Reverse Exchange loans are not saleable by the lender,
so as a result, most reverse loans are made by “portfolio
lenders” which are usually banks. Still, most
banks don’t understand them, and so they shy
away from them.
First,
let’s talk about how Reverse Exchanges
work. A Reverse Exchange happens when you
want, or need, to purchase your New Property
before you’ve sold your Old Property.
The IRS will not let you be in title to both
the old property and the new property at the
same time, so your exchange Qualified Intermediary
steps in and buys (usually) your New Property
and then holds it, or “parks”
it until your Old Property is sold.
There are not many Qualified Intermediaries
that have the technical know-how and trained
personnel to do Reverse Exchanges, so before
you start, make sure that they have the knowledge
and experience to handle your exchange.
The IRS has a procedure for how Reverse Exchanges
are to be handled by the Intermediary, and
probably the first thing your Intermediary
will do is set up a separate entity to handle
your Reverse Exchange. This entity is called
an Exchange Accommodation Titleholder (or
“EAT”) by the IRS. The EAT will
be the title holder of your new property until
you’ve closed the sale of your Old Property.
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The lender you choose will then make their loan
to the EAT, which is usually a limited liability
company (an “LLC”). This loan will
be secured by your New Property, and guaranteed
by you.
In
addition to a security interest in your New Property,
the lender will usually take a security interest
in your Old Property as well. The lender does
this to keep you committed to completing the exchange
process. It usually acts to your benefit, however,
because the lender will take the equity and loan
values of both properties into consideration when
they analyze the loan. For this reason, 100% financing
for the purchase of the New Property is not uncommon.
If
you are not blessed with a 100% loan from your
lender, the balance of the purchase price, in
other words, the equity must come from you. This
amount is also treated as a loan to the EAT. For
example, if the new property costs $500,000, and
the lender is willing to loan $400,000 for the
purchase, this loan will be in the form of a first
mortgage or deed of trust, to the EAT. The balance
of $100,000 will come from you and will take the
form of a 2nd mortgage, or deed of trust, to the
EAT.
You
want to make two modifications to the lender’s
loan documents. The first is to remove any “due
on sale” clause, or at least modify it,
so that the lender does not call the loan when
the exchange is completed, but instead, the loan
will be transferred from the EAT to you.
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second modification we recommend is a “re-amortization
clause”. This clause will re-amortize the
loan if there is a substantial pay down in the
lender’s loan when you take title. Using
my example above, if your loan payment to the
lender is $4,000 per month, and upon completion
of your exchange you pay down this loan by $200,000
with the proceeds from the sale of your old property,
your monthly payment will be the same, even though
your loan amount has been cut in half. A re-amortization
clause changes that and would reduce your payment
accordingly.
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Gary
Gorman
Managing Partner,
The 1031 Exchange Experts |
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When
you close the sale of your Old Property, the proceeds
from the sale will go to your intermediary who
will set up a closing to transfer, or “flip”
the New Property to you. The proceeds will be
used to first pay back the equity that you put
up. If there are funds remaining they will typically
go to pay down the bank loan, since any funds
that go to you in excess of the money that you
put in, will be taxable. The bank loan will be
transferred to you, the remaining balance will
be re-amortized, and the EAT will be dissolved. |
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