Reverse Exchanges Simplified

Our offices regularly receive calls from potential 1031 Exchangors who have heard about Reverse Exchanges from their Realtor or tax advisor. Initial internet searches reveal a Reverse Exchange allows tax payers to purchase property before they sell their property through the 1031 Exchange process.

It sounds like a great way to avoid one of the biggest pitfalls of the 1031, having to identify replacement property within 45 calendar days of the closing of their sale. A Reverse Exchange would eliminate that part of the process. Unfortunately, there are other hurdles that could make the Reverse Exchange impossible.

Hurdle #1: Since the client will be purchasing their property first, Security 1st Exchange (as the Qualified Intermediary) does not have funds from their sale to use on the purchase of the replacement property. The solution requires the taxpayer to bring in the cash for the acquisition of the replacement property. The question becomes, “Does the taxpayer have the cash available?” If not, they normally think that they can just get a loan. Maybe they have 25% of the down payment available and can finance the balance.

Which leads us to…

Hurdle #2: Revenue Procedure 2000-37. This Revenue Procedure issued in 2000 explains and provides a safe harbor for Reverse Exchanges. One item stipulated in the Revenue Procedure, noted previously, is in a Reverse Exchange, the taxpayer cannot hold title to both properties (the one being sold and the one being acquired) at the same time. If the client is doing a Reverse Exchange, they are acquiring that property first and would be on title, therefore holding title to BOTH properties at the same time. This is not allowed.

The solution (as explained in Rev Proc 2000-37) is for the Qualified Intermediary (QI) to create an Exchange Accommodation Titleholder (EAT). The EAT typically comes in the form of a newly created LLC. The QI creates this new LLC (EAT) which will be owned by the QI. The EAT takes title to the replacement property on behalf of the taxpayer.

However, this is where we circle back to getting a loan on this property. What is imperative to understand is that the EAT, which is owned by the QI, will be taking title to the replacement property. Most lenders will not lend to the EAT as it is a newly formed LLC which is not owned by the taxpayer at the time of the acquisition.

Because of this, in most situations, the Reverse Exchange is not a viable solution because the client cannot get the loan to acquire the replacement property.

Hurdle #3: The cost of a Reverse Exchange is much higher than a standard 1031 Exchange. Where a standard (forward) exchange can cost less than $1,000, the Reverse Exchange normally starts at $6,000 and goes up from there.

For more information about Reverse Exchanges, or for any other 1031 Exchange questions, please contact the specialists here at Security 1st Exchange for assistance.