Thursday, October 16, 2008

1031 Reverse Exchange Rules

The 1031 reverse exchange rules allow you to acquire your like kind replacement property before you sell your relinquished property. We will look more closely at the 1031 reverse exchange rules and potential ways this strategy is being applied.

Reverse 1031 exchanges give the Exchangor the flexibility to take all the time they need to locate the ideal replacement property, without the pressure of the forward 1031 exchange deadlines. Reverse 1031 exchanges have been structured by legal and tax advisors for years, but in terms of the actual "1031 reverse exchange rules" there was precious little guidance from the Department of the Treasury or Internal Revenue Service. Until very recently, investors only could look for guidance from certain tax court decisions that were handed down. Fortunately, exchangors no longer have to rely on the educated guesses of their advisors on 1031 reverse exchange rules about how to properly structure their reverse 1031 exchange transactions. Rules and guidelines have been established are basically as follows:

First, the reverse exchange must involve an Exchange Accommodation Titleholder (EAT). The EAT is an independent third party that holds, or parks, the Exchangor's Replacement Property following or prior to the exchange period. The EAT must have a qualified indicia of ownership at all times from the date of acquisition until transfer.

There are several types of reverse exchanges. The Safe-Harbor Reverse is an exchange whereby the EAT parks the replacement property prior to the sale of the old property. The exchanger must identify the relinquished property or properties within 45 days of the parking arrangement, and must have the entire transaction complete within 180 days of the parking arrangement.

The Traditional Reverse is a reverse exchange that typically looks identical in structure to the Safe-harbor reverse, yet it will fall outside of the safe-harbor due to the fact that it can not be completed within the time frames provided. Typically, the exchanger is unable to sell their old property within 180 days of the parking arrangement, and therefore the time frames set forth by the safe-harbor are not met. This type of transaction is not necessarily a "red flag" for an audit by the IRS, but does require quite a bit more documentation and consultation by the intermediary to assure the transaction is done properly to avoid scrutiny by the IRS.

A Construction/Improvement Reverse allows the exchanger to park a piece of property or land that will be built upon or improved during the exchange period. This is the most powerful reverse exchange available, as it allows the exchanger to literally create the exchange property they will eventually exchange into through the development or construction process.

As is probably no surpise from the cursory review of the 1031 reverse exchange rules, the costs surrounding 1031 reverse exchanges are considerably more than those for a traditional, Forward Delayed Exchange. However, with replacement property often being the biggest challenge to a succesful exchange, many investors think they are quite often well worth the expense.

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