IRS blesses reverse exchanges, reduces risk

By Larry Jensen

Reverse exchanges occur when a taxpayer arranges for an “exchange accommodation titleholder” (usually the qualified intermediary or a subsidiary organization) to take and hold the title to replacement property before a taxpayer finds a buyer for his exchange property. Sometimes the exchange accommodation titleholder will take and hold the title to the exchange property until a buyer can be found.

Such exchanges have been considered risky because of the lack of guidance by the Internal Revenue Service in the form of regulations or otherwise for such exchanges. Reverse exchanges, however, have been common and even preferred in circumstances in which a taxpayer had to close on replacement property before an exchange property could be sold, or where the taxpayer desired ample time to search for a suitable replacement property before selling an exchange property, which started the well-known 45- and 180-day clocks.

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After promising to do so since 1991, the IRS has finally issued safe-harbor guidance and recognition for reverse exchanges. Reverse procedures 2000-37 officially sanctions reverse exchanges that are structured to comply with the procedures outlined in the reverse procedures. The new safe-harbors are effective for reverse exchanges on or after Sept. 15, 2000.

Following is a summary of the basic requirements and provisions:

* The reverse exchange must be completed within 180 days, or the property being held by the exchange accommodation titleholder must be deeded to the taxpayer.

* The property to be “relinquished” (the exchange property) must be identified within 45 days.

*A qualified intermediary (or a subsidiary) can hold the title to either the replacement property or the exchange property pending completion of the exchange.

* A qualified exchange accommodation agreement (reverse exchange or title-holding agreement) must be entered into between the taxpayer and the exchange accommodation titleholder (qualified intermediary in most cases) within five business days after the title to property is taken by the exchange accommodation titleholder in anticipation of a reverse exchange.

The reverse procedure makes it clear that these safe-harbor provisions are not mandatory. Reverse exchange arrangements that do not meet these requirements will stand or fall on their own merits in the circumstances and will not be deemed to be disqualified merely because they do not comply with the safe-harbor provisions of this reverse procedure. Reverse exchanges entered into before Sept. 15, 2000, also will stand or fall on their own merits.

Reverse exchanges structured to take advantage of the new safe-harbors provisions will permit the following procedures without challenge:

* Taxpayer indemnification of the exchange accommodation titleholder;

* Taxpayer guarantees of acquisition financing;

* Taxpayer lease-back of the property held by the exchange accommodation titleholder;

* Taxpayer management or construction supervision of the property held by the exchange accommodation titleholder.

Reverse exchanges may well become the preferred way to manage and transact 1031 exchanges as a result of this official blessing by the IRS. The 45-day identification period of delayed exchanges, and related pressure to find suitable replacement property, is often so burdensome that taxpayers are unable to successfully take advantage of the tax-deferral potential of a 1031 exchange.

Although reverse exchanges contain similar time clocks under the new safe-harbor procedures, such as pressure to find a buyer for the exchange property within the 180 days of the title-holding arrangement, failure to do so will not result in a taxable disqualification of the arrangement. The new safe-harbor procedures merely require that the exchange accommodation titleholder deed the property being held to the taxpayer on or before the 180-day deadline with no further tax consequences.

Other issues will become self-evident as tax and exchange professionals study these new procedures.Larry Jensen, a certified public accountant with the 1031 Corp. in Longmont, is a leader in the development of 1031 exchange procedures and practices in Colorado. He can be reached at (303) 402-1031, toll free at (888) 367-1031 or by e-mail at 1031@csn.net. Visit the company’s Web site at www.1031cpas.com for additional literature on 1031 exchanges and related issues.