What is a Reverse Exchange?
In essence, a reverse exchange is a 1031 exchange in which the New Property (Replacement Property) is acquired before the Old property (Relinquished Property) is sold. The role of the Accommodator is to acquire either the Old or New Property on behalf of the Exchangor and hold legal title to it until the Old Property is sold to its ultimate buyer.
While exchanges following this basic pattern have been used for years, in 2000 the IRS issued much needed guidance for acceptable reverse exchange processes and established a series of reverse exchange safe harbors. This guidance, known as Rev. Proc. 2000-37, provides the impetus for the growing number of safe-harbor parking arrangements performed under the auspices of IRC 1031 being provided to exchangors today.
In any reverse exchange, the Accommodator should form an LLC to hold the parked property during the exchange. This LLC – specifically called the “Exchange Accommodation Titleholder” or EAT – is almost always a single-member LLC and the member is the Accommodator. Using this approach, each asset in each exchange is kept in a separate legal entity that is insulated from issues that might arise with other assets held as part of other exchanges by the same Accommodator.
Reverse exchanges have the same basic requirements and the same safe harbors as deferred exchanges. In addition, Rev. Proc. 2000-37 provides other provisions, some of which are listed here, that are useful in the execution of safe-harbor reverse exchanges:
The EAT and the Exchangor have up to five days after the close of the New Property to establish a reverse exchange arrangement.
The Exchangor may secure loans made to the EAT by third-parties to acquire properties to be parked.
The Exchangor may lend the EAT all the funds required to acquire properties to be parked.
Arrangements can be entered into by which the EAT leases the parked property back to the Exchangor and by which the Exchangor can manage the parked property without direct financial consequence to the EAT.
Any capital gains or losses resulting from the purchase and sale by the EAT can be “trued up” without consequence to the exchange.