With each passing day, more and more people are learning about the many benefits that lie within a Reverse 1031 Exchange. While more of a complex transaction than a forward or delayed 1031 exchange, the reverse exchange provides for much greater flexibility in structuring the exchange.
The reasons for setting up a reverse exchange are many, but the major reason is to solve the issue of finding a way to take control of the replacement property prior to the sale of the old property in a 1031 exchange. The code does not allow for an exchanger to exchange into a property already owned. Therefore, the reverse exchange becomes the answer when one has found, and is ready to close on a replacement property, while still trying to sell the old property. Other reasons to setup a reverse exchange include securing your replacement to avoid the risk of possibly loosing that property, and ridding yourself of the replacement property “dilemma;” once you have sold that old property, there is a very short 45 day window to find a suitable replacement property.
Once you have decided that a reverse exchange is the answer for your 1031 exchange needs, the next question becomes ‘what type of reverse exchange should I choose.’ There are a number of different options available. The most popular include:
- Safe-harbor Reverse – This is a transaction whereby the accommodator takes control (parks) the replacement property prior to the sale of the old property. The exchanger must identify the relinquished property or properties within 45 days of the parking arrangement, and must have the entire transaction complete within 180 days of the parking arrangement. This structure falls within a revenue procedure set forth by the IRS in 2000 providing for guidelines in structuring this type of transaction. If structured within the provisions of the revenue procedure, the IRS will treat this to be within a “safe-harbor” and not challenge the transaction based upon its status as a reverse exchange. This is the safest type of reverse exchange, but the most difficult to accomplish due to its tight time frames.
- Traditional Reverse – This is a reverse exchange that typically looks identical in structure to the Safe-harbor reverse, yet it will fall outside of the safe-harbor due to the fact that it can not be completed within the time frames provided. Typically, the exchanger is unable to sell their old property within 180 days of the parking arrangement, and therefore the time frames set forth by the safe-harbor are not met. This type of transaction is not necessarily a “red flag” for an audit by the IRS, but does require quite a bit more documentation and consultation by the intermediary to assure the transaction is done properly to avoid scrutiny by the IRS.
- Construction/Improvement Reverse – This type of reverse exchange allows the exchanger to park a piece of property or land that will be built upon or improved during the exchange period. This is the most powerful reverse exchange available, as it allows the exchanger to literally create the exchange property they will eventually exchange into through the development or construction process. Once again, this is a much more complex transaction than a safe-harbor reverse exchange and requires a great deal more documentation. The other downside to this type of transaction is that it will typically fall outside of the timeframes set forth by the safe-harbor. This detriment has not scared off many exchangers as many are more than willing to take on that slight risk for the tremendous flexibility provided by this type of exchange.
- Leasehold Improvement Reverse – This type of exchange is still questionable as it has not officially been recognized by the IRS as valid structure. This is an exchange whereby the exchanger will actually build on property they already own; treating the building as the parked property. Technically, it is not the building that becomes the parked property, but rather a 35 year ground lease entered into between the accommodator and the exchanger, that is the actual ‘vehicle’ that becomes the exchange property. Obviously, this too is a highly complex transaction and must have proper supporting documentation to support its structure. Once again, the complexity of this exchange has not deterred demand. Many exchangers are turning to this structure to take care of their 1031 exchange demands.
Hopefully this gives you a flavor of the many options that are available when utilizing the reverse exchange.
I encourage you to speak with me to learn more about this very powerful tool, and to see how it can directly benefit you.
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