A reverse exchange is a 1031 exchange in which the New Property (Replacement Property) is acquired before the Old Property (Relinquished Property) is sold. The role of the Accommodator is to acquire either the Old or New Property on behalf of the Exchangor and hold legal title to it until the Old Property is sold to its ultimate buyer. The asset held in this manner is frequently said to be “parked” and the formal agreement between the Accommodator and Exchangor describing the parking arrangement is called the Qualified Exchange Accommodation Agreement or “QEAA”.
In a reverse exchange, the Accommodator forms a separate “Special Purpose Entity” to hold the property to be parked during the exchange. This entity – called the “Exchange Accommodation Titleholder” or EAT – is usually a single-member LLC. Using this approach, the assets in each exchange are kept legally separate and insulated from one another.
The formal IRS guidance regarding reverse exchanges is found in Rev. Proc 200-37. It describes the “safe harbor” upon which the reverse exchange processes rely. It says that the IRS will not challenge the status of an EAT as the beneficial owner for tax purposes of an asset involved in a parking arrangement (i.e. reverse exchange) if the Exchangor and Accommodator enter into a QEAA that meets its requirements and if the standard exchange deadlines are met. The standard deadlines apply to the Old Property in a reverse exchange, as opposed to potential New Property in a forward exchange. Thus, there are 45 days to identify potential Old Property to be sold and 180 days to complete the exchange by selling Old Property that has been properly identified. The Rev. Proc. also permits a series of arrangements in support of the parking arrangement that are not required to be at “arm’s length”. For example,
- The EAT is permitted to borrow the funds required to acquire the property being parked from the Exchangor at no interest
- The Exchangor may guarantee all of the obligations of the EAT, including loans made to the EAT by third-parties to acquire properties to be parked.
- The EAT is permitted to enter into a triple-net lease with the Exchangor for the parked property at no rent.
- The Rev. Proc. also permits adjustments for economic risk, meaning that the EAT is not at risk of a decline in the value of a property it holds nor is the Exchangor obligated to share with the EAT any appreciation in value during the exchange period.
REVERSE LKE PROGRAMS
Rev. Proc. 2003-39 offers additional safe harbors to Exchangors engaged in frequent personal property exchanges. Programs using this Reverse Procedures have been executed for years on behalf of Exchangors in the automobile, energy, and heavy equipment industries, as well as leasing companies where similar assets are frequently bought and sold. The primary benefit of programs of this type, when executed in a delayed exchange mode, is the availability of substantial additional capital resulting from the ongoing deferment of taxes on gains resulting from recapture of depreciation. While many of the very-high-volume programs are designed to be “cash-less” relative to the QI involved in the delayed exchanges, many low- and medium-volume programs do have cash proceeds from used asset dispositions being held by the QI.
Petroleum Strategies facilitates LKE programs using either of the basic reverse forms – Exchange Last or Exchange First. Our LKE programs involving parking assets, as opposed to parking cash, while the used assets are sold.
Reverse LKE Processes
The Exchange First version of this process is similar except that used Assets are parked in EATs. The decision to use Exchange First or Exchange Last forms will likely be related to the means used to finance New Asset acquisitions, with Exchange First being preferable if there are complications with 3rd-party lenders providing all or part of the new Asset purchase money.
The EAT structure we use allows for both separation of assets and the ability to respond quickly to a decision to purchase New Assets. A master Delaware series LLC (the “Master EAT”) will be formed that permits individual EATs (series LLCs) to be formed in response to specific New Asset acquisitions. The Delaware structure allows individual series LLCs to be formed without specifically communicating with the Delaware authorities, resulting in the ability to form EATs (extremely quickly). Similarly, EATs can be dissolved with the same ease and timing. We will also secure a resale license for the Master EAT in the appropriate jurisdiction, so that it will be exempt from local sales and use taxes to the greatest extent possible.
Reverse LKE Documentation (Exchange Last)
The goal of the various documents is to be in compliance with all of the relevant provisions of both Rev. Proc. 2000-37 and Rev. Proc. 2003-39 while achieving strict adherence to the requirements of IRC §1031. Accordingly, the structure requires; 1) A Master Qualified Exchange Accommodation Agreement which describes the mechanism for each separate reverse exchange. 2) A Master Exchangor Note, which will allow the funds required to buy the various New Assets to be borrowed interest-free from the Exchangor, 3) A Master Lease, by which the relevant EAT will lease the New Assets to the Exchangor on a rent-free, triple-net basis, 4) A Master Exchange Agreement by which each reverse exchange will be completed when the designated Old Assets have been sold through a simultaneous §1031 exchange.
Petroleum Strategies, Inc. does not give tax or legal advice. The information contained herein should not be relied upon as a substitute for tax or legal advice obtained from a competent tax and/or legal advisor.