Reverse Exchanges

September 19, 2000, is a day to remember. On that day, the Internal Revenue Service issued Revenue Procedure 2000-37. This ruling established guidelines for the structuring of “Reverse Exchanges”. Yes we now have a safe harbor as a safety net when you need to acquire Replacement Property before you sell your Relinquished property.

The ordinary forward, like-kind exchange involves the sale of the Relinquished property by the taxpayer, followed by the acquisition of the new property within 180 days of the sale of the old property. Ordinary forward exchange rules require the taxpayer to identify the replacement property within 45 days of the transfer of the relinquished property. Under these circumstances, the taxpayer must delay the acquisition of the replacement property until the relinquished property is sold. What happens if the seller of the replacement property will not wait for the taxpayer’s sale?

Prior to Revenue Procedure 2000-37, existing regulations did not cover the acquisition of the new property before the old property was sold. Admittedly there were some exchange companies offering services as under a parking arrangement much like the September 19, 2000 ruling. The parking intermediary would actually take title to the new property, hold it, lease it to the taxpayer and then sell it to the taxpayer after the taxpayer’s relinquished property was sold. The transaction was made to appear as if the taxpayer was doing an ordinary forward exchange. The IRS did not officially recognize this arrangement.The parking intermediary did not mind being patient and holding the new property awaiting the sale of the taxpayer’s relinquished property because that is just what he was being paid to do. The agreed profit or fees earned by the parking intermediary usually ran upwards of $25,000.00, depending upon the type, value and holding period of the new property parked with the parking intermediary.

Under Revenue Ruling 2000-37, a parking intermediary can hold the new replacement property up to 180 days, at the end of which time the new property must be transferred to the taxpayer as part of a forward exchange, otherwise the parking arrangement will not qualify for safe-harbor treatment. The taxpayer must identify his relinquished property within 45 days of the time the parking intermediary acquires the replacement property.

At this point, you ask, “Do I still need a qualified intermediary?” A qualified intermediary serves the purpose of “safe-harboring” a forward like-kind exchange under the 1991 Regulations The IRS ruling on reverse exchanges does not create safe-harbor treatment for the forward exchange, and since complying with any IRS safe harbor reduces the risk of challenge, it makes good sense to follow the forward exchange regulations.

To better understand this Reverse exchange technique, you should become acquainted with some of the vocabulary that you will bump into when you read or talk about this Reverse Exchange procedure. The following terms are being used:

QEAA “Qualified Exchange Accommodation Agreement”. This is the exchange agreement that spells out the transaction, and names the players and how the transaction will be structured.

AT “Exchange Accommodation Title Holder”. This is the parking entity that will be established to hold the Replacement Property until the completion of the Transaction.

QI “Qualified intermediary”. This is the entity that makes the forward exchange work as we use in regular forward exchanges.

In a reverse exchange the AT must be the bona fide owner of the replacement property. The AT leases the property to the taxpayer. The AT and taxpayer sign an agreement to sell the new property to the taxpayer. If the AT borrows any money from the taxpayer to buy the new property, the AT gives the taxpayer a promissory note, mortgage/or security agreement. If the AT borrows money for the purchase from a bank, the taxpayer will generally be asked to give a guaranty.

As a matter of information, the AT may be the holder of either the Relinquished or replacement property, however this article discusses only the parking of the Replacement property. The use of the AT as holder of the Relinquished property will be addressed in a future article as will the use of this technique in Build To Suit Exchanges.

Most exchanges that the real estate exchanger deals with involve real property. There is an active market in reverse exchanges for a host of other types of property, from aircraft,, drilling rigs, fleets of trucks and cars and metal fabricating machines to franchise rights and broadcast licenses. As with all specialized fields, be sure that you employ an expert in that field to be your specialist.

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