What is 1031 reverse exchange and how it works

You find a property that you eagerly want to purchase, and you know that you have to move quickly to take the advantage of that investment opportunity. But, the problem is that you haven’t sold your existing property yet. Then, the 1031 reverse exchange is the best solution that can help you save thousands of dollars in capital gain taxes.

Understanding 1031 reverse exchange

As 1031 exchange transactions have seen a rise and with this, the need of reverse exchanges for like-kind property has also increased. As the name implies, 1031 reverse exchange is just opposite to forward exchange. In the reverse exchange, the new replacement property is acquired before the investor sells their relinquished property. While this structure is complex than forward exchange, it may give you the advantage to make the most solid investments.
1031 exchanges are typically of the forward type and they start when you sell a property and then buy the replacement asset of the like-kind. But more and more clients are finding themselves in the position of needing to purchase the asset before selling the old one. Experienced exchangers know that the 45-day ID period for identifying any new property is tight and many investors want the opportunity to get the new replacement property in place before they sell. There may be a case that both the sale and purchase are lined up but at the last minute they lose their buyer and their goes the sale. Now the question is, when the client is ready to buy and can’t sell, then how can they still do exchange?
Yes, the solution is reverse exchange! In this, you can purchase the new property before selling and can still get the benefits of a 1031 Like-Kind Exchange. The reverse exchange transaction is permitted under Revenue Procedure 2000-37.

How it works?

Since you can’t take the hold of two properties at the same time and do an exchange, they will allow your Qualified Intermediary (QI) to take title to your new property until you can sell the old one. Typically the QI will create a separate Limited Liability Company (LLC) and they hold or “park” the property in LLC until you close on the sale of your current property. Under the safe harbor rule, the entity which takes the title to the property is called “Exchange Accommodation Titleholder” or (EAT). While the EAT owns the parked property, the investor has to pay all the expenses of that property and collects all the income produced by that property.
Here we have provided the important steps of the typical 1031 exchange transactions for you:

1.The first step is to develop a contract to acquire a suitable replacement property and making financial arrangements.

2.Then you enter into a written agreement which may contain different provisions depending on which type of finances you arrange and how your EAT intends to hold the property.

3.The third step is for your EAT to acquire title to the replacement property.

4.Now you formally identify the relinquished property in either the qualified exchange accommodation arrangement or in a separate notice. This property must be identified within 45 days.

5.In fifth step, the EAT may lease the parked property to you, provided that the lease period doesn’t exceed the safe harbor parking period. This lease will allow you to take control of the parked property in advance.

6.Now is the time to identify the buyer for the relinquished property and execute the formal sales contract with this buyer.

7.You enter into the new agreement with the QI now who will acquire the right to transfer the title of that relinquished property to the new buyer.

8.Your QI will require that you convey that relinquished property to the buyer through a deed. Then, the buyer will transfer all the exchange funds directly to QI. The QI will use these funds to acquire parked property from EAT.

9.In the final step, EAT will deed the parked property directly to you. And, the QI will oversee this part of transaction and once you have received your deed, the 1031 exchange is finished.