A Reverse Exchange may be the best alternative to save a 1031 deferred exchange transaction when a taxpayer needs to purchase their replacement property prior to the sale of their relinquished property.

The mechanics of a reverse exchange may seem complicated, so the following general guidelines will help.

Before starting, an exchanger should review their plan with their tax advisor and a qualified intermediary. Discuss all the fees involved, the bank’s lending fees if utilizing bridge financing, exchange fees, and the tax on any cash proceeds received. Review the actual long term capital gain and depreciation recapture. This will help determine if the benefits of a reverse exchange outweigh the costs involved.

When an exchanger decides to proceed with a Reverse Exchange there are some contract considerations: Generally the purchase contract is assignable from the exchanger to a Limited Liability Company (LLC) setup by a qualified intermediary such as Bankers Escrow. Typically, the phrase and or assigns after the buyer’s name will suffice. If the exchanger has a contract in place for the replacement property purchase, it will need to be amended, assignable to the LLC.

The mechanics for a Reverse Exchange are as follows:

Phase 1: The LLC purchases and parks the replacement property. Remember that the LLC is not using any of its own funds to purchase. This will come from the bank and/or the exchanger and takes time to obtain. Both the identification and completion deadlines are triggered at purchase date of the new property by the LLC. The exchanger will have 45 days to identify their old property and 180 days to sell it. They must purchase the parked property from the LLC by the 180th day.Reverse Documents are signed at closing by the exchanger; this includes the “Option Agreement” to purchase the parked property from the LLC. Bankers Escrow will coordinate with the closer and lender to insure compliance with I.R.S. requirements for reverse exchange documentation. A lease is entered into with the LLC so that the exchanger can utilize the parked property.

Phase 2: The exchanger will need to sell the relinquished property within 180 days of the replacement property parking. There is no extension available. If the relinquished property does not sell by the 180th day, the LLC will convey the parked property to the exchanger and there is not a successful reverse 1031 exchange transaction.

Phase 3: At the sale of relinquished property,proceeds are sent to Bankers Escrow to be utilized for the replacement property purchase.

Phase 4: The LLC sells the parked replacement property to the exchanger. An Option Notice is exercised by the exchanger. The option purchase price will be the actual cost that the LLC incurred to purchase the parked property. Bankers Escrow will coordinate with the closing agent to sell the parked property held by the LLC to exchanger. Proceeds from relinquished property sale will pay down loans used to initially purchase the property.

Take the time to review a contemplated reverse exchange with a tax advisor as each investor’s tax situation is unique. A Reverse Exchange can be a very powerful tax planning strategy. For more information, please contact the 1031 Department at Bankers Escrow 303-986-4848 or 800-571-6595 or http://www.bankersescrow.com/

Please note that all material provided in this article is for informational purposes only and the author is not providing legal, tax accounting or other professional services. The accuracy of the information provided as it pertains to your situation is not guaranteed. Please seek professional consultation if legal, tax accounting or other expert assistance is required. © 2006 Bankers Escrow Corporation