The financial and operational efficiency benefits of a 1031 exchange are well established. However, in some cases a company may not be able to sell a relinquished property before purchasing a replacement asset. Two common cases include:
- A buyer for the old property has not yet been identified
- The business needs to continue using the old property until the new property has been acquired
In these cases, there’s a powerful strategy that allows the exchanger to structure the transaction as a reverse exchange. In a reverse, the business buys the replacement asset first and sells the existing asset at a later date.
About Reverse Exchanges
Section 1031 of the tax code requires that a business “exchange” assets. To successfully complete such an exchange, either the original asset or the replacement asset must be temporarily “parked” with an Exchange Accommodation Titleholder, or EAT.
In order to facilitate the reverse exchange, Accruit forms a new limited liability company – the EAT – for the sole purpose of holding ownership of the parked property. Accruit prepares the reverse exchange documents and works with the exchanger to coordinate execution of the documents and the transfer of property.
The Benefits of a Reverse Exchange
A reverse exchange allows the exchanger to continue using and producing revenue from its original asset until the time of sale. The tax benefit is the same as other 1031 exchanges – the company can defer recognition of the gain on the sale of the relinquished asset, which can exceed 40% of the proceeds of the sale – and keep those funds at work in its business. Some people liken 1031 exchanges to getting an interest-free loan from the federal government, and for good reason.
The Reverse Exchange Process, Step by Step
There are four steps in a successful “exchange last” reverse exchange:
STEP 1: THE REPLACEMENT PROPERTY IS PARKED
- The EAT borrows the funds required to acquire the replacement property.
- Accruit’s EAT takes ownership of the replacement property.
- The EAT leases the parked property to the exchanger.
STEP 2: IDENTIFICATION
- Within 45 days of the transfer of the replacement asset to the EAT, the exchanger identifies the potential relinquished property.
STEP 3: RELINQUISHED ASSET IS SOLD AND TRANSFERRED
- The relinquished asset transfers to the buyer within 180 days of the replacement asset being transferred to the EAT.
- The proceeds from the sale of the relinquished asset are transferred directly to Accruit.
STEP 4: THE EXCHANGER PURCHASES THE REPLACEMENT PROPERTY FROM THE EAT
- The exchanger acquires the replacement asset from the EAT within 180 days of the replacement asset transferring to the EAT.
- Accruit transfers the exchange funds to the EAT and the EAT makes payment against the loan.
Frequently Asked Questions About Reverse Exchanges
1. Will Accruit or the EAT use its own cash to acquire the parked asset?
No. The EAT will borrow the funds needed to acquire the asset from the exchanger and/or a lender. The EAT will repay the loan at the time the parked property is transferred to either the exchanger or a buyer.
2. Can I use the property while it is parked with the EAT?
Yes. The EAT leases the parked property to you. You are permitted to use the property and are entitled to any rental income.
3. Who is responsible for insuring the property while it is held by the EAT?
The exchanger is required to insure the property while it is parked with the EAT. The EAT must be added as an additional insured on the client’s insurance policy.
4. Who is responsible for the costs associated with owning the parked property?
The exchanger is responsible for all costs (taxes, maintenance, etc.) associated with owning the property.
5. Has the Internal Revenue Service (IRS) issued any guidance in the area of reverse exchanges?
Yes. Revenue Procedure 2000-37 describes certain safe harbors for taxpayers engaging in reverse exchanges.
6. What happens if I cannot find a buyer for my relinquished property by the 180th day?
The parked property will be transferred from the EAT to you.
7. How much does a reverse exchange cost?
The cost of a reverse is variable. The EAT will charge a fee for parking the asset. The amount of this fee depends on the risk and complexity of the parking transaction. In addition, Accruit will charge a qualified intermediary fee upon sale of the relinquished property to facilitate your exchange. An Accruit representative can review your specific situation and answer this question in greater detail.
I’m Interested – What Do I Need To Do?
Contact Accruit at 866.397.1031 or firstname.lastname@example.org) and ask for a reverse exchange specialist. This expert will discuss your situation and answer any questions you have about structuring a 1031 reverse exchange.