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$650 covers you for one relinquished property and one replacement property.

An additional $175 will be charged for each replacement property purchased afterwards.

There's a $30 wire fee for outgoing wires.

That's it.

AND we pay interest on the funds while we
hold them.

Reverse Exchanges

Exchange Last or Exchange First

With the issuance of Revenue Procedure 2000-37 (the "Rev. Proc."), it is now possible for a taxpayer to, in essence, acquire the replacement property and use it, before it has sold the relinquished property. The Rev. Proc. gives the taxpayer the "safe harbor" presumption that its exchange qualifies under §1031, if certain criteria are met.

In a  Reverse Exchange the same rules apply. Just like a normal 1031 Exchange, the proceeds from the sale of the Relinquished Property must be used to acquire the Replacement Property. For this to be possible when the Replacement Property will be acquired before the Relinquished Property has even sold requires the Exchanger to be able to produce those funds from another source and use them to purchase the Replacement Property.

This means that the exchanger must loan the LLC  formed by the Qualified Intermediary expressly for their Reverse Exchange the amount of proceeds is expected to result from the sale of the Relinquished Property. The exchanger will be repaid from the Proceeds when the Relinquished Property is sold. If the amount of proceeds from the Relinquished Property exceeds the amount loaned to purchase the Replacement Property, the difference could be taxable, unless a delayed exchange is performed with the balance.  Another replacement property must be identified and purchased.  If you suspect this might happen, it would be wise to spell it all out as to percentages in the Exchange Agreement in the beginning.

Exchange First

Which type of Reverse Exchange utilized depends on whether or not the exchanger will be financing the purchase the Replacement Property in the Exchange. In a Reverse 1031 Exchange requiring financing for the purchase of the Replacement Property, the Exchange First will be utilized.

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See Reverse Exchange Timeline below for a “simple” Reverse Exchange in which 1 property will be purchased and 1 sold. For demonstration purposes we will say that both the property being purchased (The Replacement Property) and the property being sold (The Relinquished Property) have a price of $2,000,000.00. Also, the Exchanger in this example currently has a mortgage of $750k on the Relinquished Property.

1)  The Exchanger finds and enters into contract to purchase suitable Replacement Property, inserting Exchange Clause into the contract verbiage.

2)  Exchanger must calculate the amount of Proceeds they expect to net from the sale of their Relinquished Property and be able to bring those funds, as a loan, to the closing. The loan is to be repaid within 180 days, when the sale of the Relinquished Property closes. In our example the sale price is $2mil, the mortgage is $750,000.00, and let’s say $150,000.00 in costs will be paid by the Exchanger, so the proceeds should be in the neighborhood of $1.1mil. In our example the Exchanger chooses use personal savings as well as take out an equity line on his primary home to generate the $1,100,000.00.

3)  The Exchanger makes arrangements for financing as normal (i.e. Exchanger shops around and applies for a mortgage.) In applying for the mortgage the Exchanger in this example will be using the $1.1 mil as a down payment on the Replacement Property.

4)  The Exchanger completes “Due Diligence” with regard to the Replacement Property.

5)  The Exchanger makes arrangement with Haven Exchange for a Reverse Exchange.

6)  Haven Exchange creates the LLC in the same state as the Replacement Property.

7)  At closing The LLC does a double escrow; one in which the LLC acquires the replacement property from the seller, and another with the Exchanger wherein the LLC executes a Note borrowing the $1.1mil from the Exchanger in order to acquire the Replacement Property, and simultaneously conveys the Replacement Property to the Exchanger in exchange for the Relinquished Property.  This is the escrow to be funded by the exchanger’s new lender.

8)  The Relinquished Property is then to be sold within the following 180 days and the Proceeds from that sale are used to pay off the Note owed by the LLC to the Exchanger. This completes the Reverse Exchange. When the Exchanger receives the amount of the Proceeds as loan repayment it is not a taxable occurrence.

Exchange Last

In a "safe harbor" so-called Reverse Exchange, the taxpayer locates the property it wants to acquire as its Replacement Property. The taxpayer will first enter into a purchase contract to buy the new property. It will then enter into an Exchange Agreement with the Qualified Intermediary (QI), with an underlying agreement with an Exchange Accommodation Titleholder (or "EAT"), formed by the QI expressly for the reverse exchange and assign the purchase contract to the EAT.

