Reverse 1031 Exchange Rules: Relinquished Property

The Reverse 1031 exchange rules are as follows. In a reverse exchange the exchanger has found, and wants to buy, the replacement property before their sale of the relinquished property.

In 2000 in Rev, Proc. 2000-36 the IRS set forth the procedures to safely accomplish a reverse 1031 exchanges. In a reverse 1031 exchange the IRS has given us this problem to solve: If the exchanger owns both the relinquished property and the replacement property at the same time the IRS will not consider the transaction to be an exchange of real estate. Therefore either the replacement property or the relinquished property must be held, temporarily, by a holding company known as an Exchange Accommodation Titleholder (EAT).

When the relinquished property is to be held by the EAT the procedure which we follows is:

1. Our Limited Liability Company buys the relinquished property. The LLC will act in the capacity of an “Exchange Accommodation Titleholder” (EAT) as that term is defined by the IRS. The EAT and the exchanger will enter into a real estate holding contract termed by the IRS a “Qualified Exchange Accommodation Arrangement” (QEAA). The QEAA will outline the obligations of the EAT and the exchanger during the real estate holding period.

2. Our LLC will purchase the relinquished property by borrowing 100 percent of the needed funds. We can borrow the funds from any source authorized by the exchanger. The easiest source of borrowed funds in the exchanger themselves. However, we can borrow from any source. Because we plan to resell the relinquished property very quickly, we often leave any existing financing in place on the relinquished property and take title to the property subject to the existing financing. The lender is protected by a note and deed of trust on the relinquished property. Finding a lender for a reverse exchanger can be difficult. Please contact us is you need help finding a reverse exchange lender.

3. Our LLC will also lease the relinquished property to the exchanger until the relinquished property sells, or for 180 days, whichever occurs first. Lease payments from the exchanger to Our LLC will correspond in amount to mortgage payments made by Our LLC.

4. Our, LLC will also agree to re-sell the relinquished property to a third party buyer. We list the relinquished property for sale with a real estate broker of the exchanger’s choosing. We must resell the relinquished property to a third party buyer within 180 days after Our LLC acquires the relinquished property. The 180 day time limit for completing a reverse 1031 exchange is set by the IRS.

5. At the time of sale of the exchanger’s relinquished property, 1031x.com, Inc. will act as Qualified Intermediary for the exchanger and escrow the funds from the sale of the relinquished property. Net proceeds from the sale of the relinquished property will be used to buy replacement property, from Our LLC. THE NET EFFECT OF THIS WILL BE SIMPLY TO SHIFT ALL EQUITY FROM THE RELINQUISHED PROPERTY TO THE REPLACEMENT PROPERTY. In the end this looks very much like a forward exchange with us having captured and held the relinquished property until a third party buyer can be found.

6. When we hold the relinquished property these types of reverse exchanges are also known as “exchange first“ reverse exchanges because the 1031 exchange actually takes place when the relinquished property is transferred to Our LLC.

Finally let me explain what happens when a reverse exchange fails. Our real estate holding agreement states that we will transfer whatever property we are holding to you at the end of 180 days. You end up owning both relinquished property and replacement property. A failed reverse exchange is not a tax recognition transaction. You just own more real estate than you had hoped. I hope that you find this summary of procedure helpful. Please contact us if you have any questions.

Contact us for help with your reverse exchange. Exchanges are our business!