Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
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FINANCINGFOCUS Timing u 14 Reverse exchanges can go in either direction. by Marna E. Mignone, JD Under Internal Revenue Code Section 1031, real property held for productive use in a trade or business or for investment may be exchanged and capital gain taxes deferred through a delayed exchange, which requires the taxpayer to sell the relinquished property and thereafter acquire like-kind replacement property. Taxpayers can also use a reverse exchange pursuant to Internal Revenue Service Rev- enue Procedure 2000-37. In a reverse exchange, an exchange accommodation titleholder acquires title to either property while the taxpayer locates a buyer to com- plete the exchange. T e EAT is typically a single-member limited liability company affiliated with a qualified intermediary, which is oſt en the single member of the LLC. T ere are two types of reverse exchanges: "exchange fi rst," wherein the EAT acquires and holds title to the relinquished prop- erty, and "exchange last" wherein the EAT acquires and holds title to the replacement property. Exchange First Using funds loaned from the taxpayer, the EAT purchases the relinquished property from the taxpayer at a price estimated to be the anticipated actual sales price to the future bona fi de purchaser. T is sale May | June | 2012 from the taxpayer to the EAT creates the exchange proceeds, which are then used by the QI to complete the acquisition of the replacement property. At this juncture, the EAT is holding the relinquished property and the taxpayer has completed the acquisi- tion of the replacement property. T e EAT holds title to the relinquished property until the taxpayer completes its sale to a bona fi de purchaser within the 180- day exchange period, which begins with the EAT's acquisition of relinquished property. Upon completion of the sale, the EAT uses the relinquished property sale proceeds to repay the reverse loan to the taxpayer. T e principal advantage of the exchange- fi rst structure is elimination of the EAT's participation in any third-party fi nancing that may be required for the purchase of the replacement property. T e principal disad- vantage is the potential to underestimate the ultimate sales price, which would result in excess proceeds that could be taxable. Exchange Last Alternatively, the transaction may be struc- tured whereby the EAT — again using funds loaned from the taxpayer — purchases the replacement property. Once the taxpayer has a contract to sell the relinquished prop- erty, the QI sells the relinquished property and uses the exchange proceeds to purchase the replacement property from the EAT. T e EAT then uses the proceeds from its sale of the replacement property to repay the reverse loan. T e principal advantage of this structure is that any excess relinquished property pro- ceeds may be used to purchase additional replacement properties in a separate forward or delayed exchange. T e principal disadvan- tage is that if there is any fi nancing required for the replacement property acquisition, the lender must consent to the EAT's acquisition of title and execution of the loan documents. Likewise, the lender must agree that the loan is nonrecourse to the EAT. Reverse Challenges T e taxpayer must be able to provide funds for the acquisition of the replacement property before it has sold the relinquished property. T is means that the taxpayer must Commercial Investment Real Estate Zothen/Veer