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A General Guide to Tax Deferred Exchanges
By: P. Patrick Ashouri, Esq.
Reverse Exchange
The reverse exchange is actually a misnomer. It represents
an exchange in which the Exchangor locates a replacement property
and wants to acquire it before the actual closing of the relinquished
or exchange property. Since the Exchangor cannot purchase
the replacement and later exchange into property that he already
owns, he must find a method to acquire the replacement property
and still maintain the integrity of his exchange. Reverses
are typically accomplished in two formats based upon transaction
logistics and the financing needs of the Exchangor.
Since few lenders would lend dollars to the Exchangor with
the facilitator on title, it is necessary for the facilitator
to warehouse or hold the title to the relinquished property.
In this approach, the exchange is complete at the moment the
Exchangor accepts the title to the new replacement property.
However, with the prospect of the exchange being complete,
it is necessary to balance equities between relinquished and
replacement, prior to closing. In other words, upon closing
the replacement, there must be an equal amount of equity in
the replacement property as is expected to come out of the
later sale of the relinquished property. Then, at the time
of the later sale of the relinquished or exchange property,
any debt is retired and the Exchangor is repaid any dollars
which he advanced for the replacement property acquisition.
The facilitator, with the aid of a loan from the Exchangor,
acquires the replacement property and warehouses or holds
the property title until such time as the relinquished property
is sold and the exchange can be completed.
At this point we need to insert several caveats regarding
reverse exchanges. They tend to be more complicated than other
exchanges and because they involve the holding of title by
a facilitator, they require extensive planning. Also, since
the reverse exchange strategy was specifically excepted from
the Treasury Regulations, they should be considered an aggressive
form of exchanging. Do not undertake a reverse exchange without
the assistance of an experienced and knowledgeable facilitator
or intermediary.
Delayed Exchange
Generally, when one discusses exchanges, the type of exchange
referred to is the delayed or Starker exchange. This term
comes from the name of the Exchangor who was first challenged
for a delayed exchange by the IRS. From this tax court conflict
came the code change in 1984 that formally recognized the
delayed exchange for the first time. As mentioned earlier,
this is now the most common type of exchange.
In a delayed exchange, the relinquished property is sold
and after a delay, the replacement property is acquired. The
following will represent the traditional rules and time constraints
for completing a qualifying delayed exchange.
Like-Kind Property
Property that qualifies for exchange under Section 1031 must
be "like-kind", which is defined in the Regulations
as follows:
- Property held for productive use in a trade or business,
such as income property, or
- Property held for investment.
Therefore, not only is rental or other income property qualified,
so is unimproved property which has been held as an investment.
That unimproved property can be exchanged for improved property
of any type, or vice versa. Also, one property may be exchanged
for several, or vice versa. This means that almost any property
that is not a personal residence or second home is eligible
for exchange under Section 1031. Even the vacation home that
is used for that purpose part of the year, and is rented part
of the year, is considered "mixed use" property
and may be exchanged under 1031 for other mixed use property.
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