The Reverse Exchange

A reverse exchange is the exact opposite of a delayed exchange. In a reverse exchange the Exchanger for various reasons must close on their Like-Kind Replacement Property before the disposition of a Relinquished Property. Until recently it was unclear whether reverse exchanges would be given nonrecognition treatment by the IRS. However, on September 15, 2000, that question was answered by the IRS in the form of Revenue Procedure 2000-37 (“Rev. Proc. 2000-37”). This Revenue Procedure provides that tax deferral on reverse exchanges will be recognized if the transactions fall within the scope of an announced IRC §1031 “safe harbor.” The new reverse exchange rules can be expected to lead to two categories of reverse exchanges, those that fit neatly within the safe harbor guidelines and those that do not fit within the safe harbor rules.

The “Safe Harbor” Reverse Exchange

In a reverse exchange structured under the safe harbor protection of Rev. Proc. 2000-37 the entity used to facilitate a reverse exchange is referred to as the Exchange Accommodation Titleholder (“EAT”), and the property held by the EAT is commonly called the “parked property”. The EAT will usually form a special purpose entity (the “Holding Entity”) to take title to the parked property. To complete a reverse exchange the Holding Entity can take title to either the Relinquished Property or the Replacement Property under a “Qualified Exchange Accommodation Arrangement”. The document between the Exchanger, EAT and the Holding Entity is termed the “Qualified Exchange Accommodation Agreement” (“QEAA”).

Under Rev. Proc. 2000-37, a safe harbor reverse exchange must be completed within 180 days after the Holding Entity acquires the parked property. The durational limit on safe harbor transactions is taken from those of a delayed exchange, which by statute must be completed within the lesser of 180 days or the due date of the Exchanger's tax return for the year in which the Relinquished Property is transferred. Additionally, under a safe harbor reverse exchange the Exchanger must identify one or more relinquished properties within 45 days after the Holding Entity acquires the Replacement Property. Rev. Proc. 2000-37 adopts the same identification rules that apply in delayed exchanges.
In a reverse exchange the Exchanger still has to go deed out of title on the Relinquished Property before taking title to the Replacement Property. The reverse exchange does not mean the Exchanger can sell first and buy later.