Downsides of Non-Safe Harbor Reverse 1031 Exchanges

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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© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

What Exactly is a Safe Harbor Reverse 1031 Exchange?

In the year 2002, the IRS finally issued a Revenue Procedure for conducting reverse exchanges. It's a very taxpayer-friendly rev proc in that the intermediary can form an entity to acquire either the new replacement property and hold it until the relinquished property is disposed of, or alternatively the intermediary can acquire title to the old relinquished property and hold it, and allow the new replacement property to be immediately received by the taxpayer.

180 Day Holding Period

In either instance, the IRS limited this holding period to 180 days under the safe harbor. They were mirroring the requirements that are in the straight exchange regulations that limit deferred exchanges to 180 days. The major criticism or limitation of rev proc 237 is that it only allows the parking arrangement with the intermediary to go on for 180 days.

When to Use a Reverse Exchange

But if you have to acquire your replacement property before you've had a chance to get rid of your old relinquished property, a reverse exchange can be a very effective tool to allow your acquisition to still be part of a 1031. Furthermore, in a hot seller's market where it's really really hard to buy because there's lots of competition for properties, and it's really easy to sell, many savvy investors will use a reverse exchange to acquire the replacement property in a reverse exchange so they’ve got a sure thing to exchange into, and then they'll use their 180 days thereafter to offload or dispose of their old relinquished property.

Get Help with Your 1031 Exchange

Get help with your next 1031 exchange of real estate by reaching out to CPEC1031, LLC. Our qualified intermediaries have been providing like-kind exchange assistance to clients throughout the state of Minnesota and across the country for over two decades. You can find us at our primary offices in downtown Minneapolis.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Reverse 1031 Exchanges within the Safe Harbor

In this 1031 FAQ video, Jeff Peterson talks about reverse 1031 exchanges within the safe harbor. Watch more 1031 educational videos here.

• Start Your 1031 Exchange: If you have questions about reverse 1031 exchanges within the safe harbor, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

What is a Qualified Intermediary?

In this 1031 FAQ video, Jeff Peterson talks about the functions of a qualified intermediary in a 1031 exchange. Watch more 1031 educational videos here.

• Start Your 1031 Exchange: If you have questions about qualified intermediaries in a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Safe vs. Non Safe Harbor Exchanges

When the regulations came out for 1031 exchanges, just about everybody gravitated towards the safe harbor exchanges, which allow for a sale to occur to a third party and a purchase to occur within 180 days. The only real curve ball is that under the safe harbor you have to identify in writing your replacement property within 45 days.

Safe Harbor Exchanges

The regulations do not prohibit you from doing a non-safe harbor straight exchange. But in a non-safe harbor exchange it's much more difficult to get the stars into alignment because you don't have the benefit of the deferred exchange timeline. Typically, in a non-safe harbor exchange would have to be a direct swap where you sell your relinquished property to party A and you simultaneously receive your new replacement property from party A (the same party). It’s like the old fashioned horse swap, I'll give you my horse in exchange for you giving me your horse.

Non-Safe Harbor Exchanges

A non-safe harbor exchange does not require you to hire a qualified intermediary but does require that you do a simultaneous swap with the party that you are giving your relinquished property to. For that reason it’s much more difficult to do a non-safe harbor straight exchange and given that the fees and expenses for doing a deferred safe harbor exchange are so minimal most people avail themselves with the protections of the safe harbor even when they are doing a quick or simultaneous exchange because they want the certainty that the safe harbor protections provide.

• Start Your 1031 Exchange: If you have questions about safe vs. non safe harbor exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved