The following is an outline of the procedure that is used for consummating a reverse tax deferred exchange under Internal Revenue Code section 1031:
The ("Exchanger") would loan Marin County Exchange Corporation ("MCEC") the funds for the down payment on the new investment property ("Replacement Property") to be acquired. MCEC would give Exchanger a promissory note for that amount due in 180 days or alternatively, the note provides that the Relinquished Property would be deeded to Exchanger to satisfy the note if the exchange cannot be consummated or Exchanger decides not to sell the old investment property ("Relinquished Property").
MCEC acquires the Replacement Property. At that time the transaction can proceed in one of two manners:
- MCEC holds the Replacement Property until the Relinquished Property is ready to sell. MCEC would master lease the property to Exchanger. (To accomplish the exchange using this means would require a lender willing to allow MCEC to stay on title during the period that the Relinquished Property is being marketed.) At the time the Relinquished Property is ready to close escrow, MCEC would exchange the Replacement Property for the Relinquished property, and then MCEC would sell the Relinquished Property. The proceeds of the sale would be paid to Exchanger in satisfaction of the Promissory Note.
- MCEC immediately would exchange the Replacement Property for the Relinquished Property. MCEC would master lease the replacement Property to Exchanger. MCEC would sell the Relinquished Property under terms acceptable to Exchanger. Upon close of escrow the proceeds would be paid to Exchanger in satisfaction of the Promissory Note.
In either process, at the time of the exchange (which is simultaneous and reported for income tax purposes as such), both the equity and debt on the Relinquished Property must be fully replaced to make the transaction completely tax-free. This requires calculations with the advice of Exchanger's tax advisor.
Revenue Procedure 2000-37 outlines a Safe Harbor for Reverse Exchanges. Although not mandatory, it sets 45 days from acquisition of the replacement property to identify the relinquished property and 180 days from acquisition of the replacement property to complete the exchange. The Revenue Procedure also gives 5 days after the acquisition of the replacement property to complete signature of the Exchange Agreement. However, to make the exchange work, the Intermediary needs to initially be on title to the replacement property or authorize direct deeding to the Exchanger if the type of exchange identified as 2 above is used.
Section 1031 looks to the intent of the Exchanger as to the type of property that is being acquired (investment, trade or business, or personal residential). Personal residential property does not qualify for a 1031 exchange either as Relinquished (sale) or Replacement (new) property. Documentation of the intent of the Exchanger at the time of purchase and by subsequent events help establish that intent for residential property which is subsequently converted from investment property to personal residence property. Although many of those documents may be self-serving, we recommend that a file be maintained which contains such documents to be used in case of audit. Loan applications showing that residential property will not be owner occupied, listings of the newly acquired property for lease, newspaper advertisements, etc. are examples that show intent as investment property. If an Exchanger later determines to convert investment property to personal use property, we recommend that the conversion be far enough removed so that the initial intent of the Exchanger in acquiring the property is not challenged. There is no established regulation or case law that sets a definitive time that creates a presumption of initial intent as investment property. Therefore, having events occur in different tax years avoids raising the issue in an audit. Indicia of personal residence are physical presence, mail delivery, driver's license address, voter registration, etc. Accordingly none of those factors should be present for someone holding residential property as investment property.
Marin County Exchange Corporation's fee for reverse exchanges depends upon the complexity of the transaction. The fee averages $3,000. Contact us to receive a fee quotation for your situation.