However, in some cases, circumstances dictate that a taxpayer acquire replacement property prior to selling the relinquished property; this is known as a "reverse exchange." For example, a taxpayer may wish to acquire replacement property currently at a favorable price while deferring the transfer of the relinquished property to a time when a better price can be obtained. Such transactions are more frequent in a "buyer's market." In other cases, taxpayers simply find ideal replacement property, which they want to acquire even though they may not have yet listed the relinquished property or found a buyers for the relinquished property.

REVENUE PROCEDURE 2000-37

On September 15, 2000, the IRS issued Revenue Procedure 2000-37, which sets forth rules for implementing exchange transactions wherein the replacement property is acquired before the relinquished property is sold.

REQUIREMENT OF A "PARKING" TRANSACTIONS

Under Rev. Proc. 2000-37, a reverse exchange must be structured as "parking" transaction whereby an accommodation party acquires and holds (i.e. "parks") title to either the Relinquished Property or the Replacement Property. The two types of "parking" transactions are as follows:

TWO TYPES OF "PARKING" ARRANGEMENTS

(1) TYPE 1: Accommodation Party Holds Title to Replacement Property
In the first type of "parking" arrangement, the accommodation party acquires title to the replacement property and "parks" the property (i.e. holds title) until the exchanger finds a buyers for the relinquished property. After a buyer is found, the intermediary transfers the relinquished property by direct deed to the buyer in exchange for which it causes the accommodation titleholder to convey the replacement property to the exchanger.

Step 1
Intermediary borrows funds from the Exchanger to acquire the replacement property. Exchanger deposits funds direct to escrow. Exchanger assigns their rights and duties under the purchase contract to Intermediary who uses its Exchange Accommodation Titleholder to acquire title to the replacement property.

Step 2
Intermediary's Exchange Accommodation Titleholder holds title to the replacement property while waiting for the relinquished property to sell.

Step 3
When a buyer is found for the Relinquished Property, the Exchanger assigns their rights under the Purchase contract to Intermediary who causes the transfer for the Relinquished Property to the third party buyers (via direct deed from exchanger) in exchange for causing its Exchange Accommodation Titleholder to transfer the replacement property to the Exchanger.

Step 4
The proceeds derived from the sale of the Relinquished Property are used to re-pay the Exchanger's loan to the Intermediary to acquire the Replacement Property.

(2) TYPE 2: Accommodation Party Holds Title to Relinquished Property
In the second type of "parking" arrangements, the accommodation party "parks" the relinquished property. Specifically, the accommodation party acquires the right to purchase the replacement property and then causes the transfer of the replacement property by direct deed to the taxpayer in exchange for the taxpayer's conveyance of the relinquished property; to the accommodation titleholder. Thereafter, the accommodation party will "park" the relinquished property until such time as a buyer is found. When a buyer is found, the intermediary completes the transaction by causing the accommodation titleholder to convey the relinquished property to the buyer.

Step 1
Intermediary borrows funds from the Exchanger to acquire replacement property. Exchanger deposits funds direct to escrow. Exchanger assigns their rights under the purchase contract to Intermediary who causes the conveyance of the replacement property (via direct deed from the seller) to Exchanger in exchange for which the Exchanger conveys the Relinquished Property to Intermediary's Exchange Accommodation Titleholder.

Step 2
Intermediary's Accommodation Titleholder holds title to the relinquished property until a buyer is found and the escrow is ready to close.

Step 3
Intermediary completes the sale of the Relinquished Property to the third party buyer. Proceeds derived from the sale of the relinquished property are used to pay off the loan advanced by Exchanger for Intermediary's acquisition of the replacement property.

Additional Requirements under 2000-37

(1) Requirement of a Qualified Exchange Accommodation Agreement and Qualified Indicia of Ownership
In addition to laying the framework for the two methods of structuring a reverse exchange, Rev. Proc. 2000-37 provides that the IRS will not challenge the qualification of property as either "replacement property" or "relinquished property" where the property is held in a qualified exchange accommodation arrangement (QEAA). Under such an arrangement, a person or entity known as the exchange accommodation titleholder must receive what is called "qualified indicia of ownership" of the property in question. The titleholder must not be the taxpayer or a disqualified person, and must be subject to federal income tax. Generally, qualified indicia of ownership means that the titleholder has the benefits and burdens of ownership of the real property.

(2) Permissibility of certain Contractual arrangements under 2000-37
Finally, Rev. Proc. 2000-37 further states that certain contractual arrangements between parties to the exchange are permissible and will not disqualify the exchange. For example, the exchange accommodation titleholder may also be the qualified intermediary. The taxpayer may guarantee obligations of the Exchange Accommodation Titleholder such as secured or insecured debt incurred to acquire the replacement property. The taxpayer or other disqualified person may loan funds to the titleholder or may guarantee a loan to the titleholder. The Titleholder may lease the property to the taxpayer. The taxpayer may manage the property, supervise improvement of the property, act as a contractor or otherwise provide services to the titleholder with respect to the property.

(3) Time Periods: Some of the important time periods applicable to the reverse exchange are as follows:

Within five (5) business days after the transfer of the ownership of the property to the exchange accommodation titleholder, the taxpayer and exchange accommodation titleholder must enter into an appropriate written qualified exchange accommodation agreement.
No later than forty-five (45) days after the transfer of the property to the exchange accommodation titleholder, the taxpayer must identify the property to be relinquished. Rev. Proc. 2000-37 adopts the same identification rules that apply in deferred exchanges (i.e. Treasury Regulations Section 1.1031(k)-[(c)] which require written identification be delivered another party to the exchange and limits the number of alternative and multiple properties that can be identified.
The "parked Property" must be transferred to the Exchanger no later than 180 days after the Exchange Accommodation Titleholder acquires its ownership interest in the Property.
The combined time period that the relinquished property and the replacement property are held in a Qualified Exchange Accommodation Arrangement cannot exceed 180 days. In other words, the entire exchange transaction must be completed within 180 days.
As with the rules for deferred exchanges, the rules and procedures to reverse exchanges must also be strictly complied with. Likewise, the taxpayer must keep in mind that these procedures provide for a deferral of tax and not an avoidance of tax.