The EAT  becomes the contract purchaser for the new property. The taxpayer and the EAT enter into a "Qualified Exchange Accommodation Agreement" in which the EAT agrees that, if the taxpayer (and/or some third-party lender) loans the amount of proceeds expected to result from the sale of the old property to the EAT, the EAT will use the funds to purchase the new property. The EAT will then lease the property to the taxpayer on a ‘net lease’ basis, for a nominal lease payment. Then, when the taxpayer has sold the old property, the EAT will transfer the new property to the taxpayer at the price which the EAT paid for the new property, and in exchange for the old property.  When the old property closes, the proceeds are used to repay the sum loaned to the EAT for the purchase of the new property. This completes the taxpayer’s exchange and is not a taxable event, but loan repayment.

The taxpayer has the benefit of getting the immediate use of the new property, without any interruption in its business activities. The taxpayer has the added benefit of selling its old property in a manner which brings the best price. This is the essence of a "safe harbor" Reverse Exchange. The basic criteria are that the taxpayer and the EAT must enter into a written agreement which sets forth their rights and obligations.

After the EAT has taken title to the new property, the taxpayer has to (i) identify the old property ("relinquished property") within 45 days after the EAT has purchased the new property and (ii) sell the old property, and complete the exchange by acquiring the new property ("Replacement Property") within 180 days after the EAT has purchased the new property. There is no requirement that the EAT put up its own money since the purchase of the new property can be financed 100% by the taxpayer and/or its lenders. There is also no requirement that the lease-back be on an "arms-length" arrangement.

If, for some reason, the taxpayer cannot meet either the 45-day or 180-day time limitation, then the presumption of the IRS "safe harbor" is lost. That does not mean, however, the taxpayer cannot get the benefits of tax-deferral using a Reverse Exchange structure.

Where the ‘safe harbor’ presumption is not available, the EAT’s relationship with the taxpayer has to be structured so there is some element of "arms-length", principal-to-principal relationship. Unlike the "safe harbor" structure, the EAT must have enough "at risk" to be deemed, for tax purposes, the taxpayer’s agent. Commonly, in these non-safe harbor situations, the EAT will invest 5%-10% of its own funds to acquire the new property and the agreement will only give the taxpayer an agreed purchase price for a short period of time (12-18 months). Further, the EAT will not have the right to "put" the new property it has acquired to the taxpayer, so if the taxpayer does not exercise its purchase option, the EAT will have to find another way to dispose of the new property. Finally, if the new property will undergo significant modifications between the time the EAT acquires it and the time it is transferred to the taxpayer, the EAT will have to be involved, at least in some capacity, in the construction process.

A typical non-safe harbor transaction is one where a taxpayer wants to purchase an aircraft with certain configuration (engine and/or interior), and the seller of the aircraft will not provide these modifications to the aircraft prior to transfer of title. Similar situations occur where machinery or equipment has to be specialized to meet certain needs (e.g., an offshore oil-drilling rig). Another situation is where the item has to be modified, or built from the ground up, and the person who is responsible for doing the actual construction does not want to have, or cannot have, ownership responsibility or liability (e.g., certain restrictions by governmental agencies, such as the FCC, may prohibit such activities).

In all Reverse Exchanges, the EAT is required to be treated as the taxpayer with respect to the property it holds. This means the EAT must file tax returns to properly report ownership (and capital improvements). It is also advisable for each Reverse Exchange transaction to be structured with a different single-purpose entity ("SPE"), so that any circumstance which adversely affects one property (e.g., a casualty during the retrofitting process), does not affect any other taxpayer, and the property which such other taxpayer is using to complete its separate, unrelated, "reverse" exchange.

Thus, it is critical that the transaction be carefully structured on two levels: First, at the level of the organization and operation of the EAT, and, Second, at the level of the relationship between the taxpayer and the EAT to ensure that either the IRS "safe harbor" requirements are met, or that the EAT is sufficiently "at risk" in the transaction to be deemed a principal, and not the agent of the taxpayer.

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