REVERSE EXCHANGES: "PURCHASE THE REPLACEMENT PROPERTY FIRST"

Often investors may need to explore a reverse exchange in a "seller's market," where recently listed properties are quickly under contract with a buyer. The need for a §1031 reverse exchange arises when circumstances require that the replacement (purchase) property be acquired before closing on the relinquished (sale) property.

An Exchanger must first weigh the benefits against the risk of performing a reverse exchange with their legal/tax advisors. Unlike most exchange variations, where Exchangers can rely on the Tax Code and Treasury Regulations, there are no IRS guidelines which dictate the acceptable format of a reverse exchange. Very few Intermediaries have extensive experience with these transactions or are willing to bear the risks of ownership during the period of time they hold title to a property.

THE REVERSE EXCHANGE PROCESS "PARKING" THE REPLACEMENT PROPERTY

Reverse exchanges involve the Intermediary taking title to either the replacement or relinquished property (this process is also known as "parking the title.") In one variation, of this "parking the title" arrangement, the Intermediary is given title to the Exchanger's ultimate replacement property with the steps shown below:

A. The Exchanger loans the Intermediary funds needed to purchase the property from the seller.

B. The Intermediary purchases this property and the closer transfers title from seller to the Intermediary.

C. The Intermediary provides the Exchanger with the authority to manage and maintain the replacement property under a triple net lease.

D. When the Exchanger has found a buyer for their relinquished property and is ready to close, the Intermediary enters into a simultaneous exchange. Simultaneously, the Intermediary sells the relinquished property to the buyer, and transfers ownership of the "parked" replacement property to the Exchanger via an executed Assignment Agreement.

E. The Intermediary repays the "loan" to the Exchanger with the funds they are entitled to as seller of the relinquished property.

POTENTIAL OBSTACLES

When contemplating the reverse exchange format, it is critical to be aware of the many problem areas:

- Conventional financing (many lenders will not approve a loan using the reverse format.)

- Increased closing costs (additional expenses will be incurred such as additional transfer fees, fire/liability insurance and higher Exchange Intermediary fees.)

- Often the Intermediary will require an Environmental Report on property not considered a single family residence.

- The Exchanger must have funds available to loan the Intermediary for purchasing the replacement property.

AN EXPERIENCED INTERMEDIARY IS NEEDED

Despite these obstacles, many Exchangers find the benefits of reverse exchanges outweigh the obstacles. API's staff of reverse exchange specialists can answer questions regarding all aspects of this valuable exchange strategy.

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