Undo Boot on Reverse 1031 Exchange

Taxpayer did a forward exchange, selling a rental property and ID'd 2 replacement properties. One replacement fell through, and taxpayer acquired the other, financing $1.2M. There was no debt on the relinquished property, and no boot resulting from the forward exchange of these two properties. Within the 45-day ID period, taxpayer began a reverse exchange, closing on the sale of its second property. Because the 2nd replacement property fell through, taxpayer now has excess cash, and would like to pay down the replacement property's loan with the proceeds from the sale of the 2nd relinquished property. QI is stated that the funds, which were still held by the QI, could not be used to pay the balance of the replacement property's loan because the taxpayer had taken possession as they were no longer in escrow when the 2nd relinquished property closed.

Is there any relief for the taxpayer at this point? If not, I'm looking for the code section/regs that specifically address the payment after escrow (although I suppose it's implied in the code). Finally, in a reverse exchange, I don't see any way to limit the financing on a replacement property if (additional) funds to close will not become available until the sale of the relinquished property itself, but am I missing something?

Not sure I follow the facts. A reverse exchange is where you buy the property first and park it with an EA.

It feels like something is missing or incorrect in the fact pattern.

For example, in the forward exchange there was no boot, yet you say there was excess cash. I don't see any excess cash in this fact pattern.

In a forward exchange money is placed in escrow. In a reverse exchange realty is placed in escrow.

It sounds like the reverse exchange did not qualify for 1031 because title to the purchased property was not in escrow, as opposed to the TP taking possession. I say that because my understanding is that the TP can possess the realty held in escrow via a lease.

The boot occurred on the 2nd property's sale because the property that it was to be exchanged into fell through.

The 2nd property sold was added to the first exchange, setting up a reverse exchange using the 1st property's replacement as the replacement for this property as well; the FMV of the single replacement was enough to cover the FMVs of the two relinquished properties combined.

The replacement property needed a mortgage to close because there was insufficient cash from the sale of the 1st relinquished property alone. The excess cash resulted because the 2nd relinquished property (reverse exchange) has nowhere to put the sales proceeds, since the replacement property has closed.

The investor's intent was to use the proceeds from the 2nd sale to pay off the loan on the replacement property.

Still not making sense to me. Need a timeline.

Sounds like these were set up as two separate forward exchanges. One of them busted.

When you say the 2nd property was added to the first, how was that done? Seems to me that the second sale should have been added to first sale. The second sale should have simply timely identified the first replacement property as the replacement property for its exchange. If the sellers are different entities, then each would have undivided interests.

If you are saying the first exchange closed and you are now trying to add the 2nd property to first exchange, I dont think that will work.

Hi, taxgrappler (good name),

Let's see if I can regurgitate the facts and timeline.
1. Forward exchange (money in escrow),
2. reverse exchange (realty in escrow, presumably with the same escrow agent),
3. two replacement properties identified,
4. 45 day period expires
5. close on first replacement property with lien greater than lien on relinquished realty. Excess cash in escrow.

That's as far as I could get without being confused by your description. I don't see the reverse exchange...

I think you are trying to do two things, each of which is interesting. One is to add a property to the forward exchange. I think you can do that within the 45 day period, but not after. (Did the EAT agree to add it to the first exchange?)

The second is to use the excess cash in the escrow to pay down the mortgage on the replacement property acquired in the forward exchange. At first I thought you could do that within the 180 period and avoid boot. But on reflection, I decided that it would be boot because the TP already owned the replacement property -- and thus the mortgage payment would effectively be a cash distribution to the TP.

But I suspect I misunderstood the facts.