Types of Reverse Exchange


There are three primary forms of safe-harbor reverse exchange: Exchange First, Exchange Last and Improvement. Our Exchange Officers are experts at determining which form is right for optimizing a particular exchange strategy.

The Exchange First form is frequently used when the Exchangor has arranged financing for the purchase of the New Property and the lender requires the Exchangor to be the borrower and hold title to the New Property directly. This form involves parking the Old Property with the EAT just prior to the acquisition of the New Property directly by the Exchangor. Typically, the EAT is formed and “borrows” the funds necessary to acquire the Old Property from the Exchangor. Title to the Old Property is transferred to the EAT as an interim buyer. The Exchangor then acquires the desired New Property and takes title to it directly. The exchange is then technically complete, the EAT having acquired the Old Property and the Exchangor having acquired the New Property, in that order. However, the Exchangor has 180 days to arrange for and complete the sale of the Old Property in order for the reverse exchange to be valid. Once a purchase and sale contract with the ultimate Buyer has been ratified, the contract is assigned to the EAT and the EAT “sells” the Old Property to the Buyer. In some cases, title is transferred to the Buyer and in other cases the LLC underlying the EAT is assigned to the Buyer. In either case, the funds from the purchase of the Old Property are immediately distributed to the Exchangor.

The Exchange Last form is used frequently when the New Property can be acquired without financing or when the lender agrees to have the EAT be the borrower and hold title during the exchange. Also, if the Exchangor has multiple assets that may be identified as part of the exchange, then the Exchange Last form may be optimal. In this form, the EAT acquires the New Property on behalf of the Exchangor. This is accomplished when the purchase and sale contract for the New Property is assigned to the EAT and the EAT borrows money from the Exchangor as needed to make the acquisition from the seller. Title to the New Property is then transferred to the EAT and held until the Old Property is sold. When a purchase and sale agreement for the Old Property has been ratified, it is assigned to a QI (either the Accommodator or a different QI) who effects a deferred exchange between the EAT and the Exchangor. Funds from the sale of the Old Property are then transferred to the Exchangor.

The Improvement form is essentially an Exchange Last in which improvements are made to a property acquired by the EAT during the exchange period and the Exchangor ultimately “exchanges into” a New Property whose Fair Market Value (FMV) is the combined value of the newly acquired property with the improvements made during the 180-day period of the exchange. The Improvement form includes a Construction Management Agreement by which the EAT “hires” the Exchangor to make or construct the improvements.

All of these basic forms can involve varying levels of complexity. At ES Group, we have carefully defined processes that reduce the cost and impact of complexity. We have implemented processes, for example, that work for the vast majority of standard reverse exchanges involving residential and mid-sized commercial real estate. We have processes for more complex real estate exchanges as well for personal property exchanges. For the very complex reverse exchanges, we have processes that involve completely customized exchange agreements and provisions for extending the exchange period beyond 180 days.

Complexity can arise from a variety of sources. Many of the common sources are:

The number of properties or assets involved
The degree of customization of the exchange agreements required
The effort required to negotiate loan documents, with the EAT named as borrower, if third-party debt is used to acquire the New Property.
The necessity of forming LLCs with customized operating agreements or other Exchangor-specific provisions.
The complexity of perfecting security interests in the underlying LLC
Customized structuring of partnership formation or dissolution
Exchanges which are designed to extend beyond 180 days
Our exchange processes are designed to manage differing levels of complexity. Our fees reflect the level of complexity, not necessarily the value of the assets involved in the exchange. The following summaries describe in general terms the levels of complexity that are anticipated in each of the processes we deliver:

The Standard Exchange First or Exchange Last is characterized by:

A streamlined document set which is not subject to material modification.
Either real estate or simple personal property.
One “parked” property or asset and up to three additional properties or assets.
A separate LLC with complete perfection of the security interest in the LLC through a share certificate provided to the Exchangor.
The Complex Exchange First/Last for Real Estate is characterized by:

