The term “reverse 1031 exchange” is a bit misleading. It’s a type of exchange wherein the exchanger finds a replacement property and wants to buy it before the relinquished or exchange property closes. Since the exchanger cannot buy a replacement property, then sell the relinquished property and expect to exchange into the new property he already owns, he must find a way to buy the replacement property while maintaining the exchange’s integrity.
Reverse 1031 exchanges are typically completed in one of two formats, depending on transaction logistics and the exchanger’s financing needs. When the exchanger requires traditional financing to complete the acquisition of the replacement property, the Exchange Last strategy is used. Because few lenders will lend dollars to an exchanger who has a facilitator or qualified intermediary, also known as an exchange accommodation title (EAT) holder on title, the facilitator must hold the relinquished property’s title.
The reverse 1031 exchange is complete when the exchanger accepts title to the new replacement property in this method. However, with the possibility of the exchange being completed, equities between relinquished and replacement properties must be balanced prior to the closing. In other words, there must be an equal amount of equity in the replacement property at the time of closing as there is expected to be from the later sale of the relinquished property. The debt is then retired and the exchanger is repaid any dollars he advanced for the replacement property acquisition at the time of the later sale of the relinquished property.
In an Exchange First scenario, the facilitator acquires the replacement property and warehouses or holds the property title until the relinquished property is sold and the exchange can be completed, with the help of a loan from the exchanger.
Reverse 1031 Exchange Rules and regulation
When the old property is closed before the replacement is acquired and closed, the 1031 rules and requirements for reverse exchanges are the same as those for forward 1031 exchanges.
- Reverse exchanges must be completed within 180 days of the initial closing date.
- The taxpayer buying must match the taxpayer selling.
- The related party and disqualified person rules are in effect.
- The value of the replacement property must be equal to or greater than the value of the relinquished property; otherwise, a tax on the difference is levied.
- Neither the relinquished nor the replacement properties may be the taxpayer’s primary residence.
Potential Obstacles of a Reverse 1031 Exchange
Securing a loan is one of the difficulties in a credit-constrained market. Those who have cash or access to cash can move quickly because they are not constrained by lender constraints. The disadvantage of a 1031 reverse exchange is that if the old asset does not sell within 180 calendar days, you now own two assets.
Transfer tax may be due when changing or conveying title to and from the EAT. Some states recognise the EAT’s role as a taxpayer’s agent and do not levy a tax. When the replacement property is parked with the EAT and later conveyed to the taxpayer to potentially avoid a transfer tax, an assignment of membership interest in the EAT to the taxpayer often makes sense. Each state is unique, and the Qualified Intermediary must understand and advise the taxpayer.
We should mention a couple of caveats about reverse exchanges at this point. Reverse exchanges are more complicated than other exchanges because they require extensive planning and involve the holding of title by a facilitator in the form of an exchange accommodation titleholder. Do not attempt a reverse exchange without the help of a knowledgeable and experienced facilitator or intermediary. We at Investment.net are here to provide you with the right guidance and clear all your queries.