Reverse 1031 Exchange: Buy Before You Sell

A reverse 1031 exchange lets you buy your replacement property before you sell your relinquished property, the one you are giving up. If the exchange qualifies, you can defer taxes on the gain.

Once an Exchange Accommodation Titleholder (EAT) buys your replacement property, you have 45 days to identify the property you will sell and 180 days to complete the exchange. Found the right property before you are ready to sell? This is the tool for that.

The EAT temporarily holds title to one of the properties. In the most common setup, the EAT buys and holds your replacement property while you sell your relinquished property. We call this temporary arrangement parking.

How a reverse 1031 exchange works

1. Set up the exchange before closing. Confirm your lender and title company can work with the EAT. Sign the written parking agreement with the EAT before the parking closing. IRS rules require it no later than five business days after the EAT takes title. Here's the gotcha: once you buy the replacement property in your own name, it is too late to make that purchase a reverse exchange.
2. Identify the property you will sell. If the EAT parks your replacement property, identify the property you plan to sell in writing. You have 45 days after the EAT buys the replacement property.
3. Sell and complete the exchange. Close the sale and complete the exchange within the 180-day parking period. At the sale closing, your qualified intermediary receives the exchange proceeds. A qualified intermediary is the independent company that holds your sale proceeds.

WealthBuilder 1031 charges a flat $6,500 fee for a reverse exchange. It includes forming the titleholder LLC, the state filing fee and the initial registered-agent fee. Third-party charges, such as title fees, are separate.

The IRS rules for parking come from Revenue Procedure 2000-37, updated by Revenue Procedure 2004-51. In plain terms, if you follow those steps and deadlines, the IRS treats the EAT as the owner while your property is parked.

Already under contract on your replacement property? Call WealthBuilder 1031 at 888-508-1901 at least two weeks before closing. We must set up the titleholder LLC, and your lender must consent, before the EAT can take title.

The Benefits and Risks

Pros

• Flexibility: You can secure the new property without the pressure of selling your old one immediately.
• Timing Control: This approach gives you more control over the timing of both transactions, which can be crucial in volatile markets.
• Tax Deferral: Like other 1031 exchanges, a reverse exchange allows you to defer capital gains taxes, keeping more of your investment capital available.

Cons

• Complexity: Reverse exchanges are more complicated and involve more parties, including an Exchange Accommodation Titleholder (EAT).
• Cost: The process is typically more expensive due to the involvement of the EAT and the complexity of the transaction.
• Financing Challenges: Securing financing for the new property while still owning the old one can be difficult, especially if your equity is tied up in the property you’re planning to sell.

Is a Reverse Exchange Right for You?

A reverse exchange can be an excellent option if you’ve found the perfect replacement property but aren’t ready to sell your current one. It’s particularly useful in fast-moving markets where waiting to sell could mean losing out on your desired property.

Consider Other Options If:

• You’re Tight on Cash: Because you’ll own two properties at once, you’ll need to secure financing for the new purchase while still holding the old property, which can strain your resources.
• You Prefer Simplicity: If the complexity and costs of a reverse exchange seem daunting, a deferred exchange might be a better fit, offering more straightforward timing and fewer moving parts.

Final Thoughts

A reverse exchange offers a flexible and strategic way to defer capital gains taxes while securing your next investment property. It’s an excellent tool for savvy investors who need to act quickly in competitive markets or want to avoid the stress of selling before buying.

However, the process is more complex and costly than a traditional 1031 exchange, so it’s essential to weigh the benefits against the challenges. If you’re considering a reverse exchange, be sure to work with experienced professionals who can guide you through the process and help you make the most of this powerful investment strategy.

Related guides

• How REALTORS Use Reverse 1031 Exchanges
• The Reverse 1031 Exchange Timeline
• Reverse 1031 Exchanges in Hot Markets