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Kevin Kete 

Kevin L. Kete , SIOR is Vice President of North Star Deferred Exchange Corp.,  which provides Qualified Intermediary services and acts as an Exchange Accommodation Titleholder for Section 1031 Tax Deferred Exchangors. Kevin joined North Star in 2004 after a career in the commercial brokerage industry spanning almost 30 years. He is licensed by the state of Illinois ’ Department of Financial and Professional Regulation to teach Continuing Education for Realtors on the subject of forward and reverse tax deferred exchanges. In the course of a year, he typically makes over 75 presentations on the subject of Section 1031 exchanges to widely diverse audiences including investors, Realtors, accountants and attorneys.

Reverse Exchanges: The Benefits and The Process

  Kevin L. Kete , SIOR-North Star Deferred Exchange

We often hear that the three most important things in real estate are location, location and location. The three most important things in a Section 1031 tax deferred exchange might well be timing, timing and timing. Utilizing a reverse exchange allows an investor maximum flexibility, avoids time pressures and achieves significant tax savings. It puts the investor in control of timing issues…a strategy to save, make or optimize a transaction.

In practice it is the ultimate legal fiction, provided for by Revenue Procedure 2000-37 which established a ‘safe harbor’ process to effect a reverse exchange outcome. The process is not the reciprocal of the forward or delayed exchange. Rather, it consists of two separate components which are contractually integrated and then results in a reverse exchange outcome.

More accurately it is a “parking” transaction which is then followed by a regular Section 1031 tax deferred exchange.

Why park it?  The investor for any number of reasons needs, or wants, to acquire a new or replacement property before having sold an existing or relinquished property AND needs, or wants, all the proceeds from the sale of that relinquished property to acquire the new property including all the dollars which otherwise would have to be paid in capital gain, recapture and state taxes. Some of theses reasons include:

The first component, is parking ( or “warehousing” ) the replacement property with what the IRS refers to as an Exchange Accommodation Titleholder, or EAT, which takes title to the replacement property on behalf of the investor for up to 180 days.

The investor enters into a Qualified Exchange Accommodation Agreement, an QEAA, with an EAT such as North Star, which uses funds lent to it by the investor and /or the investor’s lender to purchase and park the replacement property…essentially just holding title to it.

The investor is protected by having a Purchase / Sale Agreement with the EAT requiring the investor to buy and the EAT to sell the parked property at the original purchase price no later than 180 days from the date the property was parked. The Eat will also sign a note and mortgage in favor of the investor to secure the funds that the investor put into the transaction.

Upon the subsequent sale of the relinquished property, which must be within 180 days, the proceeds are then used by the investor in the second component, setting up a regular Section 1031 tax deferred exchange. The investor identifies the parked property as the replacement property and proceeds to buy it back from the EAT using the funds from the sale of the relinquished property being held in the exchange account. The EAT then uses these same funds to repay the “loan” made to it by the investor or investor’s lender…what goes around, comes around !

While the “parked “ property is  being held by the EAT, the investor will lease it from the EAT ( at a no dollar rental rate) and then may occupy it, sublease it to the tenants, rent to new tenants, provide property or construction management services and, except for taking depreciation, will enjoy all the benefits and burdens of ownership of the parked property.

So, don’t over look the advantage in considering a reverse exchange to take control of the timing challenges inherent in “swapping’ property ; deferring tax liabilities which can be used instead to leverage into a more attractive investment, whether it be another residential, commercial or TIC deal.