Reverse Exchanges

The purpose of a reverse exchange is to effectively allow the relinquished or selling property to be deemed to be sold 1st  so that the replacement or purchase leg property may be acquired 2nd. The safe harbor rules allow the purchase and parking of either the relinquished (selling leg) or the replacement (purchase leg).

In either case, one way or another,  the cash from the relinquished property sale must migrate to serve as equity on the replacement property. 

If debt was paid off on the relinquished (selling) leg property, that debt must be replaced with a new loan on the replacement (purchase) leg property, or you may add cash from other sources if you are financially able to do so. 

A new loan on the replacement property may also be needed to bridge the gap of time between the true selling leg transaction and the replacement leg purchase.  

A new loan on the replacement property may also be needed if the replacement property sale price is in excess of the relinquished property sale price (or to cover closing costs or planned improvements to the replacement leg property). 

In cases where the replacement property requires substantial repairs or improvements, the replacement property will be the property to be “parked” in the reverse exchange. 

In cases where the replacement property does not require repairs or improvements, or the design or permitting process makes adding improvements in the allotted exchange time frame impractical, the decision as to whether the relinquished property or the replacement property will be the property to be “parked” in the reverse exchange will be made based on pragmatic considerations.

In cases where the replacement (purchase leg) is to be “parked”,  that property is purchased and held (or parked) by an affiliate of TCEC in a single purpose single asset corporation or single-purpose single asset limited liability company.  This entity is called an "EAT" (exchange accommodation titleholder) and the arrangement under which it purchases and "parks” the property is called a "QEAA" (qualified exchange accommodation arrangement). Hence the term “EAT in a QEAA”.

The maximum (safe harbor) time that the EAT may hold a property in a safe harbor QEAA is 180 days. So for instance if the replacement property is parked on July 5, this 180 day period will end January 1 of the following calendar year.  

In either parking scenario (park replacement leg or park relinquish leg), the cash needed to purchase the parked relinquished or parked replacement property needs to come from you or a loan you arrange. 

If the relinquished property has closed, the loan comes from the exchange party’s funds on deposit with TCEC. In other case the loan come from you and/or a third-party lender  and the loan is originated to the EAT and the usual requirement is for the third party lender to have you as the net worth principal  guarantee the loan and have the loan secured by the replacement property or the relinquished property, or in some cases both properties,  as the loan collateral.

In cases where repairs or improvements to the replacement property are contemplated, the loan would need to cover the purchase of the property plus the anticipated costs to repair and/or improve  the property. 

Once you have sold the relinquished property and any desired repairs and improvements have been made or we run out of time in the exchange,  we  complete the resale of the parked replacement property to conclude the 1031 exchange and repay the loan from the proceeds of the sale of the relinquished property.

The mechanism to transfer title into and out of the EAT of  a parked replacement property (with added improvements if desired)  can be done in Texas by general warranty deed from the EAT to the Exchange Party. This is because we have a special procedural rule in Texas that enables the exchange party to be named as an insured alongside the EAT when the replacement property  is first purchased and parked.  This rule does not apply outside of Texas so in other states, the mechanism involves the creation of a new single member LLC, which is a disregarded entity for federal income tax purposes. The new LLC is   initially owned  by TCEC as the sole member and is managed by me as its sole initial manager. This new  LLC is then traded to you as the exchange party to complete the resale or unparking of the property in the exchange. Rather than deed out the property, the membership interest in the LLC is assigned from TCEC to you and I resign as the manager and you become the replacement manager and the Company Agreement is modified as needed to reflect the  transfer  of ownership and control.

Accordingly, as the loan to facilitate the parking transaction will  be in the name of the EAT, loan documents (if payable to a third party lender)  must permit the conclusion of the replacement property leg to occur by allowing the asset to be sold  by the EAT to the Exchange Party.  The due on sale clause in the deed of trust needs to contemplate this permitted transfer and there needs to be no residual liability to the EAT,  exchange company or its principal as a result of serving in the capacity as the original owner of the EAT in the QEAA or as the QI in the exchange.  At that time the loan will be either paid off or paid down and assumed by the Exchange Party. 

Usually, the loan is prepared to show  the EAT as the borrower, and you as  the  Exchange Party  guarantee the loan. To make the exchange work, the exchange and loan  documents will indicate that the owner of EAT  will be Travis County Exchange Corporation (TCEC), a Texas corporation, which is 100% owned by Craig A. Dunagan.  The obligation of TCEC to perform its obligation as the controlling owner of EAT is generally secured by a Deed of Trust To Secure Performance (DTSP) of its obligations to acquire and hold the property as the EAT in the QEAA and hand over title (by deed) when and as required in the parking agreement entered into between the EAT, QI and the Exchange Party. The DTSP is  recommended for legal reasons, but is not an exchange requirement. If used, obviously it would be specifically noted to be of inferior lien position to the 1st lien deed of trust in favor of  the third party lender.