Issues with Reverse Tax-Deferred Like-Kind Exchanges
The costs surrounding reverse tax-deferred like-kind exchanges are considerably more than those for a forward tax-deferred like-kind exchange transaction.
Fees for reverse tax-deferred like-kind exchange transactions are higher than fees for forward, delayed tax-deferred like-kind exchange transactions primarily due to the significantly increased risk that is assumed by the Exchange Accommodation Titleholder (EAT) when acquiring, holding and "parking" legal title to the Investor's relinquished or replacement property.
The Investor will also incur additional title insurance, environmental, loan, legal, property, casualty and liability insurance, and escrow/closing costs depending on the structure of the reverse tax-deferred like-kind exchange.
There is also the potential for double taxation of state, county or local taxing authorities such as transfer taxes, property taxes due to incorrect or premature reassessment when either the relinquished or the replacement property is conveyed to the Exchange Accommodation Titleholder and then transferred to the buyer ("Exchange First") or to the Investor ("Exchange Last").
However, in a recent Private Letter Ruling (PLR 200148042), the Internal Revenue Service approved an express declaration of agency for all purposes except federal income tax purposes that could be included in the Exchange Accommodation Titleholder's Qualified Exchange Accommodation Agreement with out jeopardizing the qualification of the transaction as a reverse tax-deferred like-kind exchange.
Conveying title to property from an agent to a principal is not a taxable event in most taxing jurisdictions. While the Private Letter Ruling only pertains to the ruling obtained by the specific taxpayer in this case, this nonetheless provides some insight into the Internal Revenue Service's views on the matter.
Investors can not depreciate the like-kind replacement property acquired, held and parked by the Exchange Accommodation Titleholder until the Investor has acquire title to the like-kind replacement property or has transferred the relinquished property to the Exchange Accommodation Titleholder.
The Exchange Accommodation Titleholder does not depreciate the property acquired, held and parked. The property is held on its books as inventory held for ultimate disposition.
Alternative Strategies
After reviewing the costs involved in a reverse tax-deferred like-kind exchange, Investors may want to consider approaching the seller of the like-kind replacement property to see if the transaction can be delayed until a buyer can be found for the relinquished property. This way the transaction can be restructured into a forward 1031 exchange.
The Investor may want to consider securing his like-kind replacement property by including contingency language in the purchase and sale agreement so that the acquisition closing can be delayed until the relinquished property is in a position to close concurrently with the replacement property.
The payment and unconditional release of an earnest money deposit to the seller on a non-refundable basis may be sufficient to persuade the seller to cooperate. The seller may prefer an additional payment such as an option fee to extend the close of escrow, which could be cheaper than the reverse 1031 exchange transaction.
The seller may not be willing to cooperate in delaying the close of escrow, but perhaps would be interested in carrying back some financing in the short-term to assist the Investor with his reverse 1031 exchange transaction.
Exeter 1031 Exchange Services, LLC is always available to assist Investors with complex reverse 1031 exchange transactions. We would be happy to meet with the other parties involved with the Investor's reverse 1031 exchange such as the lender, accountant, attorney, and/or escrow officer, in order to assist in structuring the reverse 1031 exchange.
In any event, the Investor should seek the advice of his legal, tax and financial counsel prior to entering into any tax-deferred like-kind exchange structure. It will be money well spent.
Contact us for more complete information or assistance in planning your reverse 1031 exchange.
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