In today’s market investors want the ability to seize profitable real estate assets before the competition beats them to it. If you invest using 1031 exchanges, you know you must sell your current investment property before purchasing replacement property. But, what if you find a new investment property before you sell the old? You don’t want to miss your chance at scooping up a great deal. This is where the reverse 1031 exchange comes in.
In a typical 1031 exchange, you sell your current property first. Then, you have 180 days to reinvest the profits from the sale into a new property to defer capital gains and other taxes. The sale of the relinquished property occurs before the purchase of the new property.
A reverse 1031 exchange allows the opposite to occur. Working within specific guidelines, investors can acquire replacement property before they sell their current property. This transaction also allows deferment of all capital gains and other taxes in the same manner a typical 1031 does.
How does a reverse 1031 exchange work?
Reverse exchanges allow investors to purchase replacement property before selling the soon-to-be relinquished property. But, you are not allowed to simultaneously hold title to the both the new property and the property you want to sell. There are several IRS rules your transaction must comply with to start and complete a successful reverse exchange. It is critically important that you be well-versed in IRC Section 1031 that governs all exchange transactions.
With that said, below are a few pointers regarding reverse exchanges. These provide you an idea as to whether these investing techniques are right for you:
There are two types of reverse exchanges.
- An “exchange last” transaction allows an Exchange Accommodation Titleholder (EAT) to take title to the newly purchased property.
- The “exchange first” option allows the EAT to take title of the property you want to sell before the new property is purchased.
Either maneuver requires the use of an EAT (the Exchange Accommodation Titleholder) to park one of the properties to prevent the investor from holding title to both properties at the same time. The IRS formed guidelines for reverse exchanges within their “safe harbor” rule as defined in Revenue Procedure 2000-37. In either type of reverse 1031 exchange, the transaction must be completed within 180 calendar days.
Rules for reverse exchanges
- All parties involved must be notified that the sale/purchase of the investment property is part of a reverse 1031 exchange.
- You must use a qualified intermediary (QI) such as Midland, before the replacement property is purchased. They will ensure the new property is titled correctly.
- The QI establishes an LLC, which takes title to either the new property or the soon-to-be-relinquished property. Note: the LLC is the EAT.
- In “exchange last” transactions, the EAT takes title to the replacement property at closing. The “exchange first” allows the EAT to take title to the soon-to-be relinquished property before the investor purchases the new property.
- While the EAT owns the parked property and is considered the owner of the property for tax purposes, it does not have advantages or obligations of owning the property.
- The investor pays all expenses for that property and collects all income produced by the property until the reverse 1031 exchange is complete.
There are additional requirements for each type of reverse exchange other than the 180-day rule. So, before you do any type of 1031 exchange, check with your lender as well as a tax advisor and a qualified intermediary. Reverse 1031 exchanges are incredibly beneficial, but are also somewhat complex. To reap the benefits, you must ensure compliance with all rules and regulations.
For additional and more detailed information about reverse 1031 exchanges, call Midland today at 239-333-1031. Our Certified Exchange Specialists® (CES®) can explain the process and guide you through every step of the exchange to ensure that the exchange is done properly.