There are Ten Steps to completing your Reverse Exchange Process with Preferred 1031.
The taxpayer contacts Preferred 1031 to start an exchange and obtain a reverse exchange document package.
Confirm that the property being purchased qualifies as like-kind property pursuant to the IRS definition. Additionally, confirm that the property is considered investment property or held for business use. Next, provide an executed sales contract complete with amendments and/or extensions. Additionally, provide contact information of the settlement agent handling the closing. Other requested information my include a copy of your driver’s license, a W-9, or entity documents in the event the property is owned in an entity.
A Special Purpose Entity (SPE) is created to hold title to the replacement property. For the purpose of a reverse exchange the SPE is also known as an Exchange Accommodation Titleholder (EAT). This is typically a single member LLC with the Qualified Intermediary acting as the sole member.
The taxpayer and the Qualified Intermediary enter into a Qualified Exchange Accommodation Agreement (QEAA) for replacement property whereby the newly formed LLC, as the EAT, will take title of the replacement property on the date of closing.
The taxpayer assigns the replacement property purchase contract to the EAT.
Provided the taxpayer is purchasing the replacement property using debt, the lender loans the funds required for the purchase directly to the EAT to enable it to acquire the replacement property. The EAT executes all applicable loan documents as the borrower; however, the taxpayer signs as the guarantor. In the event the bank does not finance 100% of the purchase price, the taxpayer makes a second loan for the balance required, sufficient to cover earnest money that may have been previously advanced.
The documents required for any taxpayer loan typically include a Non-Recourse Promissory Note and a Pledge Agreement of Membership Interest to secure the loan. The taxpayer and the EAT enter into a contract for the sale of the replacement property from the EAT to the taxpayer as well as a NNN Master Lease, which allows the taxpayer access to the property while it is held by the EAT. The loan documentation and Master Lease Agreement are provided by Preferred 1031.
The Master Lease stipulates that, in lieu of rent, the taxpayer will pay all debt service directly to the lender and/or the taxpayer, assuming a secondary loan to the taxpayer. An Environmental Indemnity Agreement may also be requested from the taxpayer.
Funds are sent directly to the closing agent by the lender and/or the taxpayer. The EAT takes title to the property at closing. Evidence of liability insurance must be provided showing the EAT as the insured party, while the lender and the taxpayer may appear as additional insured.
Within 180 days of the replacement property closing, the taxpayer enters into a contract for the sale of the relinquished property and enters into a standard Tax Deferred Exchange Agreement with Preferred 1031 acting as the Qualified Intermediary (QI). The taxpayer assigns its rights (but not its obligations) under the contract for the sale of the relinquished property to the QI and provides the buyer(s) written notice of the 1031 exchange. The relinquished property must close within 180 days from the closing date of the replacement property and the net sales proceeds are sent to the QI.
The previously executed sales contract between the EAT and the taxpayer for the purchase of the replacement property is assigned to the QI and notice of the assignment is provided to the EAT.
At the taxpayer’s request the QI will disburse the exchange proceeds to the EAT as part, or all, of the purchase price. The EAT receives the exchange funds and immediately wires those funds to the lender and/or to the taxpayer to pay down the previously executed Non-Recourse Promissory Note.
The taxpayer takes ownership of the replacement property via an assignment of the membership interest in the EAT which transfers the LLC, and the property it holds to the taxpayer. Alternatively, a deed may be issued to the taxpayer by the EAT and the LLC may be dissolved. The taxpayer takes the membership interest or the deed relating to the replacement property subject to the balance of any debt.
As a Qualified Intermediary, Preferred 1031, is prohibited from providing tax or legal advice.
Taxpayer must seek such counsel from their advisors.