Reverse Exchange Services, Inc.
The different types of reverse exchanges
The Improvement Exchange, also referred to as the Construction Exchange, gives the Exchanger the opportunity to add value to the replacement property before the Exchanger acquires title.
The Exchanger can use the exchange funds to either:
• Build improvements on a new Replacement Property or
• Make improvements to an existing property.
This variation is extremely popular because it also provides the opportunity to purchase properties needing renovation or to acquire bare land and build to an Exchanger’s exact specifications. In the most common type of Improvement Exchange the Exchanger sells the relinquished property, the QI (and the Exchanger) loan money to RES to purchase property, RES makes the improvements and then transfers the upgraded Replacement Property to the Exchanger to complete the exchange.
The improvements become part of the exchange value of the Replacement Property.
Advanced planning is essential. Normal construction delays, inclement weather and obtaining government permits can make it a challenge to complete the needed improvements within the 180-day exchange period. If the project will exceed the 180-day “safe harbor”, the Exchanger must embark on a non “safe harbor” transaction.
Why do a reversed exchange?
The following on the next tab is a list, in summary form, of the tasks which Reverse Exchange Services, Inc. ("RES"), and the special-purpose entity ("SPE") which it forms, undertake in structuring and implementing a "reverse" exchange for investors and owners of real and personal property. We hope this provides a greater understanding to you and your associates of the extent of our services.
As you will see from the list of tasks below, a reverse exchange is considerably more complicated to structure and to implement than a regular "deferred" exchange. As a consequence, the principals of RES spend a great deal of time not only with the Exchanger, but the Exchanger's attorney, accountant, and other advisors, and are directly involved throughout the process.
Of particular importance, is the fact that all three RES principals have extensive property transactional experience. Each of us has been putting real estate and personal property deals together for over 25 years, and we are all "deal-makers."
We believe the qualifications of the principals and staff of RES are something which no other "reverse" exchange accommodation company can offer. No other company provides, in-house, the professional training and actual experience which RES brings to the table. The principals of RES are able to deal, directly and professionally, with the legal and tax issues these transactions present, particularly the financing requirements, and the additional concerns when construction of improvements is required.
Here is the list of most of the activities performed by RES in connection with a typical reverse exchange:
Step 1 – Create Special Purpose Entity – Create a legal entity and qualify it to do business in the state in which the property is located. RES creates a separate legal entity (a single-purpose entity or "SPE") for each Exchanger to protect the property, and the transaction, from problems with another taxpayer's transaction. For instance, if there are environmental problems with one piece of real estate, it is "insulated" within that SPE, and another Exchanger's deal is not tainted. Some of our competitors are NOT setting up separate companies for each Exchanger. We believe this is a risk that should not be taken. The minimal cost of forming, accounting for, and finally dissolving an SPE is worth the benefits conferred.
The cost covers the following:
Formation costs, filing fees, minimum franchise fees, etc. In some states the filing fees, and local franchise (or other similar taxes), are considerable. Additional fees and taxes could be imposed by different jurisdictions; these are added to the formation costs. Establishing the SPE as a taxpayer, and filing a federal (and sometimes a state) tax return; if the transaction straddles tax years, then returns are required for both years.
Step 2 – Arrange Financing for SPE Acquisition – This includes arranging for the financing of the purchase of the replacement property with the exchanger, and/or a third party lender (and if the relinquished property has already sold, with the Qualified Intermediary ("QI") holding the exchange proceeds).
Step 3 - Prepare Documentation - Documents include: (i) the Qualified Exchange Accommodation Agreement; (ii) Typically a Lease, since the SPE net-leases the "parked" property to the Exchanger; (iii) Ground Lease (where the Exchanger already owns the replacement property on which it wishes new improvements to be built); (iv) Loan documents to evidence and secure the debt (Note(s), Deed of Trust or other security instruments) as required by the lender(s), which may include the Exchanger and/or the QI holding proceeds from the disposition of the relinquished property; and (iv) Other ancillary documents, depending on the transaction (e.g., A Project Management Agreement for build-to- suit projects, Assignment of Buy-Sell Agreement, etc.)
Step 4 - Review Third Party Documentation - Review and sign any third-party lender documentation to ensure that the terms of financing comply with the reverse exchange requirements.
Step 5 - Arrange for Insurance - Property, casualty and commercial liability insurance on the property must be procured in the name of the SPE with the exchanger as an additional named insured on the policy.
Step 6 - Consultation - Answer inquiries from Exchanger and the Exchanger's broker, as well as its legal and tax advisors about documents and other aspects of the transaction. This usually results in the direct involvement of one of the RES principals.
