that your reverse exchange is structured in the most cost-effective manner. 

Beacon Exchange will oversee the establishment of a special purpose entity (‘SPE’), generally a nominee trust or a single member LLC, which will act as Accommodation Titleholder.  The SPE will acquire title to either the Relinquished or the Replacement property on behalf of the taxpayer, as the taxpayer cannot own both properties simultaneously without violating the 1031 Exchange regulations.  Beacon Exchange Company generally will be the initial beneficiary or member the SPE that acquires title to the parked property. 

In those instances when the SPE acquires title to the new, Replacement property, the SPE also will be the borrower if debt is used to finance the acquisition of the property.  Within 180-days, when the taxpayer has arranged for the sale of the Relinquished property, Beacon Exchange Company will fulfill its role as Qualified Intermediary by transferring the Relinquished Property to its purchaser, then will transfer SPE interest in the Replacement Property to the taxpayer, completing the exchange. 

Summary

Please remember that Reverse Exchanges will close more smoothly if all parties are notified well in advance of he closing.  This is especially true when bank financing will be part of the exchange. 

Please contact us if we can answer any questions or provide additional information regarding Reverse Exchanges.