Throw your 1031 exchange in reverse.

• Author: Haislet, G. Scott
• Position: Property Exchanges; accounting

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)].

PUTTING IT IN REVERSE

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.

REVERSE EXCHANGE STRUCTURES

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...