In a Reverse Exchange, the Exchange Accommodation Titleholder (EAT) forms a Special Purpose Entity (SPE) and purchases the Replacement Property using loan proceeds from the exchanger’s lender and/or cash from the exchanger and “parks” the property until the exchanger can sell their Relinquished Property within the 180 day time frame. Upon completion of the sale of the Relinquished Property, the EAT would then transfer (through the QI) the Replacement Property to the Exchanger. IRS tax law states, an exchanger cannot have ownership to both the Relinquished and Replacement properties at the same time during an exchange. This is why the Reverse Exchange serves as a valuable solution for sellers who are in a “Must Purchase First” situation while making efforts to sell their own investment property.
Timeline Requirements
The same timeline requirements apply when doing a Reverse Exchange. The exchanger has 45 days from the date of the Replacement Property sale to identify in writing to the QI the Relinquished Property being sold in the exchange. Furthermore, the exchanger must successfully close on identified property within 180 days of the Replacement Property sale date.
How does it work?
In order for a taxpayer to do a reverse exchange within the safe harbor set forth by the IRS, an EAT (Exchange Accommodation Titleholder) must be used. The EAT acquires and holds the target property (purchase) in a separate special purpose entity, typically and LLC or Corp. Title is taken to the replacement property through a QEAA (Qualified Exchange Accommodation Agreement) prior to the purchase.
Importance of Planning Ahead
The exchanger must either front the necessary cash for the purchase or inform their lender that they will be doing a reverse exchange and that the Exchange Accommodation Titleholder will be the borrower on the loan until such time when the replacement property is transferred to the taxpayer. The loan must be non-recourse to the EAT. The lender may require that the exchanger be a guarantor on the loan and that the exchanger offer other collateral, if necessary, to meet the requirements of the lender's underwriting guidelines. The EAT will require the exchanger to name the EAT as insured or additionally insured on their hazard and liability insurance coverage. Other items may be required by the EAT such as a Phase I environmental assessment report and further documentation pertaining to the exchanger and the Replacement Property.
The most common reasons why people do Reverse Exchanges:
- Chance to purchase an exceptional Replacement Property at a good price or one that fits a particular need that has to close quickly
- The Relinquished Property transaction fell apart at the last minute
- Potential loss of deposit on Replacement Property
- Extreme market conditions
- Desire to gain more control over time to negotiate a good price for the Relinquished Property
- Relinquished Property is structured as a partnership or LLC and needs to be restructured as a tenants-in-common arrangement to meet the exchanger’s goals
- Opportunities gained exceed the extra costs associated with a Reverse Exchange