Background Information
 

In a Forward Exchange, the property owner (the taxpayer) first closes on the sale of the Relinquished Property, and later 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 title to the Relinquished property.  Reverse exchanges are less common for the simple reason that the taxpayer will own, and will carry financially, two properties for a period of time.   

Taxpayers sometimes prefer Reverse Exchanges if they need continuity of use of the asset.  A business, for example, often cannot sell its office building until the new headquarters is acquired and configured for use.  Similarly, an airline with scheduled passenger traffic often cannot sell its current aircraft until after the new asset is acquired, modified to conform to the fleet, and prepared for scheduled service; or an investor finds the perfect property at the right price, and wants to lock-up that property before another buyer does.  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.  Please visit our Section 1031 Library to read or print a copy of the Rev. Proc. 


The Regulations

Reverse Exchanges are more complex than Forward Exchanges due to one basic, underlying concept: 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’) such as Beacon Exchange Company 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. 

Under the safe harbor, the IRS will not challenge a ‘Qualified Exchange Accommodation Arrangement’ (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.

We cannot emphasize enough the importance of engaging a Qualified Intermediary / Accommodation Titleholder early in the process if a Reverse Exchange may occur.  Beacon Exchange Company will act as both Qualified Intermediary and Accommodation Titleholder to fulfill these dual roles to assist you to complete your Reverse Exchange.

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 titleholder to the parked property.  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 reverse exchange safe harbor guidelines.   Beacon Exchange Company, in its role as Accommodation Titleholder, generally will be the initial beneficiary the SPE that acquires title to the parked property, and thus will be considered the owner of this property for tax purposes during the limited parking period.  This is required to meet the safe-harbor guidelines.

The taxpayer, as trustee of the trust or as manager of the LLC, will have total control of the property, will have the benefits and burdens of ownership, but will not hold title or have beneficial ownership of the property during the parking period.

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 the exchange is carefully planned well in advance of the first closing.  This is especially true when bank financing will be used to acquire the Replacement Property. 

Please contact me if I can answer any questions or provide additional information regarding Reverse Exchanges.