A reverse exchange may be used when the Exchanger must purchase the replacement property prior to the sale of the relinquished property. The Exchanger may not own both properties at the same time, but they can “park” title of either the replacement or relinquished property. A reverse exchange is more complicated and costly than a forward exchange. In a parking arrangement, the Exchange Accommodation Titleholder (“EAT” entity), forms a pass-through entity, usually a limited liability company disregarded for federal income tax purposes, to take title to the “parked property.” Our EAT is Legal 1031 EAT Holdings, LLC.

Overview of Reverse Parking Exchanges (Replacement Property Parked)

Below is a list of the main steps in a replacement property parked reverse exchange:

1) Planning: Contact Legal 1031 and fill out a “Parking Exchange Questionnaire.” Legal 1031 will set up a preliminary discussion. It is best to also provide us with copies of purchase and sale agreements (“PSAs”) and entity organization charts where applicable. Engage Legal 1031 when appropriate.

a. ESA: If you plan to park a commercial property, obtain a Phase I Environmental Survey (ESA) and provide it to Legal 1031 for review. Legal 1031 may waive this requirement for small residential properties with a history of residential usage.

2) Analysis: Discuss the transaction with your advisors; determine the gain, debt and equity in the exchange to contemplate if your exchange is “balanced”. For more on the debt equity requirements and balancing in an exchange, read here.

3) Discuss the parking exchange with your Lenders: Third-party lenders need to approve Legal 1031 taking legal title to the parked property through the EAT LLC for the duration of the exchange.

4) Formation of the EAT LLC / titleholder LLC: Either Legal 1031 or the Exchanger’s attorney will help form the new titleholder LLC (“the LLC”) in the state where the parked property is located. Legal 1031 EAT Holdings, LLC, will be the sole member of the LLC for the duration of the exchange and it will not obtain a separate Federal EIN/TIN. The Exchanger may name the LLC subject to state rules.

5) Assignment: Purchase documents should reflect the new titleholder LLC as the buyer. Depending on the Exchanger’s progress in the acquisition timeline, purchase agreements may need to be assigned to achieve the same. Additionally, transfer and loan documents may require amendments to reflect the LLC as the buyer/borrower.

6) Documents: Legal 1031 will prepare documents needed to park the replacement property, a Qualified Exchange Accommodation Agreement (“QEAA”) for the Exchanger to review and execute.

7) Obtain insurance policies: Certificates of Insurance (COIs) must be provided to Legal 1031 for review prior to closing. The COI must insure the LLC and Legal 1031 EAT Holdings, LLC as additional insured, while meeting the requisite policy amounts. Please contact us for more information on our insurance requirements.

8) Review financing documents: If a third-party lender is involved, Legal 1031 needs a reasonable time to review loan documents to ensure that they are compliant. All loan documents must include nonrecourse language (Legal 1031 will provide).

9) Pre-Closing review and coordination: Exchanger’s Counsel and Legal 1031 will coordinate with closing agents and other parties to ensure that the closing statement, closing documents, and loan documents are properly formatted.

10) “Parking” / Closing on your Purchase: Title to the replacement property is vested in the newly formed titleholder LLC (effectively “parking” the property’s title); the Exchanger now has 180 calendar days to sell relinquished property in order to complete the exchange. The LLC provides a promissory note to the Exchanger for funds borrowed to acquire the replacement property and later pays it back.

11) Sale Contract: Finalize and execute the sale contract for any Relinquished Property and provide it to Legal 1031.

12) Documents: Legal 1031 will prepare relinquished property documents for review and execution.

13) Sell Relinquished Property: Once 1031 documents are in place, close on the sale of relinquished property.

14) Exchange: Through its documents, Legal 1031 Exchange Services has the right to the net sale proceeds; it is assigned into the QEAA and will acquire the parked property from the LLC using the exchange proceeds. Exchange proceeds can also be used to pay down any excess debt from a third-party lender secured to the parked property. This is typically done to “balance the exchange.”

15) Transfer of Parked Property: Typically, transfer of the parked property to the Exchanger is achieved by assigning them 100% of the ownership interests in the LLC, which qualifies as title for 1031 exchange purposes. In the alternative, the actual title to the parked property can be conveyed.

16) Note Payoff: Once the exchange is closed, the LLC will pay off the note to the Exchanger using sale proceeds.

17) Completion: The Reverse Exchange is complete with respect to the parked property. If there are excess exchange proceeds, the Exchanger may continue to acquire additional replacement properties via a forward exchange.

Legal 1031 Exchange Services LLC and Legal 1031 EAT Holdings, LLC do not provide tax or legal advice, nor can we make any representationsor warranties regarding the tax consequences of any transaction. Taxpayers must consult their tax and/or legal advisors for this information.Unless otherwise expressly indicated, any perceived federal tax advice contained in this article/communication, including attachments and enclosures, is not intended, or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein. Information in this article and linked herein may not constitute the most up-to-date legal or other information. We recommend that taxpayers and their advisors independently analyze the benefits and risks of their 1031 exchange and those of related tax strategies.

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