Reverse Exchange

A reverse exchange (also known as a parking arrangement) occurs when you take title to your replacement property before you relinquish your property. In 1991, the IRS announced that the like-kind exchange rules did not apply to reverse exchanges. However, due to many questions and comments on the issue, in 2000 the IRS issued Revenue Procedure 2000-37 and provided safe harbor requirements that allow reverse exchanges to be treated as like-kind exchanges.

The IRS safe harbor requirements for reverse exchanges include the following:

• An Exchange Accommodation Titleholder (EAT) must take title to the replacement property. The EAT will “park” the property until you sell your property.
• Within five days from when the EAT takes title to the property, you must enter into a Qualified Exchange Accommodation Agreement (QEAA) with the EAT. The QEAA must specify the intentions of both parties and the rules that must be followed to complete the exchange.
• You must identify the property you wish to relinquish within 45 days of signing the QEAA and you must close on the sale of your property within 180 days of signing the QEAA.

However, real estate developers who owned multiple properties found a loophole in the reverse exchange rules. An individual would transfer a piece of land to an EAT and the EAT would contract for construction of a house or building on that land. The developer would then sell another property to a QI in a deferred 1031 exchange. They would then identify their replacement property (as part of the deferred 1031 exchange) as the newly constructed property being held by the EAT. Thus, they would end up replacing their relinquished property with a property they had previously owned while deferring the capital gain on the sale of the property they sold.