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It’s Important for Investors to Understand the Types of Exchanges Available…

Exchanging can range anywhere from a simultaneous exchange of two properties to a complex, multi-leg, multi-party transaction involving construction and/or reverse exchanges.  It’s important for investors to understand the different types so they know what is best for you.  Note, the vast majority of exchanges performed are delayed exchanges. 

The Simultaneous Exchange

In this transaction, the closing of the Relinquished Property and the Replacement Property take place on the same day - there is no interval of time between closings. Prior to the 1979 Starker decision, most exchanges were limited to the simultaneous format. Since 1991, the only “safe harbor” for a simultaneous exchange is with the use of a Qualified Intermediary.

 The Delayed Exchange

In this type of exchange, the Replacement Property is closed on a date later than the closing of the Relinquished Property. Sometimes, this kind of transaction is called a “Starker Exchange,” after the well-known 9th District Court case in which the court ruled in the taxpayer’s favor for a delayed exchange prior to current IRS rules and regulations. The current IRS code dictates strict time frames for completion of a delayed exchange which are the 45 days to identify and 180 days to complete the entire exchange.

 The Improvement or Construction Exchange (Title-Holding Exchange)

This exchange takes place when an Investor wants to acquire a property and arrange for construction of improvements on the land before it is received as Replacement Property. Typically, improvements are a building on an unimproved lot, but may include enhancements made to an already-improved property  to create adequate value to balance the Exchange.

Note: Federal law does not permit a taxpayer to construct improvements on a property as part of a §1031 Exchange after the buyer has taken title to the property as Replacement Property in an exchange. In other words, it becomes necessary for the Intermediary to close on, take title, and hold title to the property until the improvements are constructed, and then convey title to the Improved Property to the taxpayer as Replacement Property.

The Reverse Exchange (Title-Holding Exchange)

Revenue Procedure 2000-37 published by the Internal Revenue Service September 15, 2000, provided  the first safe harbor for taxpayers wishing to utilize the reverse exchange format.

Why would you use this type of exchange

a. The purchase of Replacement Property (Phase II), for whatever reason, must occur prior to the sale (Phase I) of the Relinquished Property.

b. To solve timing problems if the purchase must close before the Relinquished Property or the transaction would be impossible. 

c. Frequently used in combination with another form of exchange such as a Reverse/Improvement exchange.

Structuring the Reverse Type ‘A’ exchange – (Exchange Last)

a.  Used when the Replacement Property is purchased for cash or the seller is providing financing or if the lender will allow the QI on title.

b. The Qualified Intermediary (QI), as an Accommodation Title holder (AT), buys the Replacement Property with a loan from the exchangor, (Investor), (Phase I).  The AT retains ownership for up to 180 days until a buyer for the Relinquished Property is found.  Once the Relinquished Property is sold, the proceeds from the sale are used to acquire the Replacement Property from the AT and the exchange is complete (Phase II). 

Structuring the Reverse Type B Exchange - (Exchange First)

a.  Used when the AT cannot go on title to the Replacement Property.

b.  The exchangor loans the AT funds equal to their equity in the Relinquished Property.  The AT then buys the Relinquished Property in a regular Qualified Intermediary exchange.  The QI then acquires the Replacement Property with funds from the sale of the Relinquished Property to the AT and immediately transfers title to the exchangor and the exchange is complete.  When the Relinquished

Reverse/Improvement Exchange

a. Combines the features of the Reverse and Improvement Exchanges

b. Used when the exchangor must continue to occupy Relinquished Property until a Replacement Property can be constructed.

Multi-Property and Multi-Party Exchanges

You, investor,  can trade out of one property into several or consolidate from smaller properties into one larger property.  Also,  two or more investors owning a property together can trade into separate properties.

Personal Property Exchanges

Investment personal property is exchangeable for similar-use personal property.  The government has 13 general asset classes.  Property belonging in one general asset class can be exchanged for another in the same general asst class (i.e. an aircraft can be exchanged for an aircraft or cows for other cows).