This is the most common type of exchange. The relinquished property is sold to a buyer, and the replacement property is purchased within 180 days from a third party.
Two parties either “swap” properties with each other, or the exchanger closes on both the sale of the relinquished property and the purchase of the replacement property on the same day.
When performing standard 1031 exchange transactions, investment property is sold first — after which the seller purchases a new piece of real estate. A reverse exchange allows the acquisition of new property before the selling of the existing investment.
IRS Revenue Procedure 2000-37: This law sanctioned the reverse exchange “safe harbor” rule, providing a parking arrangement for investments. If a seller cannot sell the existing property within the timeframe to perform a standard 1031 exchange, an Exchange Accommodation Titleholder (EAT) can hold title on the desired property until the first property sells. The seller is then able to take possession of the new investment parcel from the EAT.
Reverse Exchange Rules
- Reverse exchanges must be completed in 180 days. The 180-day countdown starts on the date the EAT purchases the replacement property for the taxpayer/seller.
- Within 45 days after the purchase of parked property, the taxpayer must formally identify the relinquished property(s) to be sold.
- A Qualified Exchange Accommodation Agreement must be completed by the EAT and the taxpayer.
When a Reverse Exchange is Useful
- The owner of investment property listed for sale finds the ideal replacement property before finding a buyer for the exchange property.
- The real estate investor needs to purchase prime real estate as it enters the market.
- Real estate sellers wish to avoid identifying replacement property in the 45 days required by a 1031 exchange.
In many cases, a taxpayer that is considering a reverse exchange will not have the cash to fund the new replacement property purchase. They will often need to obtain financing for the new purchase. Depending on the lender’s restrictions on how the financing is structured, it may not be possible to park the replacement property in the EAT. The taxpayer may be able to structure what is known as a Forward or Relinquished Reverse Exchange where they park the relinquished property with the EAT rather than parking the new replacement property in the EAT. Using this approach, the taxpayer will have transferred their interest in the relinquished property, thus allowing them to proceed with acquiring the replacement property in their name. Certain restrictions apply for completing this type of exchange.
In an Improvement or Construction Exchange (also known as a “Build-to-Suit” Exchange), the exchange proceeds from the relinquished property sale are used to acquire the replacement property and make the desired improvements. The property must be held (parked) by an Exchange Accommodating Titleholder (EAT) until either the improvements are complete or the 180-day exchange deadline occurs. On or before the 180th day, the improved property must be transferred to the exchanger as the replacement property.
These transactions may also be structured as Reverse Improvement Exchanges. Due to the transactional complexity of these types of exchanges, please contact Midland 1031 to discuss your specific situation.
Reverse exchanges must be completed in 180 days. The 180-day countdown starts on the date the EAT purchases the replacement property for the taxpayer/seller. Within 45 days after the purchase of parked property, the taxpayer must formally identify the relinquished property(s) to be sold. A Qualified Exchange Accommodation Agreement must be completed by the EAT and the taxpayer.
As soon as you realize that you may qualify for a reverse exchange, you should contact a qualified intermediary to discuss your situation.
These types of exchanges often require advance preparation to ensure adherence to regulatory requirements, as well as ensuring that all parties involved have ample time to make the necessary updates to their documentation.
Midland 1031 is available to discuss your transaction with you, and review the reverse exchange process step by step. A reverse exchange can be technically difficult but it is a valuable tool for avoiding paying taxes and maximizing wealth.
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