Step 7 - Coordination of Closing Process - Coordinate closing of acquisition by SPE with escrow agent. This will include documenting the assignment of the purchase contract, reviewing escrow closing instructions, settlement statements, etc.
Step 8 - Coordinate with Qualified Intermediary - This includes coordinating the closing with the QI, and where the SPE is engaged in construction, coordinating construction draw-down payments.
Step 9 - Monitor Ownership of the "Parked" Property - This includes ensuring that all documents and bills regarding the "parked" property are forwarded to the tenant (under the Lease) of that property so they are dealt with timely. RES is required to maintain accounting records for the property as the "owner" of the property during the parking period.
Step 10 - Construction Disbursements - If construction is going to be done during the 180-day "safe harbor" ownership, review and approve construction disbursements, and coordinate with RES bookkeeper to ensure that transaction is properly reported under "safe harbor" requirements.
Step 11 - Non-Safe Harbor Issues - If the transaction is outside of the 180 day "safe harbor", the major accounting firms advise that in order for the SPE not to be deemed the "agent" of the Exchanger, for tax purposes, the SPE must have between 5% and 10% equity invested, and "at risk". This of course results in a greater cost. To compensate for this risk, RES usually requires a yield of 16%-18% p.a. on the equity provided. The amount depends on a number of factors, including the credit status of, and business activities of Exchanger, the kind of property, etc.
Step 12 - Complete the Transaction: Exchange "First" - If the SPE "parks" the relinquished property, it will enter into a sales contract (and any amendments), when presented by the broker (and approved by Exchanger). Then the SPE will complete the sale, arrange for pay down of debt (and arrange for Exchanger to make-up shortfall, or arrange for payment of excess to Exchanger) and then report the sale, on its own tax return, showing no gain or loss.
Step 13 - Complete the Transaction: Exchange "Last" - If the SPE owns the replacement property, when the Exchanger is ready to complete the exchange, the SPE enters into the Exchange Agreement with Exchanger and QI, sells the replacement property to Exchanger, and then accounts for the sale on its own books.
Step 14 - Dissolve the SPE - After the exchange is completed, and the SPE no longer owns any property, the SPE is dissolved, and final tax returns are prepared and filed.
Deferred gain: Amount of “realized gain” that is not currently taxable.
Exchange Accommodation Titleholder: Following the IRS guidelines, Reverse Exchange Services, Inc. (RES) acts as the Exchange Accommodation Titleholder (“EAT”) to assist the Exchanger in completing a tax-deferred §1031 exchange.
Exchange First Reverse Exchange: In an “exchange first” reverse exchange, the SPE will purchase and park the relinquished property (and the Exchanger will have an immediate exchange), and then the SPE will sell the relinquished property to the ultimate third party buyer.
Exchange Last Reverse Exchange: In an “exchange last” reverse exchange, the SPE will purchase and park the Replacement Property, and then when the Exchanger is able to sell the Relinquished Property to the ultimate third-party buyer, the exchange will be completed when the Exchanger acquires the Replacement Property from the SPE.
Like Kind: No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for ‘like-kind’ property which is to be held either for productive use in a trade or business or for investment.
Qualified Exchange Accommodation Agreement: RES and the Exchanger enter into a written Qualified Exchange Accommodation Agreement (“QEAA”) which sets forth the terms of the transaction, set up as a reverse exchange, to ensure that it qualifies for §1031 tax-deferred exchange treatment.
Qualified Intermediary: A third party or facilitator who is an independent principal who assists in completing a successful section 1031 tax-deferred exchange.
Realized gain: Difference between sales prices and adjusted tax basis.
Recognized gain: Amount of “realized gain” that is currently taxable.
Relinquished Property: The property the Exchange is selling. Also called the old property.
Replacement Property: The property the Exchanger is buying. Also called new property.
Safe Harbor: The term “safe harbor” refers to the guidelines issued by the IRS for reverse exchanges on September 15th, 2000 in Rev Proc. 2000-37 (hotlink). Compliance with the safe harbor guidelines makes the presumption that the transaction will qualify for §1031 tax-deferred exchange treatment.
Section 1031: Section 1031 of the Internal Revenue code provides that tax on gain from the sale of real or personal property held for investment or business purposes can be deferred if the property is exchanged (rather than sold) for other like-kind property.
Special Purpose Entity: A Special Purpose Entity (“SPE”) is a separate legal entity created to qualify for business in the state in which the property is located.
We have expertise in the following types of transactions:
Relinquished Property is structured as a partnership or LLC and needs to be restructured as a tenancy-in-common arrangement to meet Exchanger’s goals, but closing in the Replacement Property cannot wait.