REVERSE 1031 EXCHANGES
In a typical 1031 Exchange, the investor sells a property (relinquished property) and then purchases a replacement property. A Reverse 1031 Exchange works in the opposite direction, allowing the investor to first purchase a replacement property and later sell the relinquished property. A Reverse 1031 Exchange can also be used when the investor wants to acquire a property and construct improvements on this “replacement” property before taking title.
The advantage to structuring a 1031 exchange as a reverse 1031 exchange is that the investor has more than the traditional 45 days to identify his replacement property. The main disadvantage is that the investor cannot use the cash coming from the sale of his relinquished property to purchase the replacement property and if he doesn’t complete the entire exchange in 180 days the property he purchased cannot be exchanged into.
Most Reverse Exchange procedures were defined by the IRS in their Rev. Proc. 2000-37. A Reverse Exchange is generally structured by having an Exchange Accommodation Titleholder (EAT) (usually the Qualified Intermediary selected by the investor) take and hold title on the replacement property before the investor sells the property to be relinquished. Another variation is to have the Exchange Accommodation Titleholder take and hold title to the relinquished property until a buyer can be found for it. Reverse Exchanges are useful in circumstances where a taxpayer needs to close on the purchase of replacement property before a relinquished property can be sold or where the investor wants more than the normal 45 days to find replacement property.
Reverse Exchanges are also common when an investor wants to acquire a property and construct improvements on it before taking title to the property as replacement property for an exchange. This may be necessary if the value of the improvements is important to meet the 1031 restrictions that the replacement property must be of “equal or greater value” in order to avoid any tax liability.
Rev. Proc. 2004-51 issued in 2004 added an additional provision that states that any property which has been previously owned by the investor within the prior 180-days is ineligible for protection under Rev. Proc. 2000-37 safe harbor procedures.
The rules governing Reverse 1031 Exchanges can be summarized as follows:
The 5 Day Rule. A Qualified Exchange Accommodation Agreement must be entered into between the investor and the exchange accommodator titleholder (QI or Qualified Intermediary in most cases) within five business days after title to the property is transferred to the QI.
The 45 Day Rule. The relinquished property (the property being sold) must be identified within 45 days.[MSOffice2] More than one property can be identified using similar rules to those used when doing typical 1031 Exchanges (3 Property Rule, 200% Rule and the 95% Rule).
The 180 Day Rule. The Reverse 1031 Exchange must be completed within 180 days of taking title by the QI.
Missing any of the deadlines above negates the option of completing the Reverse 1031 Exchange. The key to successfully completing a Reverse 1031 Exchange, also known as a Delayed Exchange, is good planning, having a clear set of investment objectives and having the right players on the investor’s team.
Some of the members of the investor’s team should a Real Estate Investment Strategic Advisor, a CPA, a Real Estate Attorney, a Qualified Intermediary (QI) and, a provider of qualified 1031 replacement property.
We suggest that the investor consult with each member of their team as they step through their 1031 Exchange.
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