Brandt Nicholson, JD, Principal

         The Market - Reverse exchanges have become increasingly prevalent during the past several years. After substantial real estate appreciation again in the late 1990's in the San Francisco Bay Area, the common complaint is lack of inventory. Sellers are confident in being able to sell their exchange property, but wish to avoid having to identify the replacement property in the required 45 days.


        The Scenario - Thus, in a typical reverse exchange scenario, the owner of investment property listed for sale finds the ideal replacement property available before finding a buyer for the exchange property. The question is thus posed: "May I buy and then sell rather than the more common delayed exchange, sale followed by a purchase?"


        New Tax Law - Effective 9/15/00, the IRS issued its Revenue Procedure 2000-37, for the first time sanctioning the reverse exchange with the "safe harbor" rule provided therein.

        It is necessary, of course, for the exchanger to fund the first escrow for the replacement property from whatever source. This might be a "swing loan" on the unsold exchange property payable upon its sale. Several exchangers with whom I have worked have refinanced their home, taking advantage of preferred loan terms on owner-occupied property. Or the cash needed might come out of savings, etc.

        Whatever the source and amount, it is advanced as a loan to the intermediary to acquire the replacement property. The intermediary gives the exchanger a nonrecourse promissory note in the amount of the advance, which, however, is repayable only to the extent of funds received on subsequent sale of the exchange property.


Procedures

        A.         Basically, the reverse exchange is converted (in form, but not in substance) to a simultaneous exchange for which there is ample tax authority. Thus, at the time that the exchanger acquires title to the replacement property, directly from the seller (thus, no problem with a lender as may be the case under Procedure B, below), title to the still unsold exchange property is "relinquished" by deeding to the intermediary where title remains until purchase by buyer, at which time the sale proceeds are used to repay the exchanger for the funds to previously buy the replacement property.

        B.        The second method is somewhat simpler, assuming no problem with a lender on acquisition of the replacement property in having title initially in the intermediary or an all cash purchase (i.e., on close of escrow on the purchase of the replacement property, title is in the intermediary trust). Later, when the exchange property is sold, the replacement property is deeded from the trust to the exchanger and the net sale proceeds are paid to the exchanger as reimbursement for funds advanced earlier to buy the replacement property.

        This method is required when construction improvements to the replacement property are part of the exchange. This was approved by the IRS in an exchange we structured (i.e., build-to-suit Walgreen drug store followed by the sale of four condominiums constituting the exchange properties).

        A frequent question concerns the time within which the exchange property must be sold. Under the Revenue Procedure 2000-37 mentioned above, the final sale should occur within 180 days of the intermediary acquiring title to the exchange or replacement property, and in any event in time to report the completed exchange in the tax return for the year in which the exchange was commenced.

IRS Audits and Approves Reverse Exchange (with construction added.)

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