A reverse exchange saves your deferral in a tight market
Tight markets add pressure to get a new property under contract, sometimes requiring a closing before your current property is sold. This isn’t ideal, but it won’t doom a 1031 exchange. When you must close on your replacement property before the relinquished property has sold, you can still complete a 1031 and maximize your deferral when structured correctly. If an exchange represents one continuous investment in real estate, “How can I own both properties at once?” you might ask. The short answer is that Reverse 1031 CORP. holds either the relinquished or replacement property until the exchange can be completed, in an arrangement known as a reverse 1031 exchange.
Reverse exchanges are common, but more complex, transactions. You might want to use a reverse exchange for many different circumstances:
- You must close on a replacement property or lose substantial down monies;
- Contingencies on the sale of the relinquished property have not been removed prior to the closing of the replacement property;
- A buyer for the relinquished property has not been found and the closing on the replacement property cannot be postponed without jeopardizing the transaction;
- Favorable financing commitments will expire without the immediate acquisition of the replacement property; or,
- You wish to make improvements to the replacement property before the expiration of the 180-Day Exchange Period.
The EAT Takes Title
Utilizing the safe harbor provided in Revenue Procedure 2000-37, Reverse 1031 CORP. serves as an Exchange Accommodation Titleholder entity (EAT, pronounced “Eat”) and employs a “parking” arrangement where the EAT holds title to either the replacement property or relinquished property. In either structure, the Exchanger, either directly or through third-party financing must loan the EAT the necessary funds to acquire the parked property. A Qualified Exchange Accommodation Agreement (QEAA) outlines the relationship and obligations between the Exchanger and EAT.
Debt Can Determine Title of Either Property
Debt on either the replacement or relinquished property can determine when, and which, property is parked. In an Exchange First transaction, title to the relinquished property is transferred to the EAT, which is then sold directly to a buyer. This is appropriate when there is no debt, or the existing debt can be paid or assigned to the EAT; the replacement property is located in a state that would require payment of duplicate transfer taxes of an amount larger than the relinquished property; or there is complex financing already in place on the replacement property.
In the second type of reverse exchange, an Exchange Last transaction, the EAT purchases the replacement property directly, assumes title and parks that replacement property. You enter into a $1 triple net lease agreement with the EAT and assume maintenance of the property, pay all insurance, real estate taxes, and utilities. Exchange Last transactions are useful when existing debt on the relinquished property cannot be paid off or you wish to make improvements to the replacement property. Exchange Last are the most common reverse exchange structure.
The 45 and 180-Day Timing Requirements Apply
Timing requirements apply to reverse exchanges. The entire parking arrangement, like a conventional, “forward” exchange, must be completed within 180 calendar days from the closing date on the parked property. You must identify the relinquished property—up to three—that will be sold in place of the new property within 45 days. As with all exchanges, it is critical to enter into an exchange agreement with a Qualified Intermediary (QI), such as 1031CORP., before the first property closes. Preparation and early notice work in your favor, as you can consider your options and plan your exchange to your best benefit.
Getting Started with a Reverse Exchange
Reverse exchanges are a marker of a healthy real estate market; property owners are confident that they will sell their relinquished property within the 180-day window. Reverse 1031 CORP. has seen an uptick in reverse exchange transactions since the beginning of 2023—a good sign!
A tight market often dictates the timing of a sale—and it might not be ideal for the rules of a conventional exchange. Section 1031 allows for some flexibility, even though a few requirements are set. Thankfully, and for many reasons, a reverse exchange can fit the bill—and Section 1031’s stipulation of one continuous investment in real estate.
If your proposed exchange has challenges due to the timing of your closing dates, a reverse exchange may be a worthwhile conversation with your tax advisor. Reverse 1031 CORP., an affiliate of 1031 CORP., welcomes a conversation about your exchange.
Qualified Intermediaries cannot provide tax advice. Be sure to consult your tax advisor about your individual circumstance.