Reverse Exchanges
     SIMPLIFIED

                                                   By Mary Lou Schwab CPA

Frequently, an investor is in the situation of needing to purchase a new replacement property prior to selling their old relinquished property. By structuring a reverse exchange an investor will have the ability to do a tax- deferred exchange and save money by not incurring capital gain taxes. Reverse exchanges are more complicated to do than a simple 1031 exchange but with proper planning it’s worth the effort.

There are two types of reverse exchanges, a short term exchange that lasts at most six months or a long term parking arrangement which can run a couple of years in duration. The first type of exchange is commonly called a “safe-harbor” reverse exchange since it follows the revenue procedure that the IRS issued in September 2000. If these guidelines are properly applied the IRS cannot disallow the reverse exchange transaction, hence the term “safe harbor” reverse exchange. The major challenge in utilizing this “safe harbor” reverse exchange is the requirement that all the old relinquished properties would need to be sold within six months from the replacement property purchase date. There is unfortunately no time extension for this six-month deadline. The replacement property purchase is completed by an Exchange Accommodator Titleholder set up by a qualified intermediary to park the property. This purchasing/parking entity is generally formed as a limited liability company “LLC”.

The second type of reverse exchange is used when the old relinquished property cannot be sold within six months from the time the LLC purchases the replacement property. Commercial, farm and ranch land property at times will take a longer time to sell. This method is a traditional long term parking arrangement that was utilized prior to the issuance of the revenue procedure guidelines. There are numerous court cases and tax law interpretation that substantiate this long-term type of reverse exchange. They do require more documentation and ownership attributes for the LLC parking entity and tend to be more costly for the investor since there would be monthly rental expenses plus additional banking, exchange and option fees.
The general rule of thumb to use in determining if a reverse exchange is worth doing is as follows: If an investor has at least $75,000 in gain or greater on the sale of their old relinquished property then the additional fees related to a reverse exchange are generally less than paying long term federal capital gains tax (currently at 15%) and any related state tax. Additionally, if an investor can directly fund the replacement property purchase by the LLC, the bank fees and interest savings can be substantial.

To structure a real estate transaction involving a Reverse Exchange the original sales contract will need to be assignable to the LLC parking entity. If bank lending is required, a commercial bank loan will be necessary to obtain since the standard mortgage portfolio lender is unable to process a loan for the LLC’s purchase. The steps related to the reverse exchange transaction are listed to the left of this article. As with any type of exchange transaction, please review your tax situation and exchange with your direct tax advisor. This article only covers a partial list of requirements and reverse exchange issues. Each individual investor’s situation is unique and it is prudent to obtain good advice prior to


©2004 Bankers Escrow Corp. Mary Lou Schwab CPA is Vice President of Bankers Escrow Corporation and oversees the 1031 Exchange Division. She has over 22 years experience in real estate taxation. For questions on 1031 exchanges call 303-986-4848 or 800-571-6595. Bankers Escrow Corporation provides qualified intermediary services for all types of exchanges including simple deferred, reverse, construction, leasehold interest and business property exchanges.