Reverse Exchange Planning

Reverse exchange planning addresses the situation where a Chicago, IL investor needs to acquire replacement property before the relinquished property has sold, which is the opposite order of a standard forward exchange. Because Section 1031 and its regulations were written around the forward structure, a true simultaneous ownership of both properties by the investor during a reverse exchange does not fit neatly into the statute. To make reverse exchanges workable, the IRS published a safe harbor in Revenue Procedure 2000 37 that allows an Exchange Accommodation Titleholder, often called an EAT, to take and hold title to either the replacement property or the relinquished property on the investor's behalf while the other side of the transaction is completed. This parking arrangement is what makes a compliant reverse exchange possible, and it introduces its own deadlines and documentation requirements that differ from a forward exchange.

How the Parking Arrangement Works

In the most common reverse exchange structure, the Exchange Accommodation Titleholder acquires and holds the replacement property while the investor works to sell the relinquished property. A qualified exchange accommodation agreement documents this arrangement and must be in place at the time the EAT takes title. From that point, the investor has one hundred eighty days to complete the exchange, and within the first forty five days of that period, the investor must identify the relinquished property being sold or, less commonly, identify the replacement property depending on which side of the transaction the EAT is holding. The forty five day and one hundred eighty day deadlines under the reverse exchange safe harbor run on the same calendar day basis as a forward exchange, with no extensions outside qualifying federal disaster relief. Reverse exchange planning coordinates the EAT relationship, ensures the qualified exchange accommodation agreement is properly documented before title transfers, and tracks both deadlines throughout the parking period.

Why Chicago, IL Investors Use Reverse Exchanges

Reverse exchanges tend to come up when a Chicago, IL investor finds a strong replacement property opportunity, such as an off market industrial building or a net lease asset with favorable terms, before the sale of their current property has closed or even gone under contract. Rather than risk losing the replacement opportunity while waiting on the relinquished property sale, the investor uses the EAT structure to secure the replacement property now. This requires financing the acquisition without exchange proceeds initially, since those proceeds do not exist until the relinquished property sells, so reverse exchanges typically involve either cash or interim financing that gets repaid once the relinquished property closes and exchange funds become available. Illinois sellers should also expect the same Cook County and City of Chicago transfer tax obligations on the relinquished property sale that apply in any Chicago exchange, which affects net proceeds used to unwind the parking arrangement. Because reverse exchanges are more complex and more expensive to administer than forward exchanges, they generally make sense only when the replacement property opportunity is time sensitive enough to justify the additional structure.

Choosing which property the Exchange Accommodation Titleholder should hold, the replacement property or the relinquished property, depends on the specific facts of the transaction, including which property has secured financing lined up and which side of the deal has more certainty around closing timing. In the more common structure, the EAT holds the replacement property while the investor continues marketing and selling the relinquished property, since replacement property financing can often be arranged more predictably than waiting on a buyer for the relinquished property. Less commonly, the EAT holds the relinquished property while the investor closes on the replacement property directly, which can make sense if the replacement property purchase is more time sensitive than the relinquished property sale. A Chicago, IL investor should discuss both structures with their Qualified Intermediary and the EAT provider early, since the choice affects financing arrangements, insurance responsibilities during the parking period, and how the eventual unwind of the structure is documented once both sides of the transaction close.