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1031 Exchange: Reverse Exchanges (Part 3)

This article is part 3 of a three-part series regarding 1031 Exchanges.

By Brandon J. Leal, Esq.

Are you in a position to defer capital gains through a 1031 Exchange but the purchase of the replacement investment property (the "Replacement Property") can't wait for the sale of the relinquished investment property (the "Relinquished Property") to close?  Would taking advantage of an IRS safe-harbor designed for just such a situation be of interest?  Assuming your answer is "yes", our Firm has recently completed multiple transactions to accomplish such a result.

A "1031 Exchange" enables an owner ("Exchanger") of real property held for productive use in a trade or business or for investment purposes to defer capital gains tax and depreciation recapture by reinvesting proceeds from the sale of said property into other qualified "like-kind" property (see articles 1 and 2 of this series for further information).  However, the requirements of Internal Revenue Code Section 1031 and associated Treasury Regulations (the "Code") do not technically permit an Exchanger to hold title to both the Replacement Property and Relinquished Property at the same time.  Therefore, a true reverse exchange in not permitted.

However, the IRS has offered a safe-harbor through the publication of Rev. Proc. 2000-37 (the "Procedure").  Under the Procedure, an Exchanger is permitted to purchase the Replacement Property prior to closing on the sale of the Relinquished Property, through the use of a Qualified Intermediary (a "QI").

In a Reverse 1031 Exchange, the Exchanger engages the services of a Qualified Intermediary to establish a Qualified Exchange Accommodation Arrangement (a "QEAA").  In a QEAA, the Exchanger assigns the right to acquire the Replacement Property to the QI and the QI takes title to the property through a separate entity formed specifically for such purpose and known as an Exchange Accommodation Titleholder (a "EAT").  A QEAA requires the Exchanger to "loan" the funds to purchase the Replacement Property to the EAT.  This loan is then discharged once the EAT transfers the Replacement Property to the Exchanger upon the closing of the sale of Relinquished Property.

The difficulty with a Reverse 1031 Exchange is that it requires that the Exchanger have access to sufficient funds to purchase the Replacement Property prior to receiving any funds from the sale of the Relinquished Property.  However, having the option to purchase the Replacement Property prior to closing on a sale of the Relinquished Property is extremely important in certain situations where timing would prevent an Exchanger from being able to qualify for the tax benefits available under the Code.

As part of the proposed legislation known as the American Families Plan, the Biden Administration is proposing to limit the deferral of capital gains available to taxpayers through a 1031 Exchange to $500,000.00 per taxpayer ($1,000,000.00 for taxpayers filing jointly) per year.  The American Families Plan is only a proposal at this time and has not passed Congress; however, investors should be aware of these potential limits.

Despite limitations that may or may not arise in the future, Like-Kind Exchanges under Section 1031 of the Internal Revenue Code offer significant tax incentives to investors and business owners.  WHP has recently helped clients with these types of transactions and can work with any Qualified Intermediary to assist with such transaction.  Therefore, when the time comes to upgrade facilities or move into a different market, please contact your WHP counsel to see if a 1031 Exchange is an appropriate option for you.


We invite you to read other articles in this three-part series:


This article provides an overview and summary of the matters described therein. It is not intended to be and should not be construed as legal advice on the particular subject.

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