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Financing Reverse Exchanges
By Gary Gorman,
Professional Exchange
Accommodators, L.L.C.
This memo details the steps necessary for an exchanger (the “Client”) to finance property in a Reverse Exchange. Since the IRS will not let the Client take title to the new property until after they’ve closed the sale of their old property, the Qualified Intermediary for their exchange takes title to the new property and holds or “parks” it until the old property closes. (The Qualified Intermediary is the independent third party that is required by the IRS in a 1031 exchange.)
Very few Qualified Intermediaries take title to the new property in their own name. They set up “special purpose entities” (or “SPE’s”) to take title. Some Intermediaries hold title to many properties in one entity. We set up an SPE for each transaction, then dissolve it when the exchange is completed. Our SPE would be a single asset entity, and is usually a Colorado LLC.
Your loan would be made to the SPE and secured by the new property. We, as the owner of the SPE, would sign the Note and the Deed of Trust. As the Guarantor on the loan, the Client would also sign the Note. Typically the lender also takes a security interest in the Client’s old property.
After the Client sells the old property, the SPE transfers the new property to them to complete their exchange. Some lenders have due on sale clauses in their documents. If so, the lender’s documents would need a clause to allow transfer to the Client. Some lenders add a provision that allows one transfer to anyone without violating the due on sale clause. Other lenders have clauses that only allow transfer to the Guarantor without violating the clause.
- Another clause that I typically request in my Client’s loan documents is a clause that allows reamortization of the loan if there is a single pay down of the
loan in excess of a stated percentage.
For example, assume the new property has a
purchase price of $1,000,000 and you are making a 70% (i.e. $700,000) loan
at the time the SPE takes title. Later, when the Client’s old property sells and
the exchange is completed, the loan is paid down to $350,000 by the exchange.
- The reamortization clause allows for the monthly payments to be cut in half.
At the time the client is ready to take title to the new property in their name,
most lenders have a simple one-paragraph document that formally recognizes
that the Client is assuming the loan pursuant to Section “X” of the loan document.
I hope that this answers your questions. If not, please call me and if I cannot
answer them, I can direct you to one of the many lenders that we’ve used to
finance Reverse Exchanges in the past.
 Gary Gorman is the manager and co-owner of Professional Exchange Accommodators, LLC. He has 25 years of experience as a Certified Public Accountant where he spent much of his career in what was then Big 8 accounting and retired as a Tax Manager with Price Waterhouse & Co. Gary now spends all of his time handling 1031 exchanges for his clients and is a frequent writer and lecturer on 1031 issues. Professional Exchange Accommodators is one of the nation’s largest Qualified Intermediary firms and handles approximately 8,000 straight exchanges and 350 reverse exchanges a year and has Florida offices in Naples and Tampa...
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