If necessary, a standard document set consisting of the QEAA, Note, Purchase and Sale Assignment, Pledge, Loan, Lease and optional LLC Assignment which may be modified based on agreements between ES Group and the Exchangor and Exchangor’s lawyer or CPA.
Up to three parked properties.
Implementation of specific strategies to avoid duplicate transfer taxes, if available.
As required, ES Group will negotiate loan documents that have the EAT as the borrower when 3rd party financing is required for the purchase of the New Property in an Exchange Last.
A separate LLC, which may have a customized operating agreement or other customized provisions and which may be formed in a jurisdiction specified by the Exchangor, specifically when it is the Exchangor’s intent to assume ownership of the LLC at the end of the exchange.
Complete perfection of the security interest in the LLC through a share certificate provided to the Exchangor.
Customized structuring of partnership formation or dissolution
The Complex Personal Property Exchange First/Last is characterized by:

Assets other than real estate. For example aircraft, tractor/trailer combinations, railcars, barges, oil and gas leases, businesses, collectable items, livestock, mining equipment and so on. In these cases, there is frequently research required to determine the “like-kind” status of New Property with respect to the intended Old Property. Assets such as tractor/trailer combinations or other vehicles are often exchanged in groups. For groups of assets larger than 100, the provisions of IRS Rev. Proc 2003-39 are likely to apply and we may, after consulting with the Exchangor, introduce a partner that specializes in program exchanges following the processes outlined in this Rev. Proc.
A document set consisting of the QEAA, Note, Purchase and Sale Assignment, Pledge, Loan, Lease and optional LLC Assignment which may be modified based on agreements between ES Group and the Exchangor and Exchangor’s lawyer or CPA.
As required, ES Group will negotiate loan documents that have the EAT as the borrower when 3rd party financing is required for the purchase of the New Property in an Exchange Last.
A separate LLC, which may have a customized operating agreement or other customized provisions and which may be formed in a jurisdiction specified by the Exchangor, specifically when it is the Exchangor’s intent to assume ownership of the LLC at the end of the exchange.
Complete perfection of the security interest in the LLC through a share certificate provided to the Exchangor.
The Safe Harbor Improvement Reverse Exchange is characterized by:

All of the characteristics and provisions of the Complex Exchange Last.
Primarily real estate but may apply to other assets, e.g. aircraft
Lease and Construction Management (or an equivalent if the asset is not real estate) agreements by which the New Property is leased to the Exchangor and the Exchangor is “hired” to complete the planned improvements.
Loan documents with provisions for draws to finance improvements.
The above processes refer to numerous documents. A summary of the purpose of each document follows:

The QEAA (Qualified Exchange Accommodation Agreement) in executed by the Exchangor, the EAT and the EAT Parent and it describes the intent of the Exchangor and the obligations required to be performed in the course of the reverse exchange.
The Pledge is executed between the EAT member and the Exchangor and grants the Exchangor a security interest in the EAT (LLC) which is holding the parked property.
The Lease provides a zero-rent lease of the parked property back to the Exchangor by the EAT.
The LLC Assignment provides for the EAT membership to be transferred or assigned to the ultimate buyer of the Old Property, or the Exchangor, depending on the form of reverse used. This agreement is unnecessary if the Exchangor or buyer elects to receive a deed or other direct indication of ownership.
The P&S Assignment is used to assign the rights, but not obligations, of the Exchangor as specific in a purchase and sale agreement reached with a buyer (of Old Property) or seller (of New Property) in order to facilitate the transfer of title between the EAT and the buyer/seller of the asset.
The Note and Loan are used to describe the terms under which the EAT borrows funds from the Exchangor to acquire the assets to be parked in the EAT and, for improvement exchanges, finance the improvements.
ES Group strives to reduce the complexity facing the clients in each of these processes as much as possible while ensuring that the processes accomplish their intended purpose. Each process is structured, as described above, but each is also flexible, within the parameters described, so that small customizations can be made and differences required by local jurisdictions can managed with little increased complexity or risk. Our fees are, accordingly, based primarily on complexity and NOT on the value of the underlying assets involved or the time that the parking arrangement is in effect.

Please see the section on Fees for further details.

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