Revenue Procedure 2000-37 was released and effective September 15, 2000.
The Internal Revenue Service (IRS) issued this Revenue Procedure to provide a “safe harbor” for Reverse Exchanges.
There were two new exchange terms used in 2000-37:
- Exchange Accommodation Titleholder (“EAT”) is the sanctioned facilitator / titleholder in a Reverse Exchange.
- Qualified Exchange Accommodation Arrangement (“QEAA”) is the Reverse Exchange agreement entered into by taxpayer and EAT.
Who can facilitate a Reverse Exchange?
The same rules that apply to Deferred Exchanges apply in Reverse Exchanges. You cannot utilize your agent (CPA, attorney, financial adviser, related party…); you must use an unrelated third party who handles Reverse Exchanges, and possibly Deferred Exchanges, in their normal course of business.
The EAT can acquire either Relinquished Property or Replacement Property as part of a Reverse Exchange.
In each structure, there are two exchanges taking place:
- A standard exchange where taxpayer trades one property for another
- A Reverse Exchange which is a parking or warehousing arrangement with the EAT holding title to a property until the Relinquished Property can be sold
Exchange Last Structure
- EAT acquires Replacement Property (the new property) utilizing Exchanger funds loaned to EAT
- Exchanger must identify Relinquished Property (property to be sold) within 45 days from date EAT acquires Replacement Property
- The multiple identification rules for deferred exchanges also apply to Exchange Last Reverse Exchanges
- EAT remains in the chain of title to Replacement Property until Relinquished Property is ready to be sold, at which time:
- The Qualified Intermediary (QI) in the standard tax deferred exchange sells Relinquished Property to a buyer
- QI purchases the Replacement Property from EAT thereby conveying Replacement Property to Exchanger in completion of the standard exchange
- Proceeds from the Sale of the Relinquished Property flow into the escrow for EAT’s sale of the Replacement Property to Exchanger. EAT’s seller proceeds are used to repay Exchanger for funds initially loaned to EAT.
Exchange First Structure
- EAT acquires the Relinquished Property (the property being sold) from Exchanger with funds loaned to EAT by Exchanger through a standard Deferred Exchange with Amherst as the QI.
- QI receives the Relinquished Property and purchases the Replacement Property in the standard Deferred Exchange completing the standard Deferred Exchange (property swap).
- EAT warehouses the Relinquished Property until it can be sold
- Upon the sale of the Relinquished Property EAT uses the proceeds to pay for the loan(s) used to initially acquire the Replacement Property
Potential for Boot in Exchange First Structure
- Determining the amount of funds to be loaned to EAT by Exchanger requires a guessed selling price for the Relinquished Property, reduced by any loans secured by the property.
- Because debt relief must be replaced, the debt amount on the Replacement Property is necessarily fixed at in the standard Exchange when using an Exchange First structure. (Exchange Last is preferred by tax advisors because no guessing is required.)
- Exchanger will have an Agreement with EAT:
- If the property sells for less than the guessed selling price, Exchanger will receive less than EAT’s loan obligation to Exchanger
- If the property sells for more than anticipated, Exchanger will receive more than EAT’s loan obligation to Exchanger, which creates the taxable event
- Different CPAs handle excess EAT proceeds (greater than EAT’s loan obligation to Exchanger) differently.
- In other words, if the Sale of Relinquished Property generates more cash than was anticipated by Exchanger in the guessed selling price, the excess (unexchanged) cash could be taxable Boot.
- In either structure, the entire Reverse Exchange and accompanying Tax Deferred Exchange must be completed within 180 days of:
- The purchase of Replacement Property by the EAT; or
- The sale of Relinquished Property by the EAT
- If the Reverse Exchange fails:
- The EAT will have the obligation to convey the Property to the Exchanger (a “Put”)
- Exchanger will have the obligation to acquire the Property from the EAT, (a “Call”)
- Puts and Calls are allowed to be part of Reverse Exchange Agreements, but each of these rights must be exercised no later than 5 days following the 180th day
Mechanics of EAT ownership of property
- The EAT must have all benefits and burdens of ownership of the property it holds. Rents are the property of EAT during the course of the Reverse Exchange and are utilized to pay property expenses as well as interest due on the Note from EAT to Exchanger for borrowed funds
- The Qualified Exchange Accommodation Arrangement (QEAA) must require EAT to be treated as the owner for income tax purposes; therefore, EAT must report all income and expenses
- Since the property will be held less than 1 year by EAT (185 days max), no depreciation can be taken by EAT or Exchanger
- Exchanger may provide additional funds as necessary to EAT to acquire and own the property. Such added funds increase EAT’s loan obligation to Exchanger
- Exchanger may guarantee loans made to EAT that are used to acquire and own the property
- Exchanger manages the property for EAT
- Exchanger may lease the property from EAT
- Exchanger indemnifies EAT from any losses or obligations it may suffer with regard to the property EAT holds
Financing in a Reverse Exchange requires the loan be placed in name of the EAT not the Exchanger
- Loans to EAT secured by the property EAT will own are guaranteed by Exchanger with no recourse to EAT
- Funds may be borrowed by Exchanger on other property and loaned to EAT
- It is possible to cross-collateralize (secure a loan with the Relinquished Property and the Replacement Property EAT will own) in a Reverse Last Exchange
- Financial liquidity required for Reverse Exchanges will limit their use to financially strong taxpayers only. Deferred exchanges can be accomplished by most taxpayers that own non-personal-use real estate. Reverse Exchanges are only possible when the taxpayer has enough liquidity to loan cash to the EAT without benefit of proceeds from the sale of the Relinquished Property.