Buy first, sell later!
Sometimes it is simply impossible to sell the relinquished property before acquiring the replacement property. Perhaps a property becomes available and must be purchased now or never. Or, you are constructing your replacement property and it can not be completed within the 180-day time frame. Or, maybe you just do not know which property you want to sell in order to exchange into a newly available and highly desirable property. For these and many other situations, reverse exchange structures have been condoned by the IRS to allow exchangers to "buy first and sell later."
"Parking" Arrangements
Until recently, no officially sanctioned reverse exchange procedure existed. To accomplish traditional reverse exchanges, "arms-length" paperwork was set up. Although new "Safe Harbor" reverse procedures have been recently created (See next section), many reverse exchanges are still accomplished through traditional methods.
It works like this: Your accommodator will first set up what is called a "parking" arrangement for either one of the properties in the exchange (either the relinquished or replacement property). "Parking" a property meant it would be purchased and held (parked) by a "special purpose entity" (SPE), usually an LLC set up just for this purpose. This technique effectively postpones either the acquisition of the replacement property or the sale of the relinquished property until such time that the officially approved "sell first and buy later" structure of the deferred exchange could be accomplished.
For example, if a taxpayer found a replacement property they liked before they had sold their relinquished property, the accommodator would set up the Special Purpose Entity to buy and hold the new property for the taxpayer. Then, when the taxpayer eventually sold the relinquished property, they would exchange it for the property being held by the SPE. Alternatively, the relinquished property could be parked by the SPE, and the taxpayer could exchange into the new property. When a buyer for the original property was eventually found, they would purchase the property from the SPE.
Safe Harbor Reverses
In 2000, the I.R.S released Revenue Procedure 2000-37, which creates a new "safe harbor" for reverse exchanges. The guidelines established a new procedure for effecting reverse exchanges under the safe harbor. However, they also explicitly recognized the traditional "parking" type methods could be accomplished outside of the safe harbor.
To be, or not to be under Safe Harbor
The safe harbor procedure complicates the reverse exchange landscape in some ways, particularly with respect to exchange timing. The safe harbor maintains the 180-day time limitation to complete the exchange. In instances where the sale of the relinquished property can be easily accomplished within the 180 day time frame the new guidelines provide for a relatively straightforward exchange experience.
However, if no buyer for the relinquished property is in sight, or several properties are under consideration as the possible relinquished property, the safe harbor may not allow enough time. In such instances, the more traditional "parking" arrangement may provide for more flexibility in the timing of the sale, since the "exchange period" would not technically start until the relinquished property is actually sold.
Safe Harbor guidelines provide for parked property to be held in a "Qualified Exchange Accommodation Arrangement." Under this safe harbor, considerable latitude is granted in terms of the legal and contractual arrangements between the taxpayer and the parking entity, or "Exchange Accommodation Titleholder (EAT)." More traditional reverse exchanges must be "arms-length" transactions, but under safe harbor guidelines, the taxpayer is allowed to supervise construction of replacement property, guarantee loans, enter into a lease with the EAT, manage the property, etc.
One should be aware that safe harbor arrangements might seriously jeopardize the exchange IF it cannot be completed under the 180-day time limit. It is critical that the accommodator be experienced in both kinds of reverse exchanges. To qualify under the new guidelines, very specific protocols must be followed. Under the older parking arrangements, the reverse exchange must maintain an "arms-length" structure in order to be successful. Summit 1031 Exchange, Inc. has long experience in facilitating reverse exchanges, insuring a trouble-free and flexible transaction that suits the client's specific needs. For more information on reverse exchanges, please contact the Summit office nearest you.