Many taxpayers ask “what's the downside of doing a reverse 1031 exchange outside of the safe harbor?” The critical component is if you're outside of the safe harbor, the LLC that’s holding title to the replacement property cannot be deemed to be an agent of the taxpayer. So there is a critical analysis and a fact-specific determination to make sure the party holding the parked property is not an agent of the taxpayer.
Exchange Accommodation Title Holder
This generally means that the taxpayer’s exchange accommodation title holder needs to act as a principle in the transaction by investing significant amounts of its own cash into the Replacement Property and taking out fully recourse financing with an independent lender for the purchase and construction. The LLC must have a real economic “upside” and substantial risk of a potential “downside” to be viewed as acting as a principle in the transaction.
Treasury Regulations
Further bolstering this situation, the Treasury Regulations state that the qualified intermediary is not considered the agent of the taxpayer for purposes of Section 1031(a), so perhaps the most ideal party to “park” the Replacement Property and take on these risks is the qualified intermediary. Given this unique and potentially adverse situation, the taxpayer must have their own separate legal and tax advisor working with them throughout the entire process, particularly because the qualified intermediary is acting for its own accord and for its own economic benefit (the opposite of an agent of the taxpayer).
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
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