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Throw your 1031 exchange in reverse.

Fundamentally, Sec. 1031 exchanges do not recognize any gain or loss on the exchange of property held for productive use in a trade or business, or for investment, if such property is exchanged for property of like kind, which is to be held either for productive use in a trade or business or for investment.

Further, IRC Sec. 1031(a)(3) requires a taxpayer to identify qualifying exchange replacement property within 45 days after closing the sale of a relinquished property.

But all too often in a Sec. 1031 delayed "forward" exchange, an exchanging taxpayer must scramble to identify a suitable replacement property in real estate markets that have too many qualified buyers and too few properties for sale.

A forward exchange occurs when a taxpayer sells the relinquished property, then later buys a replacement property within delayed exchange safe harbors, such as qualified intermediary and qualified escrow account [Treas. Reg. Sec. 1.1031(k)-1(g)].


Taxpayers facing bleak prospects for finding suitable Sec. 1031 replacement property may wish to consider a "reverse" exchange, a transaction in which the taxpayer first acquires replacement property then later sells the relinquished property.

Reverse exchanges also help taxpayers when a desirable replacement property that requires a quick closing suddenly becomes available, and the relinquished property is not ready for sale.


There are two reverse exchange structures:

Exchange First: The taxpayer transfers the relinquished replacement property to an intermediary, which buys the replacement property and then transfers the replacement property to the taxpayer to complete the exchange.

After that exchange, the intermediary, which now owns the relinquished property, transfers the relinquished replacement property to the exchange accommodation title holder (EAT). Because no unrelated third-party buyer has emerged to purchase the relinquished property, the EAT holds the relinquished property until such a buyer emerges.

This process is called exchange first because the exchange of the properties, with respect to exchanging taxpayers, is the first step.

Exchange Last: Here, the EAT buys the replacement property and holds it for a later transfer to the taxpayer. Later, the taxpayer locates a buyer for the relinquished property. The taxpayer, through the intermediary, sells the relinquished property to the third-party buyer. The intermediary then uses the proceeds from the sale of the relinquished property to buy the replacement property from the EAT. The intermediary then transfers the replacement property to the taxpayer.

This is called exchange last because the exchange of the properties, with respect to exchanging taxpayers, occurs at the last step.

In a forward exchange under Sec. 1031(a)(3), the taxpayer identifies the replacement property within 45 days of the sale of the relinquished property and acquires the replacement property within 180 days of the relinquished property's sale. This timeline can be less if the taxpayer fails to file for an automatic extension of the tax return filing deadline.

Rev. Proc. 2000-37, issued in September 2000, provided for a 180-day time limit during which the EAT can hold either the relinquished or replacement property, depending on the situation.

If the EAT holds the property for more than 180 days, the transaction falls outside the safe harbor, thus subjecting the transaction to general tax and legal principles of exchanges without regard to Rev. Proc. 2000-37.


In a forward exchange, the taxpayer typically uses the net proceeds from the sale of the relinquished property as a partial or full payment for the replacement property.

In a reverse exchange, the taxpayer will effectively carry both properties until the sale of the relinquished property.

For that reason, many taxpayers use the exchange first structure. The taxpayer will acquire title to the replacement property at the close of the exchange and obtain purchase-money financing for that property at that time. This, of course, assumes that the taxpayer has adequate financial resources and creditworthiness to qualify for that financing.

In the exchange first structure, the EAT will take the relinquished property that is subject to existing debt, thereby avoiding the need to qualify for financing. The taxpayer will carry new secondary financing, or seller carryback, for the EAT's purchase of the relinquished property.

By contrast, the EAT does not have a balance sheet or income history so it will not, on its own, qualify for financing to purchase the replacement property. Thus, often it will be easier to structure the transaction in the exchange first mode.


Without some potential benefits and burdens of ownership passing to the EAT, the EAT is an agent of the taxpayer under general legal principles.

For example, if the EAT wishes to obtain a fee for the service of holding legal title to the taxpayer's relinquished or replacement property; the EAT seeks to avoid the burdens and financial exposure of owning realty; or the taxpayer does not wish to grant the EAT the benefits of ownership.

Absent Rev. Proc. 2000-37, the IRS could argue that the EAT is merely an agent of the taxpayer, thus disallowing the Sec. 1031 exchange treatment.

However, Rev. Proc. 2000-37 provides that the EAT may be the taxpayer's agent, under general principles, in holding legal title to the relinquished or replacement properties, provided the EAT is not a "disqualified person" within the meaning of Treas. Reg. Sec. 1.1031(k)-1(k).

Further, Rev. Proc. 2000-37 provides that the taxpayer and the EAT may make agreements with respect to the property the EAT holds to limit or eliminate the EAT's liability or benefits of property ownership. An EAT ruder Rev. Proc. 2000-37 is similar to a qualified intermediary within the meaning of Treas. Reg. Sec. 1.1031(k)-1(g)(4).


There are times when Rev. Proc. 2000-37 will not work for a taxpayer expecting that the exchange period will exceed 180 days. Reverse exchanges occurring outside the ambit of Rev. Proc. 2000-37 may have a significant advantage in that the EAT can hold the relinquished or replacement property for more than 180 days.

Rev. Proc. 2000-37 does not disallow exchange treatment for non-safe harbor reverse exchanges; it merely places those exchanges outside the safe harbor. Other applicable law, absent Rev. Proc. 2000-37, will determine whether such non-safe harbor reverse exchanges will qualify for Sec. 1031 treatment.

Non-safe harbor reverse exchanges are aggressive; clients and advisers should exhaust all efforts to qualify for the safe harbor. Also, reverse exchange, including those in safe harbor, require greater documentation than forward exchanges.

G. Scott Haislet, CPA, Esq., is a certified taxation specialist in Lafayette and a frequent speaker for the California CPA Education Foundation. You can reach him at (925) 283-1031 or
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Article Details
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Title Annotation:Property Exchanges; accounting
Author:Haislet, G. Scott
Publication:California CPA
Geographic Code:1U9CA
Date:Sep 1, 2003
Previous Article:What's your type--of business entity?
Next Article:Revenue recognition: now, later or never